Advanced Micro Devices (AMD 0.69%) stock got a nice shot in the arm recently after Bank of America reiterated its buy rating, indicating that the chipmaker still has room to run higher after its impressive show so far in 2020.
The investment bank expects AMD to hit $65 thanks to catalysts such as the launch of new gaming consoles from Sony and Microsoft. But don't be surprised to see the chipmaker upstage BofA's expectations, as it is sitting on more than just one potential growth driver. In this article, we will look at two reasons why AMD could break beyond Wall Street's estimate.
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The PlayStation 5 and the new Xbox will unlock a new opportunity
BofA believes that AMD could easily hit its price target thanks to the arrival of new consoles, and it is easy to see why it thinks so. In fiscal 2019, AMD's revenue from the enterprise, embedded, and semi-custom (EESC) revenue was down nearly 14% compared to the previous year. Though the business benefited from an increase in demand for AMD's EPYC server processors, dwindling sales of previous-generation consoles hurt sales of semi-custom chips.
But that should change later this year with the arrival of the next-generation consoles. AMD has indicated that it has started ramping up the production of semi-custom chips that will go into the PS5 and the Xbox Series X consoles. The production ramp is expected to gain momentum as the year progresses and the launch date approaches, giving AMD's semi-custom revenue a shot in the arm.
More importantly, the launch of the new consoles could trigger a major upgrade cycle. That's because the installed base of the current and older-generation consoles reportedly stood at 260 million units at the end of 2019. Of that, around 150 million consoles may have been produced in 2015 or earlier, according to Jon Peddie Research.
Given that the next-gen consoles are expected to run games with movie-like graphics, gaming enthusiasts may have a compelling reason to upgrade when the new hardware hits the market. Additionally, the launch of new consoles could prove to be a long-term catalyst for AMD's semi-custom business, as the PlayStation 4 and the Xbox One have reportedly sold over 160 million units since they were launched in November 2013.
As such, AMD's semi-custom business could be in for better times ahead as the gaming console-driven growth engine starts firing.
AMD is making waves in the server processor business
Along with semi-custom chips, the strong demand for AMD's EPYC server processors will be another tailwind for the EESC business. The chipmaker has been gradually eating into market leader Intel's (INTC -1.79%) pie in this space.
Mercury Research had reported that AMD was sitting on 4.5% of the server market at the end of 2019. Market sources cited by DigiTimes anticipate that the market share of AMD's server processors could hit 10% in 2020. That won't be surprising, as AMD is on track to launch its next-generation Milan server processors before the year ends.
With this move, AMD will be able to further refine its existing server processors, which are based on a 7-nanometer manufacturing process. By 2022, AMD is aiming to move to a 5nm manufacturing node that will help it further improve the efficiency and computing power of its chips.
Intel's Xeon server processors, on the other hand, are currently based on a 14nm architecture. The technology advantage has played into AMD's favor so far, and the trend is likely to continue, as Intel's competing 10nm Xeon server processors haven't hit the market yet. Chipzilla was expected to launch the 10nm-based Xeon processors in the first half of 2020, but that was delayed to the latter part of the year.
Not surprisingly, server OEMs (original equipment manufacturers) have started tilting toward AMD. Lenovo and NVIDIA are two key server wins that AMD has landed of late, and more such contracts could further strengthen the chipmaker's position in this space. If that happens, AMD stands to win big. The server CPU (central processing unit) market is anticipated to be worth $19 billion by 2023, and AMD is just scratching the surface -- its market share is still in the mid-single digits.
Why the stock remains a buy
The EESC segment supplied 30% of AMD's total revenue in fiscal 2019, so a turnaround in this segment should positively impact the company's overall financial performance this year, especially considering that the client and computing segment that accounts for the remaining revenue is already in good stead.
At the same time, AMD seems to be trading at a "relatively" attractive valuation right now. Its price-to-earnings ratio of nearly 130 is lower than the five-year average multiple of 136, and is much lower than last year's average multiple of 241. While this isn't cheap by any means, investors shouldn't forget that AMD is aiming to deliver terrific revenue growth this year despite the cloud of the novel coronavirus pandemic.
As such, investors looking for a growth stock can continue counting on AMD, as it has room to run higher.
