Advanced Micro Devices, Inc. (NASDAQ:AMD) has everything going for it to exceed expectations once again in the coming quarters. The PC market and data center markets are recovering, gamers are about to reaccelerate their purchases of games next year, and the demand for AI chips continues to increase with each passing quarter. All of those things are likely going to become major growth catalysts for AMD, which has already outperformed expectations in recent quarters and could do so in the future as well once the management scales the sales of the company’s AI chips next year.
However, I’m downgrading my rating from BUY to HOLD, as macro risks along with the valuation concerns leave little margin of safety for buying AMD’s shares at the current price. That’s why I believe that it makes sense to take the profits now and reenter the position later at a lower price if the shares depreciate.
It’s All About AI
A few weeks ago, AMD reported its Q3 earnings results. They showed that the company’s revenues increased by 4.1% Y/Y to $5.8 billion and beat the expectations by $110 million, while its non-GAAP EPS of $0.70 was above the estimates by $0.02.
One of the biggest positive things from the report was the indication that the PC market is finally recovering as the company’s client segment generated $1.5 billion in revenues during the quarter, up 42% Y/Y. At the same time, even though the gaming revenues were down 8% Y/Y to $1.5 billion, there’s an indication that the gaming market is likely to improve in the foreseeable future and make it possible for AMD to generate solid returns in this segment as well.
When it comes to the data center business, it managed to generate $1.6 billion in revenues in Q3, flat Y/Y. However, despite such a mixed performance in this segment, there are reasons for optimism going forward. One of the biggest highlights from the latest conference call was the news that AMD is about to accelerate the volume production of its MI300A and MI300X GPUs in the following quarters, which could potentially take some portion of the market share from the current market leader Nvidia (NVDA). The company’s CEO Lisa Su has also forecasted that that series of chips will also be able to generate $2 billion in sales in 2024.
While such guidance has disappointed some investors, as a $2 billion figure is not that big in comparison to the competition, there’s a possibility that AMD would be able to exceed this forecast in 2024. This is due to the fact that the demand for AI chips remains significant to this day and the upside is not fully understood just yet. That’s why there’s a possibility that sales will scale later in 2024 when the GPUs will properly hit the market.
That’s also one of the main reasons why the guidance for Q4 has been relatively weak and below the consensus, as the acceleration of sales is expected only next year. If we look at the latest street estimates, we’ll see that a double-digit revenue growth rate is indeed expected only in 2024 and beyond.
Major Risks To Consider
AMD without a doubt was a decent momentum play in recent weeks, as the positive performance in Q3 along with the influx of positive macro data made it possible for the stock to rally and trade close to its 52-week highs. However, despite the recovery of industries in which AMD participates and the upcoming scaling of the production and sales of its AI chips, it’s hard to justify the company’s current valuation.
As of today, AMD trades at over 40 times its forward earnings, while the market’s average P/E is ~25x. What’s more, is that the company has received several dozens of downward revisions in recent weeks due to the relatively weak outlook for Q4, while Seeking Alpha’s Quant system gives the company a rating of D- for valuation. On top of that, my discounted cash flow (“DCF”) model, which was published along with the latest article on the company in August and assumed a top line growth rate of 20.1% in FY24 and beyond, showed that AMD’s fair value is $93.55 per share. Considering that the latest downward revisions indicate the growth rate is likely to be lower, it’s safe to assume that AMD’s fair value could be lower than my calculations previously showed. As such, it makes it hard to justify opening a long position at this stage given the lack of margin of safety or a meaningful upside.
What’s more, is that the geopolitical risks are not going away anytime soon as well. Despite the latest meeting between the Presidents of the U.S. and China, the Sino-American trade war is still not over, and chip export restrictions are unlikely to go away in the foreseeable future. Back in August, Nvidia warned that additional chip export restrictions would end its ability to compete in China. Considering that China is the second biggest market for AMD, it’s likely that the company’s ability to sell its AI chips there could be limited as well, which could limit its overall upside in 2024.
At the same time, there are questions about whether AMD would be able to take a significant portion of the GPU market from Nvidia in the first place. This is mostly because the revenues of Nvidia are expected to increase by over $20 billion in the next fiscal year thanks to the scale of sales of its flagship AI chips. Considering that AMD believes that its own AI chips will be able to generate only $2 billion in the next fiscal year, it’s hard to see how the company will be able to outcompete its closest peer. While a $2 billion increase in revenues is still impressive and the company’s top line growth rate is expected to return to double-digits next year and beyond, some investors might simply stick with Nvidia to potentially generate better returns.
The Bottom Line
AMD reported solid Q3 results and has the potential to generate decent returns in the future as it scales the production and sales of its AI chips in the following quarters, while the core industries in which it’s a significant player recover. However, after the latest rally that started at the beginning of this month, AMD’s stock offers little margin of safety for investors at the current price.
If the macro and geopolitical risks once again begin to outweigh the growth opportunities, then it’s safe to say that Advanced Micro Devices, Inc. shares could tumble at an accelerated pace in such a scenario. That’s why I’m optimistic about AMD’s business for the future, as it’ll likely grow at a double-digit rate next year thanks to the scaling of sales of its AI chips. However, I also believe that buying its stock is a risky endeavor with minimal upside at the current price.
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