AMD: Does this Stock have Room for Growth?

Advanced Micro Devices (AMD) is a global semiconductor leader whose offerings can be divided into two parts. The first includes its x86 microprocessors, chipsets, discrete and integrated graphics
processing units (GPUs), data center and professional GPUs, and development services. The second involves server and embedded processors, semi-custom System-on-Chip (SoC) products, development services, and technology for game consoles.

With the global semiconductor shortage prevailing and the company’s overall technology advancements, which have allowed it to strongly compete with its industry peers, AMD is enjoying great demand for its chips. (See Advanced Micro Devices stock charts on TipRanks)

A few years ago, AMD’s chips struggled to gain market share, with Intel (INTC) mostly dominating the space. The company’s marvelous advancements, however, have allowed AMD not only to actively compete, but to grow revenues at a rapid pace over the past few years.

The stock has, astonishingly, rallied from just around $2 in 2015 to around $112 as of the writing of this article, as a result. In my view, while AMD is set to keep enjoying robust revenues and potentially grow the top line further along with its free cash flow, the stock seems to have fully priced in these advancements at its current levels. For this reason, I am neutral on the stock.

Focusing on Growing Free Cash Flow

AMD’s free cash flow is detrimental to growing the business, and as an extension, enlarging shareholder returns. AMD seems to be well-positioned in the current environment to expand its free cash flow considerably. The company generated a free cash flow of $888 on revenues of $3.85 billion in Q2. To illustrate the positive tailwinds AMD is currently enjoying, the second quarter’s FCF alone was around 14% larger than the total FCF the company generated in FY2020.

During its latest earnings call, AMD emphasized that it will accelerate the production of its next-generation AMD instinct accelerators -an open-sourced ROCm software- which will assist data center GPU sales growth in the short term. Management also highlighted that enterprise will be a more substantial component for AMD than it was in the first half of the year, based on the fact that the company is experiencing strong momentum in this division.

Hence, we should not be surprised if the FCF margin keeps growing in the medium term, driven both by the ongoing momentum and the unprecedented strength in GPU end-market pricing. As you may be aware, prices for high-end graphics cards like AMD’s Radeon RX 6000 and Nvidia’s (NVDA) Geforce RTX 30 series have snowballed in 2021, partially driven by cryptocurrency miners and partially by gamers, as both groups are short of new GPUs.

With crypto prices again on the rise, the situation is set to keep worsening, conveying the current shortage, likely driving AMD’s pricing (and free cash flow) higher.

A “Priced-In” Valuation

While the ongoing market situation in the semiconductor space could sustain a euphoria in AMD’s financials, the current stock price seems to have appraised this almost fully. The company is expected to deliver EPS of $2.50 for the year, which implies a P/E of 44.75.

Even if EPS continues to grow by a double-digit rate in the medium term, note that this is an excessive multiple in the semiconductor industry. If AMD’s sales growth relaxes moving forward, the stock is likely to experience a valuation compression. Hence, current investors have a limited margin of safety.

Wall Street’s Take

Turning to Wall Street, Advanced Micro Devices has a Moderate Buy consensus rating, based on 11 Buys, 3 Holds, and 1 Sell assigned in the past three months. At $116, the average Advanced Micro Devices price target implies 3.46% upside potential.