The launch of Ryzen 7 and 5 Series in the first quarter of 2017 has been considered Advanced Micro Devices’ (NYSE: AMD) “rite of passage” returning to the high-end CPU and GPU markets. Competing head on with Intel (NASDAQ: INTC) and Nvidia (NASDAQ: NVDA), AMD plans to update Polaris GPU line in April, the high-end Vega GPUs and Naples server CPUs during the second quarter, and the Ryzen 3 CPU later this year.
On the desktop front, Ryzen 7 1700X has a higher performance-to-price ratio than Intel Core I7 6900K, but suffers from a lower margin. AMD’s Vega, at a lower $600-$700 range, aims to challenge Nvidia’s GTX 1080 Ti GPU. However, BMO Capital Market indicates weakness in GPUs, noting a 16% decline in GPU shipments from Q4 to Q1.
At the eve of AMD’s Q1 2017 earnings report, these arguments seem more academic. AMD shareholders are eager to get a glimpse of the potential revenue contribution from the new product lineup, as Ryzen 7 had booked 4-week revenue in the first quarter. At this point, both the revenue growth and the timing of profitability are the key considerations.
The real question is how much has this information been reflected in stock prices, and how much AMD will move in light of surprises.
As AMD’s negative earnings has rendered any earnings-based valuations meaningless, I use the following “Sales Franchise Value Model” which incorporates both revenue growth and operating margins in the valuation process:
In Table 1, AMD’s fair values are calculated using various scenarios of actual revenue and operating margin for Q1 2017. The base case, using the street estimates of $982 million for Q1 2017 revenue and a 32% operating margin, will yield a fair value for AMD at $13.11. Technically, AMD may move between $10 and $17 as suggested by the estimates, but it may more likely go between $12.50 and $14.50. By the way, as a highly controversial move, Goldman Sachs Analyst Toshiya Hari recently downgraded AMD stock to a “sell” and reduced its price target from $14 to $11.
There are some caveats in interpreting the results in Table 1. As AMD routinely beats the estimates, the more likely fair value is $13.40. What this means is that AMD at the current level of $13.44 has already priced in the beat.
For a while, without any information, AMD’s stock has been traded 10% over the current level. This premium can be a result of long-term shareholder loyalty, cheering for the “comeback kid,” or simply the S&P 500 indexation technicality. There is no evidence that the market has rewarded them permanently.
After all, Q1 2017 is more like a test. What investors are really looking for is any clue or guidance as to what the Q2 2017 report will look like, since most of the new products will come to fruition. As a result, while the actual Q1 2017’s beat or miss may be a non-event, there can still be a 5 to 10% premium or discount on top of the fair values.
Fair Values vs. Target Prices
It can be dangerous to take a long or short position simply based on a current valuation discount or premium. At the point when new information arrives, a more sensible process is to estimate a relevant target price for Q4 2017. An expected return can be calculated based on the target price and the current price. The decision whether to buy or sell AMD will depend on your preference on its risk/reward profile.
At today’s $13.44, say, AMD target price at $15 by the end of 2017 is equivalent to 12% expected return. Considering 59% of AMD’s revenue concentrates in 3 major customers; AMD has a track record of product failures or delayed launches; there could be a chance that Q1 2017 revenue can be missed because of the shortage in mother boards; and Nvidia’s recent upgrade to its GeForce GTX 1080 Ti, AMD’s 12% return may not be enough.
I will estimate the AMD yearend target price after the conference call on May 1.