I’ve owned Advanced Micro Devices (NASDAQ:AMD) for a while now and while my holding is much smaller than it is in Nvidia (NVDA), AMD too has a lot of potential and should do very well in the next decade, competing strongly with Intel (INTC) for several years in key markets.
In Q3-22 and specially Q4-22, AMD started unravelling like some of its rivals such as Nvidia and Intel, with falling PC (Personal Computer) and Gaming demand, delays in data center orders and excess inventory.
AMD’s Business Segments
In Q4-22, the Client (PC) segment was a disaster, dropping 51%, causing a drop of 10% for the year. Gaming, gamely held on to a 7% drop but still managed a good 21% gain for the year. And as we can see below the Datacenter was the rockstar with 64% growth for the year. The Embedded segment’s massive gain was a result of the Xilinx acquisition, which contributed a total of $4.61Bn to AMD’s $23.6Bn top line. Even without Xilinx, AMD would have still grown a decent 15.5% over 2021, which is commendable compared to Nvidia’s flat top line and Intel’s drop of 20% in 2022. We know who is eating whose lunch.
What lies ahead in 2023? AMD was understandably skittish to give full year’s guidance, merely guiding to $5.3Bn in revenues in Q1-2023, down 10% YoY, even expecting DataCenter to drop sequentially because of excess inventories.
I believe my estimates for 2023 are conservative and slightly lower than consensus and if Micron’s (MU) guidance yesterday is a good indicator, that inventories are clearing a little better than expected, we could be in for a nice surprise. Overall, AMD should stay flat for 2023, with decent gains of 13% and 12% from the Datacenter and Embedded segments, respectively. CEO, Dr. Lisa Su did point to overall weak PC demand of 10% on the Q4-22 earnings call but given that AMD is still clearing out inventory, I expect the decline to be worse than the overall market at 13%.
Gaming was still better than client revenues with a 21% gain in 2022, but I’m expecting declines as well in 2023 on lower demand from consoles and a still struggling gaming market that had got flooded with used crypto chips in 2022.
Let’s focus on AMD’s future with the two growth segments, Datacenter and Embedded.
Datacenter and growth from Generational AI
AMD’s rockstar segment contributed $6Bn of sales last year or 26% of AMD’s revenues, and even with a sequential decline in Q1-23, it should grow 13% this year as inventories close out and demand picks up towards the second half.
AMD has been taking market share from Intel. According to a Wall Street Journal article, AMD’s Milan data-center processor accelerated to 32% of so-called cloud instances, improving from 21% earlier. Secondly, AMD’s CPUs grabbed 65% of new instances in November 2022, easily outpacing Intel’s 30%.
The Datacenter market is expected to grow at a CAGR of 11%, reaching $517Bn by 2030, according to Allied Market Research, and I believe AMD will continue to grow market share at Intel’s expense.
AMD too, expects top line growth from Generational AI, perhaps not as strongly as Nvidia, but it definitely has a seat at the table. Consistent with Nvidia and its symbiotic relationship with hyperscalers, AMD too, wants to rent you a supercomputer, as Dr Lisa Su, AMD’s CEO puts it in this article from Barrons.
AI has been around for quite some time,” Su said in an interview with Barron’s, “but we’re at an inflection point, touching all of our technologies, from chips for consumer devices up to the largest chips we build for data centers. You need AI capability in every one of those devices.”
Every client deserves AI, AI at your fingertips, don’t leave home without AI. Jokes aside, AMD can and will also benefit from this gravy train, simply because we will need and adopt to higher computing standards.
To that end, at the Feb 23, CES trade show, AMD presented their new processor called the MI300, which was built for their Datacenter clients needing supercomputing and other high-performance computing applications in pharmaceuticals, autos, climate sciences and financial services. Initially it will be used in El Capitan, a cutting-edge supercomputer under development at the Lawrence Livermore National Laboratory, but as Lisa Su says:
The national labs are the first adopters, but the cloud guys are right there with them, allowing people to rent their own supercomputers.
I had a long conversation with a senior executive at a leading Life Sciences consulting company, who said that a recurring and consistent theme for the past three months has been RFP’s (Request for Pricing) for AI/Machine Learning solutions that can blast trough routine processes — nobody wants an ordinary run of the mill solution anymore. According to him, there was a time when he couldn’t land complex technology solutions because of the cost or the complexity – now clients are clamoring for nothing less and are flooding him for requests for anything AI related. And he said, this is across the spectrum – they’re not just looking for efficiencies in medical and insurance processing but also in drug discovery.
AMD’s prowess with hybrid computing through APU’s (Accelerated Processing Units) is a major factor that puts them front and center with generational AI for data centers.
As CEO Su explains in an article in the Next Platform. Emphasis mine.
The big point in the MI300 is that the CPU and GPU are on a single package, using 3D packaging techniques and sharing the same HBM memory space. There is no data movement between the CPUs and the GPUs within the package – they literally share the same memory. This will apparently simplify the programming of hybrid computing.
To accomplish this, we have been developing the world’s first datacenter processor that combines a CPU and a GPU on a single chip,” Su said in her keynote, and clearly she meant package and not chip. “Our Instinct MI300 is the first chip that brings together a datacenter CPU, GPU, and memory into a single, integrated design. What this allows us to do is share system resources, or the memory and I/O, and it results in a significant increase in performance and efficiency, as well as it is much easier to program.”
The Embedded Segment
AMD completed its purchase of Xilinx in Feb 2022 for a price of $49Bn, which added $4.61Bn to its top line in 2022. An expensive purchase, but also valuable, Xilinx had the best operating margins company wide at 50%.
At 50% this is way above Datacenter’s 31% and client and gaming operating margins of 19% and 14%. This was essential to AMD’s survival and growth because both client and gaming are low margin, cyclical businesses and getting a top quality business helps them tremendously with Datacenter as well.
AMD guided for stronger growth in 2023 for the Embedded segment in several verticals such as communications, health care, industrial, aerospace and auto. Several semi companies saw traction in Auto in 2022, specially Nvidia, Mobileye (MBLY) and Qualcomm (QCOM).
One of the biggest competitive advantages with the merger is AMD’s ability to offer customized solutions from a much wider repertoire, which now includes FPGA’s, adaptive S.O.C’s and DPU’s and the use of common software platform, which both companies are heavily invested in.
From an article in fierceelectronics.com, comments from the two C.E.O’s Su and Peng.
With server OEMs, Su said, “it’s very much a customer-specific message…There will be opportunities to do things on the hardware side and I view it as market customization. Doubling down on the software side is key to adoption.” Peng added that initiatives in edge computing and edge cloud systems rely on a common software environment.
We share the view that the common software environment is so important,” Peng added. “Workloads want to customize things. We handle optimization and fast real-time for some heavy compute.” The addition of Xilinx to AMD means a “comprehensive powerful solution tailored to workloads and even endpoints and the cloud,” Peng said.
The Bull Case:
Growth Potential: Both Datacenter and Embedded markets have tremendous potential. Even though AMD treats them as separate segments, growth and market size are classified under Datacenter. As we saw from the several sources in the article, industry growth is pegged at 11%, and AMD has been taking continuous share from Intel and growing much faster. And based on my estimates below, AMD’s revenue growth is likely to be double of Intel’s in the next 4 years.
Strategic Purchase: AMD’s purchase of Xilinx was an excellent and gutsy move, showing that AMD too was thinking strategically and smart enough to diversify from two low margin commodity businesses. Besides, they did it with a stock price of $113!
Embedded and Datacenter have good margins: Both segments also showed solid operating margins of 50% and 31% respectively, effectively stabilizing a ship that was heading into seriously deep waters with the PC and Gaming business in 2022.
There will be growth from Generational AI and high performance computing, which though is concentrated or focus on Nvidia now, will provide enough business for AMD as well. And AMD has been pro-active in enhancing its offerings through the MI300 and APU’s.
The Bear Case
Company wide low GAAP NPM: AMD’s net profit margins on a GAAP basis at 18% for the last 3 years is the lowest amongst its three competitors, including Intel’s; though with Intel’s continuous deterioration this may change. It is 38% lower than Nvidia’s and 31% lower than Qualcomm’s, indicating lower pricing power and cyclicality in its Client (PCs) and Gaming segments, which contributed 55% of AMD’s revenue in 2022.
Valuation: Based on my estimates, AMD’s revenues are expected to grow from $23.6Bn to $40Bn in the next 5 years or a CAGR of 11% and this includes $4.1Bn from Xilinx for which it paid about 10x sales. AMD’s P/S ratio is 6.4, which comes down only to 3.9 in 2027. That is expensive for a company that is not growing as fast because 50% of its growth is weighed down by cyclicals with inventory overhangs and weak demand.
AMD’s earnings are growing at 17% and inexpensive at a PE of 27x, which reduces to 12x by 2027. It also has a PEG below 1. However, these are all based on Non GAAP numbers. On a GAAP basis, AMD had a 2022 EPS of $0.88, which would have made the PE higher than 100. Sure, a large chunk of the GAAP expense is from the impairment charge of $3.55Bn from the Xilinx acquisition, but if we’re accounting for the revenue accretion, we should account for the impairment as well.
Buy or Hold
I’ve owned AMD for years and have made a decent amount of money from it, including some that I picked up in the mid $70’s in February. I definitely believe in the long term story.
However, at $96, the stock has almost doubled from its October low of $54, and gone up 65% from its January low of $60. At this stage, price discipline is a must and the valuation compared to a 11% revenue CAGR and 17% earnings CAGR is too rich for me, especially since I already own it. I rate it as a HOLD for now and will accumulate around $75-$80.