Following the handsome earnings posted by Advanced Micro Devices (AMD) in its fiscal third quarter, analysts appear to be more favorably disposed toward the company.
Last Quarter Highlights
The earnings surprise in the last quarter came on the back of gross margin improvement and good expense control, despite falling revenues. Particularly, AMD saw softness in the consumer market—similar to archrival Intel Corporation (INTC)—and it is likely that AMD also lost some graphics market share to NVIDIA Corporation (NVDA). On the positive side, enterprise did better than expected, with microprocessors for both desktop and notebook clients growing and new customers, such as International Business Machines (IBM), joining in.
During the quarter, AMD used $124 million of cash in operations, spent $31 million on capex and repaid $818 million of debt. Debt reduction has been commendable over the past few quarters, although the net debt position is still considerable at around $590 million. Working capital management left something to be desired, with inventory days declining and DSOs rising.
Current Quarter Guidance
Additionally, guidance was not encouraging, with revenue in the seasonally strong fourth quarter expected to match that in the third.
Agreement of Analysts
We see a large number of estimate revisions over the last 7 days, with 14 out of 23 analysts raising estimates for the December quarter, while only 3 analysts revised downwards. Naturally, this also impacted the annual expectations, where there were 13 upward revisions versus just 1 downward.
Estimate revisions over the last 7 days followed the same pattern for both the next quarter and fiscal 2011, with 11 and 10 upward revisions for the next quarter and year, respectively. Downward revisions stayed low, with 3 for the quarter and 5 for the year.
Magnitude of Revisions
Despite the large number of estimate revisions, the Zacks Consensus Estimate for AMD did not move around too much over the last 7 days. The estimates for the current and next quarters went up by 2 cents and 1 cent, respectively, while those for the years 2010 and 2011 went up 9 cents and 3 cents, respectively.
Analysts attributed their increased optimism to better gross margin performance, which is likely to come from a combination of factors such as stronger margins and better mix. Better opex control, slightly lower interest expenses and taxes were other positives cited.
Our Take
We agree that AMD’s margin improvements could continue in the near term, given the stronger mix of enterprise business and the company’s decision not to pursue aggressive pricing policies. However, we think that this change in policy actually helps rival Intel. Intel products continue to perform better, so with less pricing presure from AMD, Intel has less need to justify its premium pricing. Also, Intel has been doing very much better than AMD in the server market, although AMD’s gains here have been slow and steady. To top it all, the AMD graphics business had a very bad quarter and it is still too early to tell whether this can be attributed entirely to end market softness.
Given the consistent profits and margin gains over the last few quarters, we are growing increasingly positive about AMD. We therefore have a short term (1-3 months) Hold rating on the shares, as indicated by the Zacks #3 Rank. Our longer term (3-6 months) recommendation is also Neutral.
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