Advanced Micro Devices: Takeaway From Investor Day

Investor Day provided a little more clarity on where Advanced Micro Devices (AMD) is headed. Ryzen is set to benefit from multithreading. Epyc can steal market share given that it outperforms in terms of total cost of ownership. Advanced Micro Devices seems more confident about Vega. More importantly, the company has provided growth figures along with a long-term earnings guidance that gives us a good point of reference from a valuation perspective. Let’s take a detailed look.

Advanced Micro Devices goes multithreading

Ryzen has better multithread performance, thanks to higher core/threads. However, due to a lower IPC, the processor lags in single-thread performance. AnandTech notes,

“Having a big set of cores as an alternative is something interesting for end users, especially as more work flows and gaming titles rely on multithreading to scale.”

Advanced Micro Devices acknowledges that. It introduced a high-end desktop processor code-named threadripper during the analyst day. The chip will feature 16 cores with a capability of running 32 threads. Advanced Micro Devices is also planning to launch a mobile chip this year featuring integrated Vega Graphics. The company claims that the chip will provide a 40% graphics boost. Overall, Ryzen is set to compete across markets ranging from the high-end market to the mobile PC market.

Multithreading is Advanced Micro Devices’ answer to Intel’s IPC dense offerings in the high-end market.

The company can also compete on pricing. In the midmarket, Ryzen is also a better option for multitasking applications and gives the company an edge over Intel’s (INTC, Financial) offerings. The notebook market will also see an increased demand for Ryzen chips given improved graphics amid Vega integration.

On the flip side, Intel's marketing strength and ability to compete on pricing will influence the number of chips Advanced Micro Devices actually manages to sell. Because of that, it’s really difficult to foresee Advanced Micro Devices' market share until it can actually be seen.

Epyc’s fate is in the hands of power draw

Advanced Micro Devices showed its data center chip, Epyc, during analyst meeting day. The data center chip has 45% more cores, 122% more memory bandwidth and 60% higher I/O bandwidth as compared to the counterpart. Lisa Su is eyeing the growing data center market. As Intel almost exclusively holds the data center market, this seems to be a good opportunity for Advanced Micro Devices if it manages to compete in terms of total cost of ownership.

Epyc should compete on total cost of ownership. Lower performance/watt is what matters the most for data centers. Also, power consumption of motherboards is a key factor when weighing on the total cost of ownership.

Advanced Micro Devices is eyeing the 1S market that unnecessarily upgrades to the 2S only for memory and I/O scaling.

Advanced Micro Devices, through a sponsored research, argues that overprovisioned servers add to the total cost of ownership in terms of incremental motherboard costs and increased power consumption. For instance, four DIMMs may consume up to 30 additional watts. Epyc’s higher core count solves the memory and I/O scaling problems enabling purpose built 1S designs. Advanced Micro Devices didn’t mention how Epyc racks up against Xeon in terms of power draw.

Total cost of ownership (TCO) benefits from 1S scaling can be offset by a higher power draw of Epyc as it features additional cores.

It’s a significant concern that Advanced Micro Devices didn’t provide some color on Epyc’s power draw despite signifying the importance of power in TCO. All in all, the success of Epyc depends largely on TCO. Advanced Micro Devices can steal market share if it performs on this front. Anyhow, it will become clearer once the company provides more details on power draw.

Regarding Vega, Advanced Micro Devices is planning to launch it first in the professional market indicating the company has confidence in its product. Further, launching in the professional market will help Advanced Micro Devices enhance its margin and offset operational costs.

Outlook and valuation

The company is guiding for a double-digit revenue growth until 2020. Gross margin is also expected to increase to 40% by 2020. Margin growth will be supported by data center growth followed by market share increase in professional GPU. On the Ryzen side, margin expansion isn’t in the cards. To penetrate high-end CPU market, Advanced Micro Devices has to compete on pricing. In the mid- to low-end market, there isn’t enough margin to play with.

Success of Epyc and Vega can trigger margin expansion for the company going forward.

From a valuation perspective, the company finally provided something to work with. Before now, it was just assumptions and scenarios about market share gain, revenue and EPS of Advanced Micro Devices. The company expects a long-term non-GAAP EPS of more than 75 cents. This gives us a base case valuation metric. Earnings per share of 75 cents give Advanced Micro Devices a forward long-term price-earnings (P/E) of 16. Intel is trading around 12 while NVIDIA Corp. (NVDA) trades around 35. Given the mix of CPU and GPU, Advanced Micro Devices might be priced for perfection.

Assuming Advanced Micro Devices achieves its EPS target by 2020 and using an EVA approach for the valuation reveals the following:

Focus Equity Estimates

Valuation assumes earnings growth of 15% during 2020-2022. Earnings are assumed to be 75 cents in 2020, which is in line with management’s guidance. Cumulative cost of equity is expected to grow at 7.5% during 2017-2022. Valuation reveals that the stock is priced for perfection. Note that the price target holds only if the company manages to deliver on its targets set for Ryzen, Epyc and Vega.

Final thoughts

Advanced Micro Devices is in the midst of a great turnaround as it looks to challenge Intel across desktop, mobile and data center. Vega might be able to crack into HPC markets. Most of the good news is already baked in the price.

Unless you are convinced that management is too cautious about growth and earnings guidance, Advanced Micro Devices' stock doesn’t have much upside. On the other hand, downside can be initiated by missing the guidance, management missteps or poor operational execution.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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