Advanced Micro Devices (NASDAQ:AMD) produced stellar Q2 earnings on July 27 and it now looks set to benefit from its extremely profitable semiconductor manufacturing operations. Moreover, AMD has started generating large amounts of free cash flow (FCF) at very high FCF margins.
I suspect this will push AMD stock at least 31% higher, based on my estimates for next year. This article will describe how that model works.
Meanwhile AMD stock is already starting to move higher. It is up about 17% year-to-date. In fact, over the last year, it’s up almost 25%. My point is that the stock is likely to move about the same over the next year.
Where This Leaves AMD Over the Next Year
The reason for AMD Stock’s rise is because AMD is producing huge levels of FCF from its existing clients. In addition, its FCF margins are very high and appear sustainable.
For example, last quarter their Computing and Graphics segment revenue grew 65% year-over-year (YoY) and quarterly it was up 7%. It represents 58.4% of its total sales of $3.85 billion in Q2. This implies that over the next year its sales could grow at 31% over the next year.
However, analysts now forecast just 15.8% growth at $18.06 billion for 2022 vs. $15.6 billion for 2021. I suspect that its revenue will likely move at least 20% higher (mostly based on the QoQ growth rate of 28%). That brings its forecast sales to $18.72 billion.
Now we can estimate its FCF for next year. The best way to do this is to use its existing FCF margin for Q2 and apply it to the full year 2022 sales forecast.
AMD is actually one of the few technology companies that expressly lists its FCF on a quarterly basis. This is great since it allows us to easily track its FCF. And as you know, FCF is what many high technology companies now use to measure their ultimate profitability.
The reason is FCF is what companies use to pay for dividends, buybacks, acquisitions, debt reduction, and cash increases. And remember this FCF is after all expenses, working capital and capex requirements have been taken care of, leaving it “free” to use the cash flow for these other purposes.
What AMD Stock Is Worth
Last quarter AMD made $888 million in FCF, as explained by AMD on page 2 of its Q2 earnings release. Since its revenue in Q2 was $385 billion, this means the FCF margin was 23% (i.e., $888m/$3850m). This means that for every dollar in sales, 23% cents flows directly to the bottom line in FCF.
So applying this 23% margin against my 2022 forecast in sales ($18.72 billion) implies that its 2022 FCF will hit $4.3 billion. This will allow us to value AMD stock.
For example, right now AMD has an FCF yield of 2.7%. Here is how we figure that. Using its $888 million in Q2 FCF, we can estimate that its 2021 FCF will be 23% of $15.6 billion in forecast sales. That implies $3.588 billion in FCF, which represents 2.73% of its $131.365 billion market capitalization, according to Yahoo! Finance. That means we can use a 2.73% FCF yield to estimate its future market cap from the 2022 forecast.
Since its 2022 FCF is forecast to be $4.3 billion, if we divide that number by 2.73% (i.e., $4.3b/0.0273), the target market cap will be $157.5 billion. That is 20% over today’s market value of $131.365 billion.
However, I suspect that AMD stock will benefit from a higher valuation with the increase in FCF. I believe that its FCF yield will improve to 2.50%. Therefore its projected valuation will be $172 billion (i.e., $4.3b / 0.025), or 30.9% over today’s price.
This means that AMD stock is worth $141.76 per share, or 30.9% over today’s price (Aug. 25) of $108.30 per share.
What to Do With AMD Stock
The company is also now buying back shares under its new $4 billion share repurchase program. It uses its FCF to pay for this. Last quarter it bought back $256 million in shares. That will help AMD stock move higher as well.
For one, on an annualized basis, this works out to $1.024 billion in buybacks. As a percent of its $131.4 billion market value, this works out to about 0.77% (i.e., less than 1.0%) of its market. So clearly it has more room to build up its buyback program, but this is a good start.
I believe that the company’s products, its free cash flow generation and margins, as well as its buybacks, add up to a potentially 31% higher stock price. This would put it at $141.76 per share or 31% over today’s price.
On the date of publication, Mark R. Hake did not hold a position in any security mentioned in the article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.