The novel-coronavirus-driven economic crisis has triggered a sharp correction in stocks in the energy, aviation and tourism sector. On the other hand, the technology sector has been relatively resilient. For example, Advanced Micro Devices (NASDAQ:AMD) has bounced back nicely. From 52-week highs of $59.3, AMD stock has declined by just 11% and currently trades at $52.8. Even with the stock trading at a price-to-earnings ratio of 51.9, I hold a positive view and expect the stock to trend higher.
Since I talked about a high P/E ratio, the company’s growth outlook is worth talking about. Analysts expect the company’s earnings to grow at an annual average of 24.1% over the next five years. For an innovation-driven high growth stock, a high P/E valuation is justified.
As an example, Intel (NASDAQ:INTC) trades at a P/E of 12.0. On a relative basis, valuations might seem attractive for Intel stock. However, analysts expect Intel’s earnings to grow at an annual average of 7.5% over the next five years.
Therefore, it’s the growth factor that’s important. There might be other reasons to be positive on Intel. However, investors looking for exposure to high growth companies in the technology sector will find AMD stock attractive.
Optimistic Guidance for AMD Stock
At a time when companies have withdrawn guidance for the year, Advanced Micro Devices has provided a relatively strong guidance. The company still expects revenue growth of 25% with 30% growth likely in an optimistic case scenario.
I believe that the markets will be happy with a 20% to 25% top-line growth for the year. In my view, it should not be a challenge to achieve this growth.
Amidst the coronavirus-driven crisis, work-from-home has triggered demand for chips, laptops and other network goods. The company has confirmed this with the CEO Lisa Su commenting that, “We’ve seen some of our largest (cloud) customers ask us to accelerate some of our deployments.”
Additionally, as people prefer to stay indoors, the demand for videogame consoles and graphics chips will rise. The demand for chips from cloud providers will also accelerate as education institutions pursue online classes. This is a key reason to believe that growth for the year will remain robust.
Margin Expansion and Sustained Growth
It’s important to note that AMD stock is in a long-term uptrend. One of the primary factors driving the stock upside is the launch of next-generation products with a higher gross margin.
For the first quarter of 2020, the company reported gross margin of 46%. For Q1 2019, the company’s gross margin was 41%. With higher Ryzen™ and EPYC™ processor sales, I expect growth margin expansion to sustain in the coming years. I see free cash flows on a sustained basis coming sooner and that a positive trigger for the stock.
From a growth perspective, the company’s data center sales were just $348 million for the recent quarter. However, EPYC processor sales can be a game-changer in the coming years. AMD’s server unit market share was at just 4.5% for Q4 2019.
However, over the last eight quarters, market share has been steadily rising. Recently, AMD announced the launch of three new second-generation AMD EPYC. Some companies adopting these processors include Microsoft (NASDAQ:MSFT), Dell Technologies (NYSE:DELL), Lenovo and VMware (NYSE:VMW).
Even in the desktop segment, the company’s market share has been on a steady rise. Market share was 12% in Q4 2017 and increased to 18.3% at the end of the last fiscal year. With Ryzen Pro 4000 likely to make inroads in the business laptop market, I expect strength to sustain in this segment.
My Concluding Views on AMD
From a balance sheet perspective, AMD has cash and equivalents of $1.4 billion as of Q1 2020. In addition, the company’s leverage has been on a sustained decline. This adds to the positives and gives the company financial flexibility for investment in innovation.
AMD stock has not seen a sharp correction since the onset of the coronavirus driven economic crisis. There are fundamental reasons for this strength and I believe that the stock is worth considering at current levels.
The stock will be considerably higher in the coming years as free cash flow accelerates.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modeling. Faisal has authored over 1,500 stock-specific articles with a focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.
