Computer processor maker AMD (NASDAQ:AMD) reported results in line with analysts' expectations in Q2 FY2023, with revenue down 18.2% year on year to $5.36 billion. However, next quarter's revenue guidance of $5.7 billion was less impressive, coming in 2.56% below analysts' estimates. Turning to EPS, AMD made a non-GAAP profit of $0.58 per share, improving from its profit of $0.27 per share in the same quarter last year.
AMD (AMD) Q2 FY2023 Highlights:
- Revenue: $5.36 billion vs analyst estimates of $5.32 billion (small beat)
- EPS (non-GAAP): $0.58 vs analyst estimates of $0.57 (1.03% beat)
- Revenue Guidance for Q3 2023 is $5.7 billion at the midpoint, below analyst estimates of $5.85 billion
- Free Cash Flow of $254 million, down 22.6% from the previous quarter
- Inventory Days Outstanding: 154, up from 143 in the previous quarter
- Gross Margin (GAAP): 49.5%, down from 52.4% in the same quarter last year
Founded in 1969 by a group of former Fairchild semiconductor executives led by Jerry Sanders, Advanced Micro Devices or AMD (NASDAQ:AMD) is one of the leading designers of computer processors and graphics chips used in PCs and data centers.
AMD began producing computer processors (CPUs) as a second source supplier for Intel as part of Intel’s original processor deal with IBM for the first PCs in the early 1980s.
For the next few decades, AMD would have intermittent success in creating its own chips that could better run Intel's own x86 processor architecture, at times grabbing market share from Intel in the data center with innovative designs like Athlon or Opteron, it was not able to find enduring competitive success.
Faced with bankruptcy after the Great Financial Crisis, AMD spun out its manufacturing arm, Global Foundries, becoming a far less capital intensive designer of semiconductors, allowing for higher profit margins The entrance of Dr. Lisa Su as CEO in 2016 led to a turning point in chip designs, AMD’s Epyc datacenter CPUs and the Ryzen PC CPUs would eventually surpass Intel due to superior higher performance at lower cost.
Where AMD traditionally could only compete with Intel at the low end, in the years since 2016 it has captured share in the most profitable portion of the business — high-end PCs and data center servers, where performance is paramount. Essentially, AMD improved the economics of its business by outsourcing its manufacturing, and competing successfully, but partnerships with chip manufacturers like Taiwan Semiconductor Manufacturing Company will be important for enduring success.AMD’s primary competitors are Intel (NASDAQ:INTC), Nvidia (NASDAQ:NVDA), and Qualcomm (NASDAQ:QCOM).
Processors and Graphics Chips
Chips need to keep getting smaller in order to advance on Moore’s law, and that is proving increasingly more complicated and expensive to achieve with time. That has caused most digital chip makers to become “fabless” designers, rather than manufacturers, instead relying on contracted foundries like TSMC to manufacture their designs. This has benefitted the digital chip makers’ free cash flow margins, as exiting the manufacturing business has removed large cash expenses from their business models.
AMD's revenue growth over the last three years has been impressive, averaging 46.8% annually. But as you can see below, its revenue declined from $6.55 billion in the same quarter last year to $5.36 billion. Semiconductors are a cyclical industry, and long-term investors should be prepared for periods of high growth followed by periods of revenue contractions (which can sometimes offer opportune times to buy).
This was a slow quarter for the company as its revenue dropped 18.2% year on year, in line with analysts' estimates. This could mean that the current downcycle is deepening.
Product Demand & Outstanding Inventory
Days Inventory Outstanding (DIO) is an important metric for chipmakers, as it reflects a business' capital intensity and the cyclical nature of semiconductor supply and demand. In a tight supply environment, inventories tend to be stable, allowing chipmakers to exert pricing power. Steadily increasing DIO can be a warning sign that demand is weak, and if inventories continue to rise, the company may have to downsize production.
This quarter, AMD's DIO came in at 154, which is 59 days above its five-year average, suggesting that the company's inventory has grown to higher levels than we've seen in the past.
In the semiconductor industry, a company's gross profit margin is a critical metric to track because it sheds light on its pricing power, complexity of products, and ability to procure raw materials, equipment, and labor. AMD's gross profit margin, which shows how much money the company gets to keep after paying key materials, input, and manufacturing costs, came in at 49.5% in Q2, down 2.9 percentage points year on year.
AMD's gross margins have been trending down over the last 12 months, averaging 50%. This weakness isn't great as AMD's margins are already slightly below the industry average and falling margins point to potentially deteriorating pricing power.
AMD reported an operating margin of 19.9% in Q2, down 10.3 percentage points year on year. Operating margins are one of the best measures of profitability because they tell us how much money a company takes home after manufacturing its products, marketing and selling them, and, importantly, keeping them relevant through research and development.
AMD's operating margins have been trending down over the last year, averaging 21.4%. This is a bad sign for AMD, whose margins are already below average for semiconductor companies. To its credit, however, the company's margins suggest modest pricing power and cost controls.
Earnings, Cash & Competitive Moat
Analysts covering AMD expect earnings per share to grow 42.7% over the next 12 months, although estimates will likely change after earnings.
Although earnings are important, we believe cash is king because you can't use accounting profits to pay the bills. AMD's free cash flow came in at $254 million in Q2, down 72% year on year.
As you can see above, AMD produced free cash flow of just $1.87 billion in the last year, resulting in a measly 8.48% free cash flow margin. AMD will need to improve its free cash flow conversion if it wants to stay competitive.
AMD's average return on invested capital (ROIC) of 43% over the last five years implies that it has a strong competitive position and was able to invest in profitable growth over time.
Key Takeaways from AMD's Q2 Results
Sporting a market capitalization of $170 billion, more than $6.29 billion in cash on hand, and positive free cash flow over the last 12 months, we believe that AMD is attractively positioned to invest in growth.
It was encouraging to see AMD narrowly top analysts' EPS expectations this quarter. That really stood out as a positive in these results. On the other hand, its revenue guidance for next quarter underwhelmed and its operating margin shrunk. Overall, the results could have been better. The stock is flat after reporting and currently trades at $104.66 per share.
Is Now The Time?
AMD may have had a bad quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity. There are several reasons why we think AMD is a great business. For a start, its superb revenue growth implies that it's winning market share, and that growth rate is even expected to increase in the short term. And while its growth is coming at a cost of significant cash burn, the good news is its high ROIC suggests it is well run and in a strong position for profitable growth.
AMD's price-to-earnings ratio based on the next 12 months is 29.3x. Looking at the semiconductors landscape today, AMD's qualities stand out, and we like the stock at this price.
Wall Street analysts covering the company had a one year price target of $134.3 per share right before these results, implying that they saw upside in buying AMD even in the short term.
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