AMD Finds it Tough to Play Second Fiddle

Advanced Micro Devices (AMD) reported first quarter results on Thursday evening and shares have been pulled down in reaction to the announcement. In a vacuum, the quarterly results were actually pretty decent, but unfortunately for AMD they are being compared to primary competitor Intel (INTC) who reported a blowout quarter on Tuesday. Of course, these comparisons are fair and truly need to be made, but we wonder if the market isn’t discounting to the underdog in this fight. For the quarter, AMD earned net income of $257 million or the equivalent of $.35 per share. On a non-GAAP basis, which is more comparable to analysts’ estimates, the company earned $63 million or 9 cents per share on revenue of $1.57 billion. Wall Street estimates had called for a loss of 7 cents on revenue of $1.54 billion, so the reality topped consensus on both counts.

In addition, AMD reported gross margins of 47% (43% on non-GAAP), which expanded two percent from the fourth quarter. AMD credited its first quarter profit to strong performance from its graphic, server and notebook platforms. Indeed, sales of graphics chips surged 88% from a year ago, but these are clearly comparisons versus a very weak quarter. However, the company did say they expect to see second quarter revenue to be “down seasonally,” which was not the tone investors wanted to see in an apparent strengthening trend in PC sales.

We believe the reason AMD is down 7.5% at this time has more to do with the strength of Intel than it does anything that AMD did. Intel’s results exceeded the lofty expectations as they saw sales soar 44%, and profit nearly tripled from a year ago on 63.4% margins. The market and industry analysts were fired up about the solidifying evidence of a PC refresh cycle in the Intel results. AMD benefited from some of the same trends, but they just could not live up to outstanding performance of Intel. For a stock that had nearly tripled over the last twelve months, it appears some investors are content to simply take profits.

AMD has almost certainly lost market share to the bigger and stronger Intel in the last quarter, but the bearish sentiment among many financial pundits and commentators has reached a fevered pitch. It is impressive that the stock has gained the way it has over the last year because from what we can tell the market’s mood is now extremely negative on the stock. So, a contrarian investor may see an opportunity in AMD with undeniably improving fundamentals, if they believe the marketplace for microprocessors is big enough for more than just one dominant player.

The collective analyst community sees the stock as appropriately priced with an average rating of 20 analysts at 2.9 or just slightly better than neutral with a mean price target of $9.66 per share, according to Yahoo finance. At Ockham, we currently have a Fairly Valued or neutral rating on AMD shares, but if the stock were to decline much further we would have to seriously consider upgrading to Undervalued. With fundamentals gaining strength, the price appreciation does appear warranted according to our methodology. For example, AMD currently trades for a price-to-sales per share of 1.00x which is on the low end of the historically normal range of .75x to 2.27x for this valuation metric. Similarly, the market has historically been willing to pay 5.5x to 15.4x cash earnings, but at current levels price-to-cash earnings of 4.6x sits below the historical norms. We will not make the case that AMD is outperforming their rival Intel right now, but if the stock falls very far, it could be the more attractive stock. As a point of reference, we also have INTC rated Fairly Valued right now as well.

Fundamentals are improving and we expect the current PC refresh cycle to continue to lift both chip makers results, as pent up demand starts to work through the system. Judging by the market’s reaction and various commentaries on AMD today, we think it is reasonable to say that the market is not giving the AMD turnaround enough credit. If the stock continues to fall much further, we think it presents decent value and we would likely upgrade it in coming weeks.

About Ockham Research 645 Articles

Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

We utilize this straightforward approach to value over 5500 securities, with key emphasis given to the study of individual securities' price-to-sales, price-to-cash earnings and other historical valuation ranges. Our long term value investing methodology is powered by the teachings of Ben Graham and it has proven to be very adept at identifying stock prices that are out of line with fundamental factors.

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