3 Reasons Advanced Micro Devices, Inc. Stock Could Fall

Here are three reasons AMD's stock could fall from current levels.

Aug 26, 2014 at 10:23AM

Shares of Advanced Micro Devices (NASDAQ:AMD), which designs PC processors, graphics processors, and semi-custom chips, have had some pretty wild swings. However, despite the volatility, the company's stock is up just a hair under 10% year to date.

As with any company, there are bullish and bearish investors. Here are three reasons investors might be bearish on shares of AMD. 

Concerning top line for computing solutions
While AMD has clearly indicated that it wants to lessen its exposure to the PC market by expanding into other chip markets, the reality is that the company still gets a large portion of its revenue from selling processors into laptops and desktops.

Amd

AMD's plan to diversify its end markets. Source: AMD. 

During its most recent quarter, AMD reported that its Computing Solutions division (which consists largely of PC processor sales) saw a year-over-year decline in sales from $841 million to $669 million. 

Though weakness in the overall PC market is partially to blame, AMD's chief competitor, Intel (NASDAQ:INTC), reported that its PC Client Group revenue was up 6% year over year in its most recent quarter. These numbers imply that AMD continued to lose PC processor market share.

On the bright side, AMD reported that operating income for its Computing Solutions division rose from $2 million to $9 million year over year. This increase was driven by, according to commentary from AMD's CFO, the sale of higher margin laptop chips, as well as a "$3 million benefit from sales of inventory reserved in Q3 2012."

Debt is still an issue
AMD reported having approximately $2.21 billion in debt on the balance sheet and, unsurprisingly, needs to pay interest on that debt. One problem that AMD continues to face is that its quarterly operating income is still low enough that the interest that it pays on that debt eats away significantly at its bottom line.

To illustrate, even though AMD generated $63 million in operating income during the quarter, it reported interest expense of $46 million -- or approximately 73% of its operating income -- to service its debt. 

Worse yet, if AMD can't sufficiently ramp up its operating income and start generating a healthy profit after interest expenses, it could have difficulty paying this debt by the time the principal is due. 

Fortunately, AMD's management has structured its debt so that the company has ample time to try to significantly improve its business. AMD's first large chunk of debt, $600 million worth of 6.75% senior notes, is not due until 2019.

Lower research and development spending is a red flag
The lifeblood of any technology company is strong research and development. This is particularly true in the highly technical world of semiconductors.

One long-term concern for the company has been the steep decline in its research and development spend over the past several years.

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AMD's R&D spending is down significantly over the last several years. Source: YCharts. 

The following chart shows that AMD's research and development spending trends opposite that of its peers in the semiconductor industry:

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Source: YCharts. 

Finally, on an absolute research and development spending basis, AMD again looks weaker than its peers:

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Source: YCharts. 

The lower research and development wouldn't be too much of a concern if AMD were signaling that it intended to narrow its scope, but this doesn't appear to be the case. In fact, it appears as though AMD still plans to compete in roughly the same areas that it has traditionally played in (PC processors, discrete graphics, and server processors) but is, overall, investing less. 

Will it be able to prove competitive against, say, Intel in the PC and server space with a dramatically smaller research and development budget? What will ultimately need to give to support this lower cost structure?

Only time will tell, but there are legitimate reasons to be bearish. 

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Ashraf Eassa owns shares of Intel. The Motley Fool recommends and owns shares of Apple and Intel. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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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