What's Next for Advanced Micro Devices?

As AMD struggles in key segments of the PC market and sees its visual chip business peak, should investors buy at the bottom in hopes of a value opportunity?

Jul 22, 2014 at 3:00PM

Advanced Micro Devices (NASDAQ:AMD) may have seen its second-quarter revenue grow 24.1%, but it was only because of a 141% increase in the company's graphics & visual solutions chips revenue. Meanwhile, its PC and server chips segment saw a 20% year-over-year decline in sales, despite peer Intel (NASDAQ:INTC) thoroughly impressing Wall Street with 6% growth in the same segment. Therefore, as graphics and visual chips carry AMD, should you take a leap and buy on the stock weakness?

Wall Street responds to AMD
AMD's stock has fallen nearly 20% in a two-day span following an earnings report that missed expectations to compliment weak guidance. Clearly, the company's weak performance in the PC and server space was in-focus, as this was an area where many investors thought AMD would be strong, especially following Intel's quarter just days before.

However, when it comes to PCs and servers, AMD and Intel are obviously on different ends of the spectrum. Thus, AMD investors are left hoping that strong sales from graphics and visual chips are sustainable. Yet, according to its CEO, Rory Read, those wishes may not be a reality.

What happens next?
For those unfamiliar with AMD's graphics and visual chip business, the company develops the chips used in PlayStation 4 and Xbox One game consoles. In previous years, this was a smaller piece of AMD's business, but due to strong growth, it currently accounts for about half of total revenue.

In 2013, both consoles launched, and with half a decade since a system refresh, demand was quite high for both systems, which have sold more than 14 million units combined since last year. Nonetheless, AMD receives a pretty penny for its part in the hardware, estimated to be between $70-$100 for each system sold. The problem is that such high demand is not sustainable long-term and is historically a low margin business.

With that said, the company doesn't seem to enthusiastic that strong console sales are sustainable through 2014. In fact, AMD expects the third quarter to be its peak quarter for APU (graphic chips) shipments. Furthermore, when asked about this expected drop-off in shipments, Read gave no response, providing no forecast for the fourth quarter or beyond. This, combined with a 10% quarter-over-quarter rise in inventory, has given investors a real reason to feel spooked in looking ahead to the next quarter and beyond.

Failing to make a splash in refreshed PC market
As a result, investors can conclude that once shipments begin to die down, AMD will be left with its core PC CPU/GPU chip business. For investors, this is a problem, as AMD has very little exposure to the higher-margin corporate PC market, which has seen strong growth in 2014 and has been a staple in Intel's strong fundamental performance.

Intel spoke directly on its conference call about signs of an enterprise PC refresh cycle, which is something AMD is failing to experience. Instead, AMD has seen strong performance in other segments of the PC market, such as low-end, where PCs and laptops are built cheaply and carry particularly low margins.

Foolish thoughts
In retrospect, AMD is lagging in the areas where it needs to be strong, outperforming in those where it's better to be weak, and is seeing its single growth driver lose steam. On the contrary, Intel is doing the exact opposite, and the difference is its stock sits at 10-year highs while remaining a favorite among analysts.

Albeit, at 22.3 times forward earnings, it's hard to see much value in AMD, a beaten-down stock that lacks fundamental direction. Moreover, considering the woes that surround it, investors would likely be best suited by putting money to work elsewhere, such as with Intel.

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Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel. 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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