Jerod Harris
Advanced Micro Devices, Inc.’s (NASDAQ:AMD) Q3 earnings report presented a mixed picture – solid third-quarter results that slightly exceeded predictions, juxtaposed against a Q4 outlook that was somewhat weaker than anticipated. However, amidst this contrast, a key element has captured investor attention and driven the stock upwards – AMD’s robust and promising artificial intelligence (“AI”) initiatives. This upward trend, despite the missed guidance, might come as a surprise to some. But, as we delve deeper, we see that AMD’s strategic emphasis on AI, from the powerful launch of their Genoa server CPU to the innovative developments of MI chip series, is not only influential but also instrumental in shaping the company’s future. This piece will explore how AMD’s focus on AI is reshaping its corporate narrative, carving a path of resilience and growth even in the face of guidance challenges.
Q3 Earnings Analysis
AMD’s third-quarter results were solid, slightly exceeding predictions in terms of revenues and earnings per share (EPS). The company reported revenues of $5,800 million and an EPS of $0.70, surpassing the market’s expectations of $5,703 million in revenues and an EPS of $0.68. The better-than-expected results were primarily driven by the Client segment, although the Data Center, Gaming, and Embedded segments fell a bit short of consensus.
Despite initial skepticism, the powerful launch of AMD’s Genoa server CPU is driving the average selling price significantly higher, aligning the fourth-quarter Data Center revenue with what AMD hinted at three months ago. Also, the MI300A (a combined GPU and CPU for High-Performance Computing) and the MI300X (a GPU only for cloud) are on track with their previously outlined timelines. AMD has set an ambitious goal for $2 billion in Data Center GPU revenue for 2024, a figure we believe exceeds Street expectations.
Moreover, PC revenue is recovering quicker than anticipated. AMD, facing easier comparisons and outperforming Intel (INTC) in the second half of 2024, suggests that this positive momentum will continue into December before the supply channel is refilled and more regular seasonal trends take effect in the first quarter.
Looking ahead to the fourth quarter, AMD’s projections are somewhat weaker than what the market anticipated. The company anticipates revenues of around $6,100 million and an EPS of approximately $0.76, which are lower than the market expectations of $6,398 million in revenues and an EPS of $0.90.
In terms of the different segments, AMD expects growth in the Client and Data Center segments but predicts decreases in the Gaming and Embedded segments. Despite the overall weaker outlook, the company still expects the Data Center segment to grow by 50% in the second half of the year, suggesting a mid-40’s percentage sequential increase. This puts it roughly in line with market expectations. The Client segment is also expected to grow quarter over quarter.
Conversely, both the Gaming and Embedded segments are expected to see double-digit percentage decreases sequentially, which is likely to lower overall revenues. Specifically, the embedded segment is correcting faster and to a greater extent than anticipated, with AMD expecting further declines in the first quarter. Gaming is also weaker than expected for the fourth quarter, as this console cycle appears to have ended earlier than anticipated. It’s likely that gaming will remain weak in 2024 before a new console cycle begins in 2025. However, given these are AMD’s lowest multiple businesses, we believe they won’t impact valuation as much as the PC and Data Center segments.
Regarding gross margins, AMD expects them to increase quarter over quarter due to changes in product mix. However, this forecast is still lower than what the market was expecting. Despite the strength in the Data Center and PC segments, the declining Gaming and Embedded segments are placing increasing pressure on operating margins. These headwinds are expected to persist through March.
It’s All About AI
One may wonder why a growth stock like AMD is rallying even though it fell short of its guidance. The explanation lies within the realm of AI. The prospects of their AI-oriented business are becoming increasingly promising, as evidenced in the recent earnings call.
In my view, software is of paramount importance for AMD to increase its market share in AI workloads. During the recent call, management emphasized the company’s progress in broadening its AI software ecosystem, most notably through the enhancement of the ROCm software’s capabilities and performance. ROCm is a crucial piece of the puzzle as AMD strives to compete against Nvidia’s (NVDA) CUDA by providing developers with an equally robust software solution for AI workloads.
The integration of ROCm into mainstream PyTorch and TensorFlow ecosystems, in addition to its regular updates and validation for Hugging Face models to operate on Instinct accelerators and other AMD AI hardware, exemplifies the company’s commitment to this effort. In a significant milestone, the AI startup Lamini announced that they had achieved software parity with CUDA for Language Models (LLMs) running on Instinct MI250 GPUs. This means enterprise customers can now deploy LLMs that are specifically fine-tuned for their data on Instinct MI250 GPUs with minimal code changes. According to our analysis, if this trend continues, AMD will be well-positioned to gain a substantial share of the AI market.
AMD’s strategy to strengthen its AI software capabilities also involves key acquisitions, including those of Mipsology and Nod.ai. Mipsology, a long-time AMD partner, brings a wealth of expertise in delivering AI software and solutions tailored for data center, edge, and embedded markets on AMD’s adaptive SoCs. The acquisition of Nod.ai is significant as it brings on board a team known for their substantial contributions to open-source AI compilers, with their software already in use by many leading cloud enterprises and AI companies. Nod’s compiler-based automation software can significantly speed up the deployment of high-performance AI models, specifically optimized for AMD’s range of processors like Instinct, Ryzen, EPYC, Versal, and Radeon.
With the progression seen in their AI roadmap execution and the commitment from cloud customers, AMD now expects their Data Center GPU revenue to reach approximately $400 million in the fourth quarter, and to exceed $2 billion in 2024 as revenue increases throughout the year. This projected growth trajectory would make their MI300 the fastest product to achieve $1 billion in sales in AMD history. AMD is set to reveal more about its advancements in the AI field at its upcoming December AI event.
Financial & Valuation
Note: All historical data in this section comes from the company’s 10-K filings, and all consensus numbers come from FactSet.
Despite this recent success, sell-side consensus forecasts suggest a contraction in revenues by 3.2% this fiscal year, reaching $22.8 billion. However, a significant recovery is expected the following year with a projected revenue growth of 20.0%, reaching $27.4 billion. This forecasted dip and subsequent recovery align with AMD’s recent revenue growth trend, as the company has experienced a compound annual growth rate (CAGR) of 51.9% over the past three fiscal years.
Although the operating margin slightly contracted to 22.0% this quarter from 22.7% a year ago, the EBIT margin has seen a substantial increase of 14.4% points over the past three fiscal years. However, a contraction of 522 basis points to 21.6% is expected this fiscal year, followed by an expansion of 468 basis points to 26.3% in the subsequent fiscal year.
In terms of cash flow performance, AMD is projected to generate a free cash flow (“FCF”) of $3,745 million this fiscal year, representing a robust 16.4% FCF margin. This is a significant improvement from four years prior when the FCF was $282 million, a 4.2% FCF margin. The company’s capital expenditure relative to revenue averaged 2.8%, indicating a capital-light business model.
AMD’s balance sheet remains strong, with a net cash position of $3,694 million. However, the lack of a dividend, which contrasts with the 1.6% dividend yield offered by the S&P 500 (SP500), may not sit well with income-focused investors.
Turning our gaze to the stock market performance, AMD’s stock has returned 54% more than the S&P 500 over the past year, representing an absolute return of 64.0%. Despite trading 4.6% above its 200-day moving average, it’s still 21% below its 52-week high of $132.83 and 80% above its 52-week low of $58.03. The relatively low short interest of 2.0% suggests market participants are not heavily betting against the stock.
Looking at valuation multiples, AMD’s current EV/Sales multiple is 6.0, EV/EBIT multiple is 22.9, P/E multiple is 25.6, and FCF multiple is 32.4. Compared to the S&P 500, AMD is trading at a premium across all these metrics, suggesting a relatively high market expectation for the company.
AMD’s current P/E ratio of 25.6 is below its 5-year mean of 34.9 and within the 2-standard deviation range of 14.8 to 55.0. This puts it at a historically medium valuation relative to its 5-year range.
When compared to its peers, AMD’s forward 12-month P/E is slightly lower than Nvidia Corporation’s (NVDA) 26.4 but higher than Intel’s 21.0. This suggests that AMD is moderately priced relative to its closest competitors.
Conclusion
The Q3 earnings analysis reveals AMD’s strategic focus on AI and its potential to reshape the company’s future. AMD’s decision to prioritize AI, as seen through its software advancements and key acquisitions, paints a promising picture of what’s to come. Despite the predicted contraction in the Gaming and Embedded segments, the company’s investment in AI software capabilities and the Data Center segment could be a game-changer, potentially leading to significant market share in AI workloads.
However, AMD’s growth trajectory is not without challenges. The company’s projections for Q4 are somewhat weaker than market expectations, with the Gaming and Embedded segments expected to see decreases. Nevertheless, the expected increase in gross margins due to changes in product mix and the projected growth in AMD’s Data Center GPU revenue suggest that the company is well-positioned for the future. With AI at the forefront of AMD’s strategy, the company is setting itself up for success in an increasingly AI-centric world.
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