Advanced Micro Devices Inc. (NASDAQ:AMD) stock gained more than 400% in the 12 months between the start of Q2 2016 and the end of February 2017 when it reached a 52-week high. On the business side, the company has reported losses for five consecutive years since 2012. Lately, with the market valuing AMD mainly based on quarterly sales changes, an incomplete picture of the underlying business, potential overvaluation was all but likely during the stock’s recent high-flying rally.
Continued overall dismal business fundamentals will again weigh down on AMD stock once sales pickups fail to materialize, always a struggle for the company. More importantly, AMD’s computing and graphics business has been a chronically money-losing segment and needs some strategic attention. Or else, investors will eventually realize that the company may never see daylight again. Short of making some needed strategic business adjustments, AMD may see the value of its enterprise, embedded and semi-custom business, the other segment that’s been consistently profitable, forever buried under its weak, consolidated business results.
AMD stock rose on strong momentum in the last 12 months or so amid broad advances in the semiconductor sector on the belief that chips are making their way into new markets of connected devices. The start of the stock’s ascent also coincided with a sequential increase of 23% in the company’s sales in Q2 2016 after two down quarters prior, thanks to higher sales of semi-custom system-on-chip products for gaming consoles. However, operating losses continued and extended into the quarters after. Relevant data are shown in the table below.
Quarterly Sales and Operating Losses
|$ in millions||Q3 2015||Q4 2015||Q1 2016||Q2* 2016||Q3 2016||Q4 2016|
*The quarter when sales increase and the start of the stock’s rise coincided with each other.
Despite occasional bumps in sales, AMD stock’s current price level may not be sustainable, given the company has consistently lost money since at least 2012 with no real sign of becoming profitable anytime soon. AMD has, over the years, accumulated a deficit of $7.8 billion in the returned earnings account as of December 31, 2016, significantly depleting its equity capital. Total shareholders’ equity turned negative at the end of 2015, and new shares had to be issued the next year to restore the equity base.
AMD had only $416 million in total shareholders’ equity at the end of 2016, or $0.44 per share. With a closing price of $12.84 on April 19, 2017, the stock is trading at a price-to-book ratio of nearly 30 without the support of any return on equity. In comparison, Intel Corp. (NASDAQ:INTC) has a P/B ratio of mere 2.6, backed by a five-year average ROE of 19.1%.
With no earnings or equity returns to base its stock’s valuation on, the market has had to price AMD shares on the company’s product developments and expected future sales. The stock may have been overhyped on the company’s latest release of the supposedly more powerful Ryzen processors and the hotly anticipated Radeon Vega for graphics. However, it’s not the first time AMD trying to survive Intel’s computing chips on the one hand and Nvidia’s (NASDAQ:NVDA) graphics cards on the other.
Between AMD’s two reporting segments, the computing and graphics business has consistently done worse than the enterprise, embedded and semi-custom business in the latest four years since 2013 in terms of sales and operating profitability. While its computing and graphics segment is shrinking in sales with losses, the enterprise, embedded and semi-custom segment is growing with profits. The relative strengths of the two segments have clearly shifted from the former to the latter, whose revenue in the latest two years grew past 50% of the company’s total revenue. The table below presents relevant data for comparisons:
Segment Sales and Operating Income (Losses)
|$ in millions||2014||2015||2016|
|Computing and Graphics||3,132||1,805||1,967|
|Enterprise, Embedded and Semi-Custom||2,374||2,816||2,305|
|Computing and Graphics||(76)||(502)||(238)|
|Enterprise, Embedded and Semi-Custom||399||215||283|
If this trend continues, it will be more apparent to investors that the computing and graphics business is losing further and the enterprise, the embedded and semi-custom business is gaining ground. Closely related to chip-making for the so-called Internet of Things, AMD’s enterprise, embedded and semi-custom business is more aligned with growth opportunities and may provide the real promise for the company’s future. Unlike in traditional computing chip-making, whereby AMD seems to be always behind Intel, within the area of the Internet of Things the two companies are more or less on a level playing field. Intel’s annual revenue for its Internet of Things segment has been also in the $2 billion range since 2014.
At some point, shareholders may demand AMD start focusing more on the enterprise, embedded and semi-custom business to capitalize on the increasingly pervasive uses of internet-connected devices. Anything short of separating those two business segments into two independently operated entities could prevent the company from returning to regular profitability.
In case of a failure to make such strategic adjustments, coupled with less-than-expected sales boost from its new chip designs, particularly the Ryzen processors, AMD stock may give back its recent gains over time and come down to its pre-rally levels. The company’s dwindling equity capital, plus the shortage of operating cash flow – a cause of concern for potential business interruptions – only helps highlight the stock’s pending downward price pressure.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.