Better Buy: Advanced Micro Devices, Inc. vs. NXP Semiconductors

By Markets Fool.com

It's no secretAdvanced Micro Devices is struggling. AMD has posted a loss in each of the past four years, with share losses to Intel in the CPU market and to NVIDIA in the GPU market putting the company in a difficult spot. Design wins for the major game consoles have saved the company from ruin, providing a much-needed source of revenue and profits, but AMD's turnaround has shown few signs of progress. The company is planning major new CPU and GPU launches this year, which could finally turn the tide.

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NXP Semiconductors , in contrast, is coming off a very profitable 2015. The company, which designs chips for a wide variety of areas including automotive and mobile payments, earned $1.5 billion of net income last year on $6.1 billion of revenue. NXP's recently closed acquisition of Freescale Semiconductor deepened its automotive business, positioning the company to benefit from the increasing connectivity and computing power of the automobile.

Which of these two options -- an uncertain turnaround story with significant upside if things go right, or a wildly profitable company betting big on smarter cars -- offers the best opportunity for investors?

Advanced Micro Devices

Image source: Advanced Micro Devices.

The financial situation at AMD does not inspire confidence. The company has been burning through cash, posting a negative free cash flow for the past four years, and it was recently forced to sell off assets, its assembly and test manufacturing facilities, in order to shore up the balance sheet. At the end of 2015, AMD still had $785 million of cash, above its minimum target of $600 million, but the company's book value had plunged into negative territory.

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These losses can't continue forever, but there may be light at the end of the tunnel. AMD plans to launch brand-new graphics cards later this year, based on its Polaris architecture, that promise major improvements in performance and efficiency. AMD has fallen badly behind NVIDIA over the past couple of years, with its unit share of the discrete graphics card market falling from 40% to 20%. If the company can put out competitive products, matching or beating NVIDIA's upcoming Pascal graphics cards in terms of performance, some of that market share could return to AMD.

Also coming later this year is Zen, AMD's brand-new CPU architecture. Zen will replace Bulldozer and its various revisions, which have largely been a disaster for the company. AMD's share of the PC and server CPU markets have plummeted, and a weak market for PCs is rubbing salt in the wounds. Zen promises to boost by 40% instructions per clock, a measure of single-threaded performance, which should help close the performance gap with Intel products.

If everything goes right for AMD, and both its new GPUs and CPUs are successful, the stock could soar. But AMD has a history of over-promising and under-delivering, and if these new products don't improve AMD's financial performance, the stock could tumble even further. Buying AMD stock is a risky bet on a turnaround that may never materialize, but the potential rewards could be worth the risk for some investors.

NXP Semiconductors

Image source: NXP Semiconductors.

The acquisition of Freescale has tilted NXP's portfolio of products more heavily toward automotive. According to the company's guidance for the first quarter, automotive revenue will account for about 36% of total revenue, up from around 20% prior to the merger. According to NXP, the company is now the No. 1 provider of automotive semiconductors in the world. Beyond automotive, NXP offers a variety of products, ranging from NFC chips that enable mobile payment systems to AC-DC power conversion chips for notebook computers.

Even with a larger automotive segment, NXP remains a highly diversified semiconductor company. That doesn't protect it from cyclical downturns in the industry, though, and the company is currently going through a rough patch. Based on NXP's first-quarter guidance, total revenue is set to decline by about 18% compared to the combined revenue of NXP and Freescale in the prior-year period.

NXP stock appears cheap based on last-year's record earnings. The company managed a GAAP operating margin of 33%, generating EPS of $6.10. That puts the current stock price at about 13.6 times earnings. But there's a danger in valuing a cyclical company like NXP based on peak earnings, and if the company's margins don't prove to be sustainable, the stock may ultimately not be as cheap as it seems. Analysts expect non-GAAP earnings to be essentially flat this year, although that may be too optimistic, depending on how long NXP's revenue slump lasts.

In the long run, NXP is well positioned to benefit from the increased penetration of advanced driver assistance systems in automobiles, and eventually, from self-driving cars. In the short run, though, the company's results may be volatile.

NXP is a market leader in many of the areas where it competes, while AMD is playing catch-up in its core markets. For an investment in AMD to work out, everything needs to go right for the company over the coming year. For NXP, the company just needs to avoid major mistakes. From a long-term growth perspective, NXP also seems to offer greater potential, while AMD is still heavily dependent on a slumping PC market. In the end, NXP looks like the clear-cut winner.

The article Better Buy: Advanced Micro Devices, Inc. vs. NXP Semiconductors originally appeared on Fool.com.

Timothy Green has no position in any stocks mentioned. The Motley Fool owns shares of and recommends NXP Semiconductors. The Motley Fool recommends Intel and Nvidia. 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.