AMD (AMD - Get Report) continues to be a highly controversial stock. It closed Friday up 0.41% at $24.51. Bullish investors push the argument that the only thing that matters is gaining market share, while bearish investors point to its high valuation. Whichever side of the argument one falls on, most of us were surprised by the share price movement in the time following earnings.
Q4 2018 Results
The day before AMD's earnings came out, Nvidia (NVDA - Get Report) pre-announced its earnings; surprising the market that its crypto-hangover continues to persist for slightly longer than it had expected. This caused its share price to materially weaken, selling off roughly 14% on the day.
Furthermore, the week before, Intel (INTC - Get Report) had also announced its results, with Intel's top line FY 2019 pointing towards it being flat year-over-year growth, which disappointed investors and the stock fell 7%.
Consequently, when AMD, the smallest of the peer group and potentially the most fragile, forecast 9% of growth for FY 2019, its shares soared. For investors, who were bracing themselves for terrible news, anything better than horrendous was very much welcomed.
In fact, it didn't even matter to investors that AMD's Q4 results missed analysts' top line estimates. Also, AMD had been claiming the whole year that it would post mid-20% year-over-year revenue growth, and ultimately, when it released its final quarter of the year, it only amounted to 23% of full-year growth. None of this appeared to matter to investors. It appears that investors were so prepared for the worst that they were exuberant at any sign of good news.
What Happened To The Shorts?
As of yet, we don't have the updated list of how many shares were sold short going into earnings, but what we do know is that AMD had been a heavily shorted stock for the majority of 2018 and into 2019. And that in the two full trading days prior to AMD's earnings release, its share price had fallen by slightly more than 12%, which I contend was the result of short sellers taking up positions in light of bad news from AMD's peers.
Moving on, when AMD's earnings guidance was not as bad as investors feared and the stock rallied, short sellers were forced to find shares to close out their positions. In other words, presently, a short squeeze is taking place, which readers should not expect to last, particularly given that its Q1 2019 is forecast to be down 24% year-over-year. Said another way, I strongly recommend that investors stay clear of AMD, as the present jump in its share price is mostly the action of short covering rather than fundamentals improving.
Free Cash Flow Continues To Be Missing
AMD posted negative free cash flow of $129 million, which was even worse than the cash burn of $105 million for FY 2017. Why are investors so dismissive of this fact?
Because, for now, the story is focused on AMD's potential market share wins. That's the true focus here. First, AMD gains market share, then, later on, AMD will look to monetize this opportunity.
Meanwhile, AMD is more than happy to stick to this side of the story, which is very difficult to accurately quantify. So much so, that CFO Devinder Kumar did not even discuss in its guidance for FY 2019 what AMD's free cash flow potential could be. In fact, though, throughout FY 2018, Kumar had been guiding for "positive" free cash flow for FY 2018, and when that free cash flow target was not met, Kumar simply highlighted the reason was that AMD was building up its inventory store.
Valuation - Is There a Margin of Safety Here?
AMD is the smallest amongst its peers, and when compared with either Nvidia or Intel its financial position is materially weaker. As the table above shows, its cash flows from operations are very expensively priced.
And its free cash flow (not shown in the table) continues to be very much negative. And finally, as we have already discussed above, AMD's growth rate is slowing down quite considerably over time, from 23% all the way down to the high single digits. Yet, at the same time, its share price continues to increase. Additionally, from a P/Sales perspective, we can see that relative to its own historical pricing, AMD's present valuation trades close to four times higher than its historical average. This once again reinforces the fact that there is no upside potential for AMD.
AMD certainly has a lot of potential and continues to defy the odds against it. There is little debate on that front. But I caution investors not to mistake a great story for great investment potential. AMD's red-hot valuation leaves investors with no margin of safety.
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