AMD Stock: Obliterated, A Speculative Buy Now (NASDAQ:AMD)

If you have not been paying attention, the semiconductor stock AMD (NASDAQ:AMD) has seen its price be sliced by 2/3rds since reaching all-time highs. The sector has been horrific. Sentiment on these stocks has absolutely cratered. It is so negative that as a contrarian firm, we think the stock is a speculative buy. That is just what we do. We like to find beaten down stocks in unloved sectors, and profit from their rebound when sentiment and operational conditions improve. Both sentiment and operational condition are poor. But is this priced in down some 67% from highs? We think largely the answer is yes. But it is not just this stock. It is not just the semiconductors. Folks, right now, sentiment in the market is as negative as we can remember. This reminds of us the anxiety in October 2008, and the extreme fear of March 2020. To be clear, it has been a horrendous 6-7 months, but it has really been a horrible 6-7 week period.

So what about AMD? Bad stock. Bad sector. Horrible market. Bad news piling up left and right. We are here at $54 per share and it seems the stock has been left for dead. Make no mistake, semiconductor sales continue to fall globally. It is just painful. Let us not forget that fundamentally, the United States is trying to prevent China from using chips against us to improve their military or their economic advantage in tech. As such, new export regulations are in place which will certainly weigh on the sector. Overall, anxiety on the consumer is building and this is hurting demand. Because demand is slowing, and there is fear that there will be a very slow period for new computer sales or TV sales, car sales, data centers, and basically every other product that uses chips. Now, AMD has a few things going for it. It has been a strong competitor and has been taking some market share in recent quarters. It also has a strong management team. But the problems have been brewing for months, and is finally starting to be reflected in performance and expectations. The stock has been obliterated on this. Let us discuss.

Q2 earnings were strong, but it may have been the near-term peak

The challenges for AMD began earlier this year, if not sooner. Competition is strong. Pricing dynamics are weakening, as is demand. Now look, by all accounts Q2 was tremendous, although the forward view continues to weaken seemingly month by month.

In Q2, which we think was the near-term peak, revenue was $6.6 billion and increased 70% year-over-year driven by growth across all segments. That was a huge plus for the company. It also has integrated Xilinx, which is contributing revenue. Some weakness was seen in GAAP gross margins, which were 46%, a declining 2% year-over-year, primarily. But if we make adjustments for the impact of Xilinx, the gross margins were up 54%, an increase of 6% year-over-year. Data center strength was a main contributor.

As the revenues and adjusted margins expanded the company put out a record for operating income in Q2. It was a solid $2.0 billion, or 30% of revenue, up from $924 million or 24% a year ago primarily driven by higher revenue and gross profit. Winning. Just winning. But the stock continues to sell off despite also seeing record net income of $1.7 billion, up from $778 million a year ago, or $1.05 per share compared to $0.63 a year ago.

We like the balance sheet and cash use

Now, before we get into more reasons why the stock is faltering and performance is weakening, we like a buy here based on the exceptional balance sheet. Yes there is debt on hand, but there is a ton of cash, and the company. AMD had about $6.0 billion in cash to start Q3 while debt was $2.8 billion. It was another record when we consider cash from operations. Those were $1.04 billion compared to $952 million a year ago, while free cash flow was $906 million compared to $888 million a year ago. The slight increase in free cash flow was a bit of a surprise, but you have to consider what free cash flow was used for. AMD repurchased $920 million of its stock in Q2, boosting shareholder value.

So why is AMD stock falling so hard?

We can only blame “the overall market” so much when considering the decline in shares. While it is true the overall market is pretty bad right now, and an argument can be made the overall tech space is getting hit pretty hard, this stock is down 67% from highs.

One reason is the fear of declines in possible revenue from ongoing export controls, limiting what the company can sell and to who. That is a risk for sure. The U.S. is of course quarrelling with China over semiconductor production and use. The goal really is to prevent China from using American produced technology against the U.S. militarily, but the secondary goal is to keep China’s technological advances second to the U.S., we believe.

Secondly, demand for chips has been on the decline. Folks, the decline in demand has come with a decline in a lot of chip pricing as well, and this can only weigh in the near-term. Of course, AMD has also been aggressively pricing chips to help it compete against other chipmakers. Still this will weigh.

Then of course, there was the real hammer that fell just last week. It was bad. AMD reported preliminary Q3 2022 results that missed estimates by a wide margin. This really sent shares spiraling down to their current $54 levels which we see as a contrarian and speculative buy level for a bounce. But it was a drastic decline in performance.

Just how bad? Revenues for Q3 were horrific, compared to expectations anyway. Total Q3 sales would be coming in at about $5.6 billion, compared to estimates of $6.71 billion. Folks this is 16-17% below expectations. That is no small miss. It was a bad quarter, and reflected a lot of the pain in demand and pricing. Making matters worse, and giving credence to our thesis of “peak AMD”, adjusted gross margins were roughly 50%, and way below the 54% the company thought it would hit. The stock was obliterated on this news.

Looking more at sector performance, the slowing was largely a result of slowing PC demand. The client segment revenue fell 53% from the Q2 peak, and was down an incredible 40% year-over-year to $1 billion. Over in the gaming segment, revenue was flat from Q2, but was up 14% year-over-year to $1.6 billion, which was some good news. Xilinx helped the embedded segment see 4% growth form Q2, while the big positive was data center revenue rising 8% from Q2 and 45% year-over-year to $1.6 billion. Still, this was below expectations, but it is not as horrible as it seems.

Looking ahead

So what is going to happen from here? Well, we certainly think weakness persists in PC demand for another few quarters especially as recessionary impacts are felt. But there is reason to like the stock, especially down 67%. First, even though earnings are going to fall commensurate with revenue declines, the valuation has drastically improved. However, cheap can get cheaper if performance falls. But most of this seems baked in at $54. While PC demand is hurting, the data center, embedded, and gaming segments continued to show strength, and that is a very good sign. Another good sign is the company did reduce expenses by $100 million versus what it had guided. Of course, EPS will now fall heavily for Q3 and for the year versus what was expected. If we assume the trends for Q3 persist in Q4, that is, weakness in client and slight improvement in the other sectors, we think annual revenues will now track to be $23-$24 billion, which would still be very strong year-over-year growth, though of course, far below what was initially expected. Assuming margins hold around 50% in the remaining quarter, EPS for the year should track to $3.35-$3.80 for the year. This would still be growth as well, even though performance near-term peaked earlier this year. At 14X FWD EPS, we think AMD stock which has been obliterated, is a contrarian and speculative buy. We believe the market will find its bottom in coming months, just as we head into ‘real recession.’ And then, the market will start pricing in recovery and eventual rate cuts. We think you can start buying here.