AMD Continues To Be Worryingly Overvalued (85%!) Despite Management Optimism Reveals Analysis
Chip designer Advanced Micro Devices, Inc (NASDAQ:AMD) held its Financial Analyst Day this week, after a three-year hiatus. The event is generally preceded by a certain degree of anticipation, as folks other than analysts tune in to determine what the company has in store for them for the future. AMD often highlights its product roadmap in the event, in addition to providing details about assumptions factored in its financial model.
This year's event was no different, with team red not only providing us with important financial metrics but also providing a glimpse into its product development. If you haven't caught up yet, then read up, as AMD's promised us Ryzen 4000-based desktop central processing units and EPYC Milan-based server processors no later than this year. Additionally, the company also highlighted performance gains that users should expect through its second generation RDNA graphics processing unit microarchitecture.
Naturally, while these claims are impressive, and come at a time at which Intel Corporation continues to struggle, information on what AMD expects its financial metrics to be is equally important. The company's chief executive officer Dr. Lisa Su and its chief financial officer Mr. Devinder Kumar provided key metrics for the company's short and long term future this Thursday. Here we take a look at how they fit in AMD's bigger picture.
AMD Continues To Be Heavily Overvalued Despite Management's Optimism For Future
If you're a regular reader you'll know that we've posted several times on how AMD is overvalued. Back in January, a brief analysis that projected the company's financial performance until the end of this year revealed that AMD has the highest price-to-earnings ratio in the industry. Another piece that reversed the company's share price relative to its projected cash flows illustrated that for AMD to justify a per-share price of $49.32, the company had to grow its free cash flows by at least 44% over the next seven years.
Naturally, such estimates inject an element of unease for the company's stock and we were hoping that AMD's management would provide facts and figures at its analyst day that would help us refine our models. They did, and we went back to our trusty LibreOffice sheets to see how Dr. Su and Mr. Kumar's assumptions fit in AMD's long-term future and fair value.
Starting with the basics, AMD has updated its Total Addressable Revenue estimates for the three semiconductor product categories that it designs and sells. In its 2017 Analyst Day, the company had estimated TAM for PC, 'Immersive' and Datacenter to stand at $28 billion, $15 billion and $21 billion respectively by the end of last year. Last week, the company provided TAM values for the end of 2023. You can take a look at them below.
Using the above estimates lets us calculate AMD's expected compound annual growth rate (CAGR) for the three segments. And if you're astute, you'll note that PC + Gaming (or 'Immersive' - which is AMD's 2017 classification for non-Datacenter, non-PC markets) segment TAMs grow only by $1 billion from the end of last year to the end of 2023 - a factor resulting in a 0.58% CAGR.
This rate, combined with the company's performance in the fiscal year 2019 lets us gauge market penetration. Additionally, using AMD's guidance for the fiscal year 2020 lets us model what the company expects from its balance sheet by the end of this year.
Projecting revenue metrics for the year 2020 and beyond then lets us calculate an implied fair value for AMD's share price - using two methods. The first of these discounts the company's projected future cash flows, while the second uses a price-to-earnings multiple in tandem with a projected earnings-per-share calculated for the year 2023.
Price-to-earnings fair value computation indicates a downside of 7% for AMD (NASDAQ:AMD)'s current share price - implying that all growth has already been factored in
Using AMD's guidance for 2020 lets us firstly estimate revenue, operating income, net income, earnings per share and free cash flow that the company expects to post for the full fiscal year 2020. Based on the guidance, AMD stands to earn $8.7 billion in revenue, $1.3 billion in operating income, $984 million in net income and generate roughly $283 million in un-levered free cash flows; making for 29%, 51%, 188%(!) and 21% year-over-year growth, respectively.
Naturally, you'll see that 21% year-over-year growth for un-levered free cash flow is half of what we've calculated AMD needs to justify current share prices. And, keep in mind that the 44% growth rate estimate calculated previously uses a lower weighted-average-cost-of-capital of 13.84%. Switch this out with an updated, truer metric of 17.26% and you'll see that the chip designer truly is one of the most overvalued companies on Wall Street right now - held afloat by the potential of increasing market share on the back of an Intel Corporation undergoing a shift in priorities.
To simplify things and to bring our estimates in line with AMD's materials, we have combined revenue earned by AMD through dedicated, discrete and custom (console) graphics processing units with the revenue it earns through central processing units. This allows us to isolate Datacenter revenues, which is important since the company expects the segment to grow in importance over the coming years (as shown above).
At the time of publishing, AMD has a price-to-earnings ratio of 162 based on its fiscal year 2019 earnings-per-share and Friday's closing price. On the other hand, companies that can be arguably said to be AMD's peers have the following price-to-earnings ratios:
- Intel Corporation (NASDAQ:INTC): 11.6
- NVIDIA Corporation (NASDAQ:NVDA): 57.3
- Texas Instruments (NASDAQ:TXN): 21.3
- International Business Machines (NYSE:IBM): 11.9
- ON Semiconductor Corporation (NASDAQ:ON): 32.8
Our projections leave AMD with an earnings-per-share of $1.66 at the end of its fiscal year 2023. This estimate has been calculated using the company's outlook, and to make things easier for AMD, we've kept interest, tax and other expenses the same for the years 2020-2023. Additionally, in order to keep in line with management's projected sentiment of cost efficiencies, marketing, general and administrative expenses will increase to 12% of revenue this year and continue to stay this way through 2023.
Using a target price-to-earnings multiple of 29 results in a fair value of $48.25, which is roughly equal to AMD's current market valuation. However, imputing the Philadelphia Stock Exchange capitalization-weighted index of semiconductor stocks (PHLX Semiconductor Sector - iSOXX)'s weighted-average-price-to-earnings ratio of 25.83 gives us a fair value of $42.98/share for AMD based on its earnings-per-share three years, implying that all future growth (and then some) has already been factored in. This marks for a 12% downside over Friday's close.
Discounted cash flow analysis reveals a staggering 85% downside
If you thought that a 12% downside was far-fetched, wait for what we have in store for you next. One of the several methods to evaluate a company is through projecting its free cash flows into the future and then discounting them to equate them to their current value. This lets us factor in growth assumptions in a share price, and carrying out this process for AMD yields unconventional results to say the least.
Our analysis reveals that AMD's fair value based on future cash flow projections using management guidance is $7.16/share, resulting in an 85% downside over Friday's close. The three metrics impacting AMD's future free cash flows are shown in this piece's first image gallery, and we've done our best to be as conservative as possible here.
What this result means is that it is not possible for AMD to justify its current share price based on management's estimates of its future market performance. Mr. Kumar's stress on improving gross margins through 2023 at the analyst day reflects this fact and hints that perhaps AMD's management is also well aware of this reality.
Nevertheless, a market re-pricing to account for this harsh reality is unlikely in our opinion especially as Intel has explicitly stated that it is not interested in solely targetting the total addressable market for personal computing central processing units; instead, blue team hopes to target the total addressable market for ALL semiconductors, as evidenced by its decision to introduce 5G base station chips in the market.
As always, readers are reminded to conduct their own due dilligence prior to making investment decisions. Wccftech, its staff, its writers, and its management do not hold any liability for the consequences of your trading decisions as a result of reading this piece. The writer does not have a stake in NASDAQ:AMD and does not intend to acquire one in the next 72 hours or in the near future.
The sole intention of this piece is to educate readers and consider the impact of varying variables on a company's cash flow. At the time of the update made to this discretionary statement, (NASDAQ:AMD) is outpacing the NASDAQ Stock Market's overall drop of 4.37% due to the disruption in oil prices, global supply chains and consumer demand.
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