Is AMD overvalued?
In addition to Nvidia,$Advanced Micro Devices (AMD.US)$it is still one of the most eye-catching alternative investments in the field of AI chips. However, the reason why the stock cannot receive a bullish rating is that its valuation is very high. Although its growth rate is only a small part of Nvidia's, its valuation can be comparable to it. Recently, the stock price has fallen after breaking through $200. Although the valuation is still quite unfavorable, it can be said that there are several bullish factors in the future that may be worth temporarily upgrading.
From previous reports in February, AMD's valuation seems to be several years ahead of its actual performance. This is in stark contrast to the actual leader in the field of artificial intelligence, Nvidia, given its strong growth (which allows it to quickly grow to the valuation level), its stock valuation has never been so expensive. For AMD, such strong growth was not present (or at best started from the minimum basis).
In terms of performance, data center revenue reached a record-breaking $2.3 billion, an increase of 80% year-on-year, thanks to the Ryzen and Instinct product lines. Although Epyc showed a seasonal decline, revenue grew 2% compared to the previous quarter due to the growth of Instinct. Customer business continues to recover from the trough, with a minimum drop of about 50%, but a year-on-year increase of 85%. Gaming business and embedded business are the main reasons for the overall performance being flat, with gaming revenue of $900 million, a year-on-year decrease of 48%, and embedded revenue of $800 million, a year-on-year decrease of 46% and a quarter-on-quarter decrease of 20%.
Mixed performance
AMD's performance has been mixed since Q1 2023. First-quarter revenue was $5.5 billion, and 2% revenue growth means that overall revenue has been stagnant since Q1 2021, when the company achieved $5.9 billion after acquiring Xilinx. AMD has indeed not exceeded $6.5 billion announced one quarter later.
However, as early as 2021, the stock did continue to rise by the end of the year and is still at similar levels. This indicates that investors are still quite optimistic about further growth during this period, although this did not happen and there was a substantial decline at the end of 2022.
Looking closely at the performance, data center revenue reached a record-breaking $2.3 billion, an increase of 80% year-on-year, thanks to the Ryzen and Instinct product lines. Although Epyc showed a seasonal decline, revenue grew 2% compared to the previous quarter due to the growth of Instinct. Customer business continues to recover from the trough, with a minimum drop of about 50%, but a year-on-year increase of 85%.
The main reason for the overall performance being flat is gaming and embedded businesses, with gaming revenue of $900 million, a year-on-year decrease of 48%, and embedded revenue of $800 million, a year-on-year decrease of 46% and a quarter-on-quarter decrease of 20%.
In terms of profitability, non-GAAP earnings per share were $0.62, gross margin was 52%, and operating margin was 21%. However, GAAP gross margin was 47%, GAAP operating margin was 1%, and earnings per share were $0.07.
AMD expects second-quarter revenue to be $5.7 billion, a year-on-year increase of 6%. Therefore, similar to Intel (INTC), most of the growth is expected to occur in the second half of the year.
After announcing the initial expectation for AI revenue in 2024 was $2 billion, it was subsequently raised to $3.5 billion. This strong growth has sparked speculation about actual results, which means it is highly likely. Therefore, AMD seems to have exposed some more optimistic forecasts, which were in the trend of billions of dollars, and the update in the first quarter was only $500 million higher than expected, reaching $4 billion.
Still a hot topic, but with a high valuation
After Nvidia made a similar statement, AMD recently announced that it will switch to annual release rhythm.
The company's expected PE ratio is 45 times, and as mentioned earlier, there is a large (20 percentage points) difference between GAAP and non-GAAP earnings, so the stock price is expensive. However, from some potential upward factors, it is indeed necessary to make preliminary upgrades.
Firstly, as mentioned earlier, the two main businesses of AMD (gaming and embedded) continue to perform poorly. If the market conditions improve, the total quarterly revenue may reach $1.5 billion, or $6 billion annually. In addition, even for customers, its quarterly revenue continues to be lower than the nearly $2 billion before the US economic downturn.
Secondly, although Instinct set a record-breaking $1 billion (cumulative) revenue, it is still in the early stage. This business seems to be able to double (or more) from the current forecast of $4 billion in 2024 as time goes by.
Overall, in an optimistic situation, this means that revenue may rise to about $36 billion: $8-10 billion Instinct, $6-8 billion Epyc, $6-9 billion Ryzen (client), $6-8 billion gaming, and $5-6 billion embedded products. The range of these estimates is $31-41 billion. Looking at Nvidia, most of the potential upside seems to be in the Instinct product line.
In addition to the new AI accelerator business that is entering, this forecast does not necessarily require a significant increase in market share (except perhaps for gaming, it has further ceded some market share to Nvidia), and it can mainly increase by moderately total addressable market ("TAM"). For example, in the client field, new AIPC trends may increase ASP, and in the data center field, Intel (INTC) expects the per-core price to remain relatively stable, and as the number of cores increases, ASP will increase over time.
Assuming a 25% operating profit margin, the net income (non-GAAP) could reach $9 billion. This is equivalent to an EPS slightly above $5.50, with an expected PE of 29 times. If the operating profit margin expands to 30% (which the company achieved in the second quarter of 2022), the multiple would be further reduced to 24 times. As the AI accelerator business clearly has very high profitability, there may be (even very likely) further operational leverage.
This PE ratio below 20% is very close to the growth prospects in a bullish situation. Alternatively, the low PE ratio can partially ease the PE ratio pressure while still bringing returns to shareholders, since the stock is already heavily valued. Given its historically high valuation, the latter scenario seems more likely.
The main risk is that the optimistic forecasts of continued accelerator growth and full business recovery will not materialize. For example, personal computer revenue was driven by a broad cycle during that time, and the PC TAM has since reverted to historical levels. Plus, with increased competitiveness from Intel, significant market share gains seem unlikely, so most growth opportunities may have already been realized with the 85% YoY growth in the first quarter. However, some bulls may note that AMD's market share is quite low, barely above 20%, which still presents a long-term growth opportunity.
Similarly, in the datacenter segment, Intel continues to boost competitiveness and aims to regain market share through its latest 2024 product releases. In the embedded segment, the company is currently digesting inventory, which means some (sequentially) growth should recover quite quickly. Conversely, part of the digestion was due to oversupply, so full revenue recovery may not happen very soon if these peak sales figures were based on (caused by) market oversupply.
Finally, even with optimistic numbers assumed for all the businesses, the non-GAAP (let alone GAAP) PE ratio would still be higher than the average level of the S&P 500 index. Even if AI revenue was around $8 billion or higher, this business would still account for only a small portion of the company's total revenue, so even if the business continued to grow rapidly at such a scale, it might not be enough to ensure the company's current high valuation.
Overall, a PE ratio around 20% seems more realistic for a company like AMD. Therefore, in the worst case, considering the current financial status, this would put about half of its stock price and market cap at risk, so the valuation indeed reflects further growth in the coming years.
As a fabless company, AMD has almost no risk in capital expenditures to maintain its business. In contrast, Intel has recently invested heavily in constructing new fabs, which severely affects its free cash flow.
From a realistic perspective, the stock should be uninvestable, given about half of its market cap and share price are at risk considering the current financial status. Nevertheless, this creates an investment opportunity, since many of AMD's businesses are still far below peak revenue, even approaching the troughs of its embedded and gaming businesses. Furthermore, long-term investors' confidence in the stock has been strong, so the hype around AI makes it unlikely for the stock to cool off significantly. However, even after months of stock price decline, this investment opportunity is still constrained by the high valuation.
But it's worth noting that in an optimistic scenario of full recovery and continued AI growth, revenue in the coming years could grow from the projected $24 billion in 2024 to $36 billion or higher. Coupled with the increase in operating profit margin, this could lead to a multiple of just over 20 times at the current share price.
Editor/Jeffrey
Editor/Jeffrey