Advanced Micro Drops 12%: Where's the Beef? Ask Bears – Barron's

[Updates with stock decline.]

Shares of Advanced Micro Devices (AMD) are plunging, down $3.24, or 24%, at $10.38, breaking down the entire session, and extending last night’s after-market losses,  after the company yesterday afternoon reported Q1 results more or less in line with consensus, and forecast this quarter’s revenue higher, but raised questions about its comeback given what seemed to some lower-than-expected gross profit margin.

(See my colleague Teresa Rivas’s defense of the stock in this afternoon’s Barron’s Take.)

In focus today is the company’s outlook for gross profit margin of 33% this quarter, a point below the 34% achieved last quarter.

To the disgruntled, after a sharp run-up in the shares, a decline in gross profit from one quarter to the next is not acceptable given new “Ryzen” processors coming into the market were supposed to boost margins.

Despite a discussion of the matter by CEO Lisa Su and her executive team on the conference call following the report, that hasn’t obviously stopped the stock fall nor prevented some critical language in the Street coverage this morning.

There is at least one downgrade of the stock this morning, by Macquarie‘s Srini Pajjuri, who cut his rating to Underperform from Neutral, and cut his price target to $10 from $14, writing that the results and outlook are simply not enough given high expectations.

That’s the view of several this morning.

Stacy Rasgon with Bernstein Research, reiterating a Market Perform rating, and an $8 price target, asks “Where’s the beef?

He notes “gross margins were seen only in-line at 33%, and down QoQ even with better Q1 performance and a full quarter’s worth of Ryzen parts. And, updated annual guidance (low double-digit revenue growth, YoY gross margin expansion and positive EPS) demonstrated no upside to current consensus.”

The company has yet to prove itself, he writes:

Unfortunately AMD has not yet provided investors with the inflection point that many have been hoping for as the story begins the transition from hopes and dreams to reality. The stock (after the strong run) likely needs perfection to continue the trajectory, and while last night’s results were not necessarily disastrous, they certainly weren’t perfect. To paraphrase Clara Peller, right now we taste too much bun, not enough beef, and we’re still hungry.

Goldman Sachs’s Toshiya Hari, reiterating a Sell rating, and a $10.60 price target, writing that the company “failed to exhibit the 2Q upside the Bulls were anticipating.”

Hari cites “poor free cash flow” in particular, with inventory rising 12% from the prior quarter, versus what had been an expectation for it to be roughly flat.

Concludes Hari, “Bottom line, as we illustrated in our April 6 initiation, we believe the stock at 33x our CY19E op EPS is priced for perfection (as can be implied by the 11% after hours price decline) and recommend investors stay cautious.”

Stifel Nicolaus’s Kevin Cassidy reiterates a Hold rating, calling the results “respectable,” writing that the results and outlook show a “successful Ryzen launch” and therefore “remove some near term execution risk,” as do the indications the other product debuts are on schedule.

He notes disappointment with the margin outlook and writes that the share gains so far “priced in a successful new product cycle.”

Credit Suisse’s John Pitzer, reiterating a Neutral rating, and a $10.50 price target, writes that “investors will be disappointed that a full quarter of Ryzen is not driving better leverage,” even if “bulls argue that Ryzen is still a small percentage of mix and Naples has not yet shipped,” referring to the company’s forthcoming server processors.

Pitzer doesn’t like the company’s days of sales outstanding, at 117, which “are the highest in company history and a risk.”

He concludes of the margins that “disappointing gross margin and higher operating expenses support our long term concern that even if Ryzen/Naples are successful, operating leverage will be disappointing as AMD raises investments after multiple years of below trend spending,” even though he realizes “increasing investments is the right long-term strategy.”

Not everyone was disappointed, and the Bulls largely argue the sell-off is an over-reaction.

Jefferies & Co.’s Mark Lipacis, reiterating a Buy rating, and a $16 price target, writes that “while semis are in the part of the cycle where those that beat and raise still trade down, the 11% aftermarket sell-off appears like an overshoot to us.”

“AMD is executing on its first high-end desktop MPU in two years, which we think is a positive indicator for a robust product cycle and GM expansion in second-half 2017.”

Canaccord Genuity’s Matthew Ramsey reiterates a Buy rating, and a $17 price target, writing that the “sell off is a bit of an overreaction,” even though he admits “this wasn’t the clean beat and raise that we hoped for.”

Ramsey pintpoints part of the problem in an accounting change pertaining to how the company reflects expenses for the “mask set” for Ryzen, a critical piece of the manufacturing process that showed up in cost of goods:

Finally, an accounting change in regards to capitalizing versus expensing foundry FinFET mask costs added some confusion to near-term margin and expense modeling. While we believe the accounting change is inconsequential to the company’s future and cash flows, we believe the confusion added to the AH sell-off in shares given heightened expectations.

To Ramsey, the stock is still worth holding for the payoff of new product.

Overall, though the stock will likely be weak in overreaction to the results, we believe a host of positive catalysts are still to come during the remainder of 2017 and our BUY thesis remains very much intact. While we recognize roadmap execution and competitive risks remain, 2017 is a critical year for the company with new product introductions across the PC, GPU and server segment that (if successful) should all yield materially higher gross margins versus today’s offerings.

 reiterated an Outperform rating and raised his “valuation range” to $13 to $15 from a prior $11 to $13, writing that the company “continues to execute well,” and that the sales rise of 18% in the quarter, and its outlook for 12% growth this quarter, shows “AMD is continuing to demonstrate a recovery in sales and move towards profitability.”

Wong doesn’t dwell on the margin issue, but rather notes the company is “on track” with its upcoming product introductions:

AMD noted that it remains on track to launch Zen-based servers (Naples) and its new Vega GPU chips in the second quarter of 2017. AMD indicated that it expects to launch Ryzen 3 desktop processors early in the second half of 2017, and Ryzen mobile processors towards the holiday cycle in the second half of 2017. AMD also expects to launch of Radeon Instinct accelerators in mid-2017.

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