AMD’s Q3’14 Earnings Preview: Focus On Commercial PCs & High Growth Markets

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Advanced Micro Devices

Microprocessor and graphic processor manufacturer AMD (NYSE:AMD) will report its Q3 2014 earnings on October 16. Owing to its restructuring efforts, the company returned to profitability in Q3 2013  and Q2 2014 marks its fourth consecutive quarter of positive non-GAAP net income. AMD has diligently managed its expenses and lowered its cost structure, in turn significantly reducing its operating expenses, which has helped it increase its investment in innovations that will fuel future growth.

AMD’s stock price declined by more 20% last week mainly due to a change in leadership and Microchip’s weak earnings. AMD appointed Dr. Lisa Su as president and CEO and member of the board of directors (effective immediately) as part of its transition plan. The stock was downgraded by few analysts who felt that the leadership change could be a sign that AMD’s turnaround may be taking longer than anticipated. Microchip, a leading provider of microcontrollers with over 80,000 customers, pre-announced a significant revenue miss for its September quarter ($529.3 million versus the prior guidance of $560.0 to $575.9 million). Microchip attributed the miss to an unexpected decrease in demand from China and suggested this was the first indication that the next industry correction has begun. We note, however, that Microchip does not address AMD’s core markets.

We believe in AMD’s long-term growth potential. The company’s restructuring strategy is clearly paying off, and it claims to be half way through the three-step transformational process. Its revenue increased 26% and non-GAAP EPS improved by $0.26 in the first half of 2014, compared to the same period last year. Additionally, the company has improved its balance sheet by re-profiling debt at lower rates, which it expects will reduce its interest expense with no significant debt coming due until 2019.

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Our price estimate of $4.17 for AMD is now at a more than 50% discount to the current market price. We will update our valuation after the Q3 2014 earnings release.

See our complete analysis for AMD

Increasing Sales For Commercial PCs

Having grown at a robust rate for many years, PC sales started declining from 2011 onward. According to the research firm IDC, PC shipments declined 3.7% and 10.3%, in 2012 and 2013 respectively. The rate of decline dropped down to 4.4% in Q1 2014 and remained flat in Q2 2014, as Windows XP migration (to machines running newer operating systems) and commercial spending helped offset the weak consumer PC demand. [1] [2] According to preliminary results by research firm Gartner, global PC shipments declined 0.5%, reaching 79.4 million units, in Q3 2014 as growth in mature markets was offset by a decline in shipments in emerging markets. However, Gartner claims that positive results in Western Europe and North America can be a sign of gradual recovery for the PC industry as tablet adoption peaks with mainstream consumers. [3]

AMD estimates the overall PC market will decline 5% to 7% in 2014, but believes that its increasing focus on the commercial PC segment will help it improve its performance in this segment. AMD has a larger presence in the consumer PC segment, which still remains weak. AMD launched its Pro A-Series APU in Q2 2014 and claims to be on track to more than double the number of AMD-based commercial offerings available by the end of the year. HP has already announced a full range of elite commercial offerings powered by AMD and the company expects additional OEMs to begin rolling out AMD-powered commercial offerings this quarter.

Last month, AMD created a single market focus team design to strengthen its traditional PC business and drive growth in adjacent markets where its leadership IP provides the company with a competitive advantage. Though AMD has significantly lowered its dependence on the PC market, it continues to derive a considerable portion of its revenue from the segment (including GPUs and APUs). Its PC strategy remains focused on developing profitability by diversifying into the commercial segment, stabilizing the overall PC business and leveraging the channel to deliver profitability.

AMD Is On Track To Derive 40% – 50% Of Its Revenue From High Growth Markets

AMD announced a three-part restructuring plan in Q3 2012 in an effort to strengthen its competitiveness in the market and better manage its expenses and cash. In 2013, the company completed the restructuring phase which helped generate strong revenue by successfully ramping up a diverse set of new products. An important part of AMD’s restructuring strategy was to derive 40%-50% share of its revenue by 2015 from high growth markets, including semi-custom and ultra-low power processors, professional graphics processors, as well as processors for dense server and embedded solutions. The company claims to be on track to achieve this goal.

AMD witnessed record semi-custom unit shipments in Q2 2014, as it continued to see strong demand for AMD-powered game consoles. The company devised a unified gaming strategy in March 2013 that addresses its plan to drive the gaming market across consoles, cloud platforms, tablets and PCs. AMD powers all major next generation consoles including Sony’s PlayStation 4, Nintendo’s Wii U and Microsoft’s (NASDAQ:MSFT) Xbox One. The company claims to be on track to secure one to two additional semi-custom design wins in 2014.

For many years, AMD has been under-represented in the professional graphics segment, which is dominated by Nvidia (NASDAQ:NVDA). Nevertheless, competitive pricing and improving hardware have helped increase AMD’s professional graphics market share from 12% in 2009 to 20% in 2013. Strong performance in professional graphics was an important factor that drove AMD’s growth in the last few quarters. AMD is increasing its investment in the area to build a stronger relationship with key customers and expects to drive even more share gains in this margin accretive market.

AMD’s embedded processor revenue increased by double-digits sequentially in Q2 2014. It launched several new products in Q2 2014 and announced wins with HP’s thin clients and Boeing’s next generation advanced cockpit display systems, among others. AMD has a broad range of embedded processors for different segments in its portfolio, offering a number of price, performance and power options to meet the needs of embedded designers. The company intends to take on the different segments in the embedded market by offering its customers a range of solutions to chose from —  from low-power to high-performance — with a broad ecosystem of software and hardware partners supporting multiple operating systems, including Windows and Linux.

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Notes:
  1. Windows XP Migration and Commercial Spending Helped Offset Weak Consumer PC Demand in The First Quarter of 2014, IDC Press Release, April 9, 2014 []
  2. Gartner: Global PC shipments post flat growth in Q2, Business Line, July 11, 2014 []
  3. Gartner Says Worldwide PC Shipments in the Third Quarter of 2014 Declined 0.5 Percent, Gartner Press Release, October 8, 2014 []