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The market continues to make all new all-time highs at the time of this writing as measured by the S&P 500 (SP500, SPX). The NASDAQ (COMP.IND) is pushing to get back to the highs in 2021. We have seen this largely led by a massive, and some would say parabolic, move, in the semiconductor sector, as well as the end users of these products in the middle of this AI boom.
This momentum has been strong. We have profited extremely handsomely at our investing group from this move, but publicly, we have covered and suggested two stocks in the space, Super Micro Computer (SMCI) and Advanced Micro Devices, Inc. (NASDAQ:AMD). Both stocks have surged, but in this column, we follow back up on our recent public trade with AMD.
So what to do with AMD? Growth is ahead, particularly in data center, although gaming has been mixed. If you are a student of our Investing Group, then you are likely running a house position after the last trade set up. For reference, here is that trade we suggested, as we were buying when AMD was on the verge of going into a bear market last year:
The suggested play
Target entry 1: $106-$107 (25% of position).
Target entry 2: $101-$102 (35% of position).
Target entry 3: $96-$97 (40% of position).
Stop loss: $88.
Target exit: $128.
Options considerations: Option considerations were reserved for members of our investing group
Note: This trade was an example of what members receive along with the research at our investing group. After hitting an exit target we always suggest moving gains into a house position for long-term investment.
Discussion
So we successfully saw this trade execute. Now shares are in the $170’s, and the space has really started to move parabolic. Folks, it is great to see for longs, but we must be realistic. This cannot continue forever. Chasing these stocks here is dangerous. The broader market has been on a massive run, and it will not take much for a correction to ensue. We suspect one is coming for markets, just statistically speaking. What the trigger is, that remains unknown. Will it be a Fed that is resistant to rate cuts? Will it be a yield surge? A macro event internationally? A failed bank? Reports of slowing AI demand? The debt burden of the United States or other nations?
There is a lot going on. Sentiment remains strong right now, so we remain cautiously bullish. But, we suggest letting the house position run. New money should try and hold it for a correction. One approach is buying a little bit now, then scaling in during a correction.
Remember, chips are cyclical, but we just saw the bottom of a cycle a few quarters ago. We covered this substantially. Is the performance of AMD worth buying? Yes, but we suggest being patient after this huge move. With that said, the earnings performance in Q4 supports a buy on this large pullback, in our opinion. The future remains bright.
Performance was strong in Q4
The AMD Q4 earnings were overall strong. The headline results were above consensus for revenue. The AI revolution is boosting operations. That said, in Q4, revenue was $6.2 billion and increased 10.7% year-over-year. Sequentially, we were up from Q2’s $5.6 billion. There was mixed performance in most segments from last year, however.
One item we watch closely is gross margins, and these have been under some pressure in recent quarters. AMD’s GAAP gross margins were 47%, rising from 43% from a year ago. It was flat from Q3’s 46%. So, we are seeing progress here, for the most part. Adjusted gross margins were, however, 51%. This was flat from a year ago, and flat from Q3.
When we last covered AMD stock with our winning trade, we suggested margins have bottomed out. We stand by that call
Operating income on the rise
As the revenues and adjusted margins improved, AMD saw an increase in gross profit. The one negative we saw was that operating expenses were elevated, flat on a GAAP basis from a year ago but rising 8% on an adjusted basis. From the sequential quarter, we were up 2% on a GAAP and adjusted basis. With higher revenue and margin, this offset the operating expense increases and led to operating income improving.
AMD Chair and CEO Dr. Lisa Su stated:
“We finished 2023 strong, with sequential and year-over-year revenue and earnings growth driven by record quarterly AMD Instinct GPU and EPYC CPU sales and higher AMD Ryzen processor sales. Demand for our high-performance data center product portfolio continues to accelerate, positioning us well to deliver strong annual growth in what is an incredibly exciting time as AI re-shapes virtually every part of the computing market “
We view this commentary positively, but the CFO, Jean Hu did note that there was a “mixed demand environment.” In Q4, AMD’s operating income, as adjusted, fell and was $1.41 billion, up 12% from $1.26 billion a year ago. Putting it altogether, AMD’s net income rose to $1.25 billion, up 12% from last year, and up 10% sequentially. Earnings per share were $0.77 vs. $0.69 last year. The company has a great balance sheet, and issued a positive outlook in our estimation.
AMD still has a great balance sheet
Make no mistake, the AMD balance sheet remains healthy. At the end of 2023, cash was $3.9 billion. Net cash from operations was $381 million, though this was down compared to $567 million a year ago for Q4, on the back of higher liability expense. Free cash flow was also a bit lower, at $242 million compared to $297 million a year ago. This is one point that gave us a bit of pause, but remains positive. Total debt remains manageable at $2.47 billion.
Outlook for 2024
So, in this AMD quarter we saw strong data center demand, though a bit of gaming weakness. Some of that coincides with the gaming cycle, titles, platforms, etc. It varies. AI is the main demand generator and will fuel future revenues. We still think it is prudent to wait for a pullback after such a run, or to scale in. For Q1, the outlook was not all that strong. It was fine, but nothing overly impressive in our opinion. Revenue looks to be $5.1-$5.7 billion, with data center revenue flat from Q4. The company is projecting sequential declines in all other segments. Where there is some control is on expenses, as adjusted gross margin is projected to be 52%.
Our view for the year 2024 on revenues is for mid-teen (double-digit) increases. We are looking for $25.8-$27.8 billion. We see revenue strength ramping later into 2024. Assuming at least a 50% margin for the year, and even roughly comparable capex and opex, we see EPS of $3.60-$4.20 for 2024 as likely. This means shares are pretty expensive despite the growth. While the earnings have reversed from a 2023 dip, and will rise from $2.65, you need to be cautious. AMD stock is not cheap, at nearly $180 per share, we are 45X FWD EPS. Very richly valued, just like the sector.
Take-home
Advanced Micro Devices, Inc. stock was a great trade, like the others we made in the space. You should be running with some house money here. What is dangerous is chasing this growth. The sector has started to move parabolic and there is FOMO here in our opinion as evidenced by the surging valuations.
The Advanced Micro Devices, Inc. earnings are growing and justify a higher share price, but no stock or sector can run forever. It is great while it lasts, but new money should really wait for some corrective action in our opinion. Alternatively, if we are wrong, at least start with a small position, and if it goes up, great. But the risk-reward here is getting lopsided in the unfavorable direction.
