AMD: That’s It! (NASDAQ:AMD) | Seeking Alpha

Do you ever just get completely frustrated watching market action? Even as market professionals, we are not immune to the effects of a tough tape and a market that is discounting just about everything in fear of total economic collapse in 2023. This feeling often precludes wise decision making. This feeling often comes before capitulation, when you throw your hands up and say “that’s it.” You wave the white flag.

We see this a lot with novice traders, as they learn to remove emotion from the equation. But it is difficult often to remove emotion from watching your money move. Extreme joy when you see double-digit returns, and despair when you see massive declines, especially if you have already averaged down.

One sector where we are seeing really poor sentiment is in the chipmakers. This comes especially due to the Q3 earnings that have been reported thus far. They have been relatively better than expected, while guidance has also been largely positive compared to expectations as a whole. And yet, despite these decent results and outlooks, the action in some of these chip stocks continues to be depressing.

There is a strong example in Advanced Micro Devices, Inc. (NASDAQ:AMD), which we have recently turned bullish on based on valuation and buying before a true turn. We think the market has priced in much of the slowdowns and negative macro risk. But, we can see why traders are simply having a feeling of giving up. Stay the course. Let us discuss.

Horrible action

Everyone knows we are going to slow in 2023. The market is discounting a ton of bad news in our opinion, and AMD as a stock has been cut by 2/3rds since reaching all-time highs. The sector has been horrific and sentiment on these semiconductor stocks has absolutely fallen off a cliff. It is so negative that we still believe now that this sector is a speculative buy.

AMD is a beaten-down stock in an unloved sector. Bull markets emerge from the ashes. We get it, the cycle is still slowing, demand is moderating, and pricing has as well. But all of this, including the horrible sentiment, in our opinion, is priced in here, down nearly 70% peak to trough. We have recovered a little, but AMD has been a tough stock, in a hated sector, in a horrible market. It is also tax-loss selling time, too, on the biggest beaten down names. Bad news piling up left and right.

With that said, even though earnings are going to fall commensurate with revenue declines, the valuation has improved. However, cheap can get cheaper if performance falls. But most of this seems priced into the stock in the $50’s. While PC demand is hurting, the data center, embedded, and gaming segments are doing well, particularly data center. Another good sign is the company did reduce expenses, as we saw in what we are dubbing “not horrible” Q3 earnings that were just reported.

We do know that 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 center demand, and all of the areas AMD and its competitors serve. But despite the action, AMD has been a strong competitor and has been taking some market share in recent quarters. We like the management team here, too. While the market has priced in pain, and is not giving AMD any real love on its earnings, they give us reason enough to guide you to stay the course.

Q3 earnings so-so

Make no mistake, all of the fundamental challenges for AMD and the sector began about a year ago. Then you factor in the immense competition and weaker pricing and demand, and it is just ugly in the near-term. Still, Q3 was not a great quarter but was not all that bad, either. That’s all you can say about the results really, but we also know that the company preannounced much of the quarter, so there was not too much of a surprise here.

In Q3, we saw the impacts of a downturn in the cycle when compared to earlier quarters this year, and, of course, the results were below consensus. Revenue was $5.57 billion and increased 29.2% year-over-year, driven by decent growth across all segments from last year, albeit down over $1 billion sequentially from Q2. That was a huge plus for the company. It also has successfully integrated Xilinx, which is contributing revenue. Some weakness was seen in GAAP gross margins, which were 42%, a declining 610 basis points year-over-year and down 400 basis points from Q2. Ouch. But if we make adjustments for the impact of Xilinx, the gross margins were up 50%, actually up 200 basis points year-over-year, but still down 400 points on an adjusted basis from Q2. We will point out that data center continues to be a strength.

As the revenues and adjusted margins expanded, the company saw a year-over-year increase in operating income in Q3. It was a solid $1.26 billion, or 23% of revenue, up from $1.05 billion or 24% a year ago. However, the rise in operating expenses is notable, rising 47% from a year ago. Operating income also fell heavily, from $2.0 billion in Q2. Again, these results were less than expected, and earnings missed consensus, too, in addition to revenues falling a touch short. Net income was $1.1 billion, up from $893 million a year ago, but down big from $1.7 billion in Q2. Earnings per share fell, however, to $0.67 vs. $0.73 last year. Is there reason to be positive?

Sector performance telling

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 dropped 40% year-over-year to $1 billion. Over in the gaming segment, revenue was flat from Q2, but up a moderated 14% year-over-year to $1.6 billion. Keep in mind that Xilinx helped the embedded segment, which registered 4% growth sequentially. Once again, we see data center as the big strength. Data center revenue saw and 8% sequential increase from Q2 and 45% year-over-year to $1.6 billion.

Commenting on the quarter during the conference call, CEO and Chairperson Dr. Lisa Su stated:

Third quarter results came in below our expectations due to the softening PC market and substantial inventory reduction actions across the PC supply chain… Despite the challenging macro environment, we grew revenue 29% year-over-year driven by increased sales of our data center, embedded and game console products. We are confident that our leadership product portfolio, strong balance sheet, and ongoing growth opportunities in our data center and embedded businesses position us well to navigate the current market

It was just not the best quarter, but because it was preannounced, we expected a muted reaction largely. What really was the catalyst was guidance, and yet, it leaves traders feeling like, “that’s it?” The guidance was decent. After a 60%-plus decline, we felt “decent” would be a catalyst, but there was just not much of a pop here.

Q4 outlook bullish, overall

So, all eyes were on the Q4 outlook, in our opinion. Overall, the revenue guide of $5.2-$5.8 billion we though was pretty good. It would be a halt in the sequential declines at the midpoint, and up 14% vs Q4 2021 at the same midpoint. At the higher ends, it would be solid growth, all things considered. That would mean 2022 revenue would be $23.2-$23.8 billion, a 43% drop or worse potentially if below the midpoint from 2021. Growth in data center and the embedded businesses will be the big positives. Given cost cutting measures, margins are expected to be 51% in Q4, which we view as positive. Given these results and the forecast, depending on down-line items, we see EPS for Q4 coming in at $0.65-$0.78. The other thing to keep in mind is that, despite the declining performance, the balance sheet is in great shape.

Strong balance sheet

Folks, we know there is debt on hand, but there is a ton of cash, and there is a lot of cash flow here still. AMD had about $6.0 billion in cash to start Q3, while debt was $2.8 billion. At the end of Q3, cash was $5.6 billion, and it was another good quarter for cash from operations. Those were $965 million compared to $849 million a year ago, while free cash flow was $842 million compared to $764 million a year ago. The slight increase in free cash flow was a bit of a surprise, given the big reductions we saw up the line in the report. We also like the shareholder-friendly use of cash, which was to reduce debt, and to repurchase shares.

In Q3, the company bought back $617 million of stock in Q3, and that follows AMD repurchasing $920 million of its stock in Q2, boosting shareholder value. We continue to see management addressing debt and buying back shares so long as the situation does not completely collapse in 2023. So far, at this juncture, we still like buying the stock in the $50’s.

Looking ahead

Valuation has improved. Q4 guidance was largely decent, despite the market pricing in disaster. We like the balance sheet. Chip demand will ebb and flow. Pricing will be volatile. But chips are much more secular than they once were. There is a strong management team here. More pressure may come in 2023, but we like starting to buy here on the long-term potential of the company. A lot of AMD bad news is priced in.

Do not throw your hands up and say “that’s it!” Keep emotion out of it, and look at the metrics that matter. Based on how the market has priced the stock, despite all of the chaos in the world, we like buying other investors’ bad bets.