Why Advanced Micro Devices Should Outperform Intel

If PC sales rebound, think of AMD like a never expiring option in the PC space

Jun 24, 2014 at 5:00PM

Assuming PC sales rebound, is Advanced Micro Devices (NASDAQ:AMD) or Intel (NASDAQ:INTC) a better buy? The answer is AMD, and here's why.

What's good for Intel and Micron is also good for AMD
For the second quarter, Intel is projecting revenue of $13.7 billion, which is about $700 million higher than the previous midrange guidance of $13 billion. In addition, it also expects some revenue growth for the full year, up from a prior estimate for flat sales. This is a sign that PC sales are on the rebound. 

But Intel is not the only sign that PC sales are coming back. Bank of America Merrill Lynch upgraded Micron Technologies (NASDAQ:MU) from an underperform to a buy rating, with a price target of $40 a share from a previous $22. One of the reason for this aggressive upgrade was "a favorable chip pricing environment as a result of relatively tight supply." 

So, if the general climate is good for Intel and Micron, it should also be good for AMD.

AMD's revenue has been going up despite lower PC sales
Lower PC sales aside, AMD's revenue has been going up mostly because it is the core technology provider behind Nintendo's Wii U, Sony's PS4, and Microsoft's Xbox One.

And if AMD's CFO Devinder Kumar is correct -- at a recent BoA Merrill Lynch technology conference, he said console life cycles "are probably going to be shorter" -- that might mean higher churning in the console space and more business for AMD longer term.

AMD has many other things going for it that should sustain its current revenue trajectory. For example, Mark Papermaster, AMD's chief technology officer, said that AMD aims at a 25-fold improvement in the energy-efficiency of its products by 2020, using a series of design techniques that go beyond those that have historically come from shrinking transistors on chips.

AMD isn't aiming just at reducing power consumption, but also boosting computing performance at the same time. That combination could help drive AMD's chips, which are now mostly in laptop and desktop PCs, into more tablets and smartphones. Sam Naffziger, an AMD researcher, sees about a five-fold increase in computing capability for the typical laptop while drawing about one watt of power, down from five watts or so today. That means typical battery life would go far beyond the current typical maximum of eight to 10 hours, to several days, claims Naffziger. 

AMD's leveraged balance sheet has been holding the stock back
One of the problems with AMD is that it is highly leveraged, meaning it has a very high debt-to-equity ratio -- currently standing at 4.18. On the plus side, however, most of this debt is long term, and the company does not face any liquidity problems. The quick ratio currently stands at 2, which is very healthy.

AMD Debt to Equity Ratio (Quarterly) Chart

AMD Debt to Equity Ratio (Quarterly) data by YCharts.

So, how will leverage help AMD perform better?
Let's say an omnipotent being tells you the S&P 500 index will climb to 5,000 in the next six months. Obviously, if you buy an ETF that follows the index, you will do good, but why not do better? If you know for a fact that the Index will go that high, why not buy the most leveraged ETF you can find? In fact, why not buy the most leveraged ETF you can find -- and double up on margin also? This is basically the reason AMD will perform better than Intel if PC sales come back.

If PC sales come back and AMD's revenues continue to rise (as has been the case over the past several quarters), that will help the company became profitable and lower its debt. If that happens, then it should perform better, because AMD is trading at depressed levels because of its high debt load. 

AMD PS Ratio (TTM) Chart

AMD PS Ratio (TTM) data by YCharts.

One way to chart just at how depressed AMD is trading compared to Intel is the price-to-sales ratio.  As you can see in the above chart, Intel's price-to-sales ratio stands at 2.9, where AMD's is 0.55.

If AMD can fix its balance sheets issues over the next several years, then the market should view the stock more favorably, and AMD should trade more along the lines of Intel relative to its revenue (if it lowers its debt, that is).

So, how much can AMD outperform Intel, assuming PC sales will continue to improve, and assuming AMD can lower its debt? In theory, if AMD trades similar to Intel on a price-to-sales ratio basis in the future, it has to increase fivefold to trade on par with Intel. So if PC sales come back, think of AMD as an option that never expires in the PC space.

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George Kesarios has no position in any stocks mentioned. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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