Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
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For months, analysts on Wall Street have been singing the praises of Advanced Micro Devices (NASDAQ: AMD), arguing that AMD is gaining strength in PCs, in artificial intelligence, and in computer deep learning. But yesterday, AMD reported its financial results for fiscal Q1 2017, and all of a sudden, not all analysts are certain AMD is as good as it looked before.
Shares of AMD tumbled as much as 20.6% in Tuesday morning trading after those earnings came out, and analysts are deeply divided on what they mean. Here are three things you need to know.
Few analysts were shocked when historically unprofitable chipmaker AMD lost money again in Q1. Image source: Getty Images.
1. The bull case for AMD
On the plus side, AMD satisfied analyst expectations for earnings yesterday, reporting 18% growth in revenue, and quarterly losses just one third ($0.04 per share) of what the company lost one year ago ($0.12 per share). TheFly.com confirms that these numbers basically met the expectations that analysts had set for the stock -- $0.04 per share in losses, on revenue of $984.4 million.
Investment banker Wells Fargo, which has an outperform rating on AMD stock, quickly hailed the results as proof that AMD is "continuing to execute well," as the TheFly reports. Accordingly, Wells raised its price target on AMD stock to a range of $13 to $15 per share.
Canadian banker Canaccord -- likewise an AMD backer with a buy rating -- argued that AMD's Ryzen line of desktop CPUs is gaining traction in the market. The analyst doubled down on its buy rating, and continues to insist that AMD's stock, which was priced at $13 and change before earnings, and which sold as low as sub-$11 on Tuesday, is worth at least $17 a share.
2. Bears respond
But not all analysts are enthusiastic. Goldman Sachsfor example, which made a bold call against AMD stock earlier this year, zeroed in on weak guidance at AMD as supporting its thesis that the stock is "priced for perfection." Operating costs are rising, warns Goldman, while free cash flow has already turned negative at AMD. Accordingly, Goldman is also doubling down on its rating -- sell -- and cutting its price target to $10.60 per share.
Citigroup, meanwhile, is even less certain of AMD's chances. Rating AMD stock a sell as well, Citi sets its price target at just $4 a share. Why? Says Citi, while AMD has raised revenue guidance for the current second quarter of 2017, the company cut its gross margin guidance by 60 basis points, which implies that added revenue may not add much to AMD's profit. Even more worrisome, Citi points out that AMD's "inventory and valuation are at the all-time highs despite the company losing money," writes TheFly. Finally, Australian banker Macquarie has just chimed in with an actual downgrade of AMD stock, cutting AMD to underperform (with a $10 price target). In a note covered on StreetInsider.com, Macquarie echoes Citi's concerns that margin expansion "will prove to be a challenge," and warns that any market share AMD is gaining from Intel (NASDAQ: INTC) will quickly be lost again to Intel when it cuts prices on its chips to win back customers from AMD. And with AMD warning that its gross margin is already starting to ebb, AMD may not be able to survive a price war against Intel.
3. What AMD said
So how bad was AMD's report, actually? Pretty bad -- and certainly worse than media reports, which have been focusing on AMD's pro forma numbers, let on.
By the pro forma standard of non-GAAP financial results, AMD lost only $0.04 per share last quarter, which as I said above was a two-thirds improvement from last year's Q1 pro forma loss of $0.12. Under GAAP accounting standards, however, AMD lost $0.14 per share in Q1 2016, and cut that loss by less than half in Q1 2017, to $0.08 per share -- twice the size of the pro forma loss that AMD bulls are citing. Free cash flow, as Goldman Sachs pointed out, ran negative to the tune of $322 million in cash burnt during the quarter.
Meanwhile, on the guidance front, AMD:
- is projecting revenue growth of only 12% year over year in Q2.
- forecasts gross margin of only 33% (and only pro forma) in Q2 -- down from Q1's 34% gross margin.
- promises only pro forma profitsfor the full year -- not GAAP profits.
The most important thing: Can AMD turn profitable?
So how should investors make sense of all the above? Here's how I look at it:
AMD did what analysts expected it to do last quarter, but really, since they expected it to lose money, that's not something to boast about. Moreover, AMD has lost money every year for the past five years, and burned cash in most of those years as well. Although AMD briefly turned slightly free cash flow positive last year (generating positive free cash flow of $13 million on sales of $4.3 billion according to data from S&P Global Market Intelligence), AMD is once again back to burning cash and losing money in Q1 2017.
Meanwhile, AMD is guiding toward only moderate growth in sales next quarter, and promising weakening profit margins, which sounds a lot like what the AMD doomsayers have been predicting -- that AMD might gain market share temporarily, but would quickly suffer the ill effects of a price war as Intel, NVIDIA, and other chip rivals fight back for their lost share.
To me, none of this sounds like a scenario that will end in AMD breaking its historical pattern of losing money and burning cash. Put me in the bears column on this one. If you own AMD stock, now seems like a good time to declare victory, take profits, and seek a more viable business to put them to work in.
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