Will Advanced Micro Devices Stock Rally 50% in 2015?

By Markets Fool.com

Is chipmaker AMD , which lost 39% of its market value over the past year, a contrarian bet which could bounce back later this year?

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Several Wall Street firms think so. Wells Fargo, which has an "outperform" rating on the stock, recently maintained its $3.00 to $3.50 price target on AMD. FBR & Co., which rates AMD as a "hold", also set a price target of $3.50. Could AMD really hit $3.50 -- which is nearly 50% higher than its current price -- or is it just wishful thinking?

Source: AMD

Understanding the bear case
To understand the bull case for AMD, we should first discuss its main problems.

AMD's business is split into two main units -- Computing & Graphics and EESC (Enterprise, Embedded, and Semi-Custom). The Computing and Graphics unit sells x86 chips, APUs, GPUs, and add-in graphics cards. The EESC unit sells embedded chips and SoCs for other products, such as microservers and game consoles.

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AMD's Computing & Graphics division is being crushed between Intel in x86 chips and Nvidia in graphics chips and add-in cards. AMD currently controls single-digit market shares of the notebook and server CPU markets, and less than 20% of the desktop market, according to IDC. In add-in graphics boards, AMD controlled just 24% of the market at the end of 2014, compared to Nvidia's 76% share, according to JPR.AMD's EESC unit has fared better, thanks to strong demand for gaming consoles.

Unfortunately, neither business posted sales growth last quarter.

1Q Revenue

YOY growth

% of 1Q Revenue

Computing & Graphics

$532 million

(38%)

52%

EESC

$498 million

(7%)

48%

Source: AMD quarterly earnings report

Average selling prices declined at both divisions. The Computing and Graphics unit reported an operating loss of $75 million, down from a profit of $3 million in the prior year quarter. Operating income at EESC fell 47% annually to $45 million. AMD's total revenue fell 26% year over year as its net loss widened from $20 million to $180 million.

Finding the silver lining
Despite all those gloomy figures, AMD stock is technically undervalued based on its price-to-sales ratio of 0.35. By comparison, Intel and Nvidia respectively trade at 2.8 and 2.4 sales.

However, Intel and Nvidia's sales are consistently rising, while AMD's are plunging. So until AMD can post stable revenue growth again, its P/S ratio can't be considered a reliable metric of the stock's "cheapness."

AMD Revenue (TTM) Chart

Source:YCharts

To get that growth back on track, AMD discussed two long-term strategies during its analyst day in early May.

First, AMD intends to focus on three higher-margin, higher-growth markets -- gaming, immersive (virtual/augmented reality) platforms, and data centers. In 2016, AMD will return to the high-end market with Zen, a new x86 CPU design. Zen's ARM based sibling, K12, will arrive the following year. AMD hopes that offering higher performance chips will help it gain ground in the desktop and data-center markets against Intel.

Second, AMD plans to avoid crowded low-margin markets like smartphones, tablets, and IoT client devices. That might be a smart move, considering how heavily Intel subsidized its mobile partners just to gain a toehold in the market.

AMD's long-term goal
Based on those plans, AMD unveiled a long-term growth model for its revenue and operating margins.

Flat to down

Mid-single digit % growth

Double-digit % growth

Revenue

PCs

GPUs, Semi-custom

Pro graphics, server, embedded

Operating margin

PCs, GPUs

Pro graphics, server, embedded, semi-custom

Source: AMD presentation

If AMD can hit those targets, it expects to claw its way back to annual earnings of $0.50 per share. AMD didn't set an exact date for that forecast, but analysts on average still expect AMD to post a loss of $0.24 per share in fiscal 2015.

Source: AMD presentation

Much of AMD's future depends on its ability to avoid costly battles with entrenched competitors, predicting market trends, and rapidly expanding into overlooked markets. AMD believes that it can effectively execute those strategies, but the numbers don't back up that claim yet.

Should you buy AMD today?
AMD isn't a stock for queasy investors. Its products still have value, but with its market share, revenue, and profits all headed in the wrong direction, it's too optimistic to expect AMD to ever achieve $0.50 per share or for its stock to surge 50%.

It's bold of AMD to challenge Intel in the server and PC markets, but investors should remember that Intel's deep pockets and in-house foundry let it consistently produce the most powerful PC and server chips on the market. AMD might establish an early presence in immersive platforms and other niche markets, but there's no guarantee that Intel or other rivals won't expand into those markets when they get bigger. Therefore, I'd like to see real signs of improvement -- in solid numbers -- before I invest in AMD's turnaround plans.

The article Will Advanced Micro Devices Stock Rally 50% in 2015? originally appeared on Fool.com.

Leo Sun owns shares of Apple. The Motley Fool recommends Intel, Nvidia, and Wells Fargo. The Motley Fool owns shares of Wells Fargo. 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.