Justin Sullivan
Semiconductor stocks continue to trend lower despite already being one of the worst-hit sectors in this year’s market rout. Investors’ sentiment in the sector has been whipsawed with ever-evolving headwinds spanning industry-specific regulatory challenges and mounting macroeconomic uncertainties. And the turmoil looks to continue over the coming months as profit margins get squeezed by protracted inflationary pressures. This is consistent with the case of AMD (NASDAQ:AMD), whose slight earnings miss plus a conservative forward outlook on growth and profitability that came in shy of analyst estimates comes on the heels of a similar forecast for slower demand and a higher cost environment from peer Texas Instruments (TXN) last week.
Although data segment sales delivered a strong showing during the third quarter, which was celebrated with a post-earnings rally on Tuesday evening, hyperscaler demand is starting to see signs of slowing based on recent commentary from mega-caps like Microsoft (MSFT) and Amazon (AMZN). This continues to corroborate that no company nor industry is fully immune from the near-term macroeconomic headwinds – even data center sales, which have largely been the more resilient business savior for chipmakers like AMD, will become prone to belt-tightening endeavors taken pre-emptively across the commercial sector ahead of a looming economic downturn. FX headwinds also look to worsen over the coming months as the Federal Reserve remains fixed on further monetary policy tightening to tame runaway inflation.
While AMD remains the backbone of critical next-generation technologies – a bullish rhetoric for the stock that remains largely intact – with steady market share gains as it continues to displace legacy chipmakers like Intel (INTC), the stock’s downtrend this year will likely persist for a little longer. We see a rocky industry-wide and macro backdrop over the coming months in response to continued Fed tightening, which will likely introduce further volatility to the stock, creating more compelling risk-reward entry opportunities.
AMD Will Remain a Victim of Consumer Weakness
A key theme in the latest earnings season thus far is that investors expect nothing short of in line or better-than-expected forward earnings guidance, which has already been reasonably revised downwards to align with the broad-based consumer slowdown and inflationary environment ahead. On the contrary, companies that have guided below estimates have been met with an immediate and steep selloff.
Yet, on Tuesday evening, AMD benefited from post-market gains despite a slight double miss on both revenue and earnings, and a forward sales guidance of $5.5 billion that fell short of the average consensus estimate of $5.9 billion. Investors were largely impressed by the company’s ability to maintain profitable growth as peers within the sector brace for declines ahead of contracting demand. Although the company has already released mediocre preliminary third quarter results earlier in October that have set the tone for more weakness to come, management’s conservative forward outlook shared on Tuesday evening turned out better than those of peers’, assuaging investors’ angst.
Weakening PC shipments this year and the overall consumer slowdown is already a largely known fact, with the “intuitive argument” across the semiconductor sector being that said softness has already been priced in given the violent selloff this year. Yet, time and again, AMD’s peers have continued to find themselves getting punished for known weakness with a heavy hand, underscoring the weight of fragile investors’ sentiment on the sector’s valuation prospects. As such, the AMD stock will likely be subject to further turbulence in the months ahead as anticipated declines in its consumer-centric Client and Gaming segments materialize – meaning the post-earnings rally on Tuesday evening will likely fizzle first.
Specifically, consumer weakness has become an inevitable fact given inflationary pressures, which are eroding household budgets – especially for discretionary spending on goods like consumer electronics. This is further corroborated by Visa’s (V) recent earnings commentary – although aggregate spending levels have remained resilient and consistent throughout the year, consumer behavior has inevitably changed as a result of worsening economic conditions and surging inflation, with data showing a decline in purchasing power. The fraying trends on discretionary spending are also consistent with the worsening decline in PC and smartphone shipments this year – third quarter PC shipments have declined 19.5% y/y, compared with -15% y/y in the second quarter and -6.8% in the first quarter; meanwhile, global smartphone demand has fallen to the lowest levels since 2014.
And looking ahead, the situation is not expected to show material improvement within the immediate term, which is consistent with AMD’s modest forward outlook for the remainder of the year, especially in consumer-centric segments like Client processor and Gaming GPU sales. With rapidly deteriorating global macroeconomic conditions, and consumer budgets buckling at the weight of surging inflation and rising interest rates that have made everything from daily necessities to mortgage payments evermore expensive, there is likely no immediate reprieve. Not even the extra week of sales in the current quarter nor holiday-driven sales are expected to stem the near-term weakness:
I think if you look at the pluses and minuses in the quarter. The guidance for Q4 really is around sort of PCs and, let’s call it, Gaming being lower, and again, those are — with all the holidays in place, we are not counting on too much there. And then Data Center is — Data Center, Embedded are higher, but we are not expecting that the extra week has a material impact.
Even the commercial sector, which was previously regarded as a potential lifeline for chipmakers like AMD to offset some of the consumer headwinds, is likely looking to tighten the belt wherever possible. Although digital transformation investments have been one of the most resilient corners of the economy, related spending intentions have already showed signs of slowing as decision-makers brace for an uncertain macroeconomic outlook ahead, which is consistent with slower-than-expected Client segment revenues at AMD during the third quarter. Given the situation at hand, and fragile investors’ sentiment under today’s market climate, the stock will likely be subjected to further volatility over the coming months.
Is Data Center Bullishness Weakening Too?
What is more of an immediate concern in our opinion, and also less talked about, is the inevitable near-term slowdown in data center sales. While the segment is expected to remain resilient overall amidst the looming economic downturn, bolstered by AMD’s optimism on its EPYC server processor sales, we think the sole bright spot across the semiconductor sector will dim a little over the coming months, which could be another downside risk for the stock.
The latest round of big tech earnings delivered proof that no company/industry is immune to the looming economic slowdown – including some of AMD’s largest data center clients. Many hyperscalers – including Microsoft’s Azure and Amazon’s AWS – have warned of deceleration in demand to some extent over the near term due to macroeconomic uncertainties, leading to potential tightening of profit margins and ensuing implementation of aggressive cost management initiatives over the same period. This accordingly risks a delay and/or cutback in data center investments, and threatens near-term demand for related semiconductors that AMD has largely relied on to partially cushion the impact of slowdown in some of its other more recession-prone segments.
However, from a long-view perspective, data center chip demand will likely remain robust given multi-year digital transformation trends that are still underway across industries spanning not just hyperscalers but also other verticals like auto, communications, and other AI-enabled technologies. We remain bullish on the longer-term demand environment for data center chips and solutions to keep up with the fast-expanding hyperscaler market, which makes strong tailwinds for AMD’s fundamental and valuation prospects despite near-term bumpiness ahead of a cyclical downturn. Specifically, we view AMD’s multi-facet involvement in server processors – especially its diverse portfolio of next-generation EPYC server processors spanning general purpose applications (Genoa), high-performance general purpose applications (Genoa-X), cloud-optimized applications (Bergamo), and intelligent edge and communications applications (Siena) – a competitive advantage in reinforcing sustained long-term market share gains in the data center segment.
For instance, Alphabet’s (GOOG/GOOGL) Google Cloud Platform (“GCP”) remains committed to expanding its availability worldwide and closing its gap in market share with industry leaders AWS and Azure; Meta Platforms (META) continues to double-down on “investments in data centers, servers and network infrastructure” to expand its AI capacity. And in other verticals, even non-hyperscalers spanning auto OEMs and 5G communications service providers are met with an increasing need for data center processors like those offered by AMD to support innovative next-generation technology developments over the longer term.
This accordingly makes any near-term pullback in the stock due to cyclical weakness a compelling entry opportunity, given AMD’s longer-term upside potential continues to be backed by a robust, need-driven demand environment.
Addressing Geopolitical Risks
Another near-term overhang on the AMD stock is the rising regulatory and geopolitical risks. While AMD has previously said that the latest export restrictions on advanced semiconductor technologies to China will not place a material impact on its business, rapidly deteriorating U.S.-China relations may indicate otherwise. As discussed in our previous coverage, rising geopolitical tensions may imply that the recent restrictions on sharing advanced chip technology with China are only the beginning of more curbs to come, which puts AMD’s 25% sales exposure in the region at risk.
Yet, drawing on our quantified impact analysis and AMD’s actual third quarter results, said risks have likely been already priced into the chipmaker’s current market value. In other words, any anticipated near-term selloff in the stock will likely remain in tandem with broader market volatility in response to deteriorating investors’ sentiment ahead of the looming economic downturn, instead of a structural reflection of AMD’s longer-term fundamental prospects.
Final Thoughts
Admittedly, the current market climate does not bode well for semiconductor stocks like AMD, given mounting downside risks spanning macroeconomic challenges (e.g. FX headwinds; consumer slowdown) to being stuck in a geopolitical cross-fire. Yet, these headwinds are unlikely to derail AMD from its long-term bull thesis. Specifically, AMD’s market leadership remains intact, with its steadfast commitment to innovation being key to maintaining its role as a critical enabler of next-generation technologies. And while its profit margins have hit a slight snag in the near term, we view this as a result of the industry-wide inflationary environment instead of idiosyncratic risks that point to internal inefficiencies – AMD remains one of the most profitable in its field, nonetheless, with its bottom line beating those of rival Intel by wide margins still.
But because there likely is no immediate reprieve to the mounting downside risks discussed above, the AMD stock remains highly susceptible to further turbulence in tandem with anticipated market-wide volatility over coming months as sentiment on the global macroeconomic outlook sours. While this means AMD will remain “down” for a little bit longer, it is certainly not “out” given the sustained long-term growth and profitability drivers discussed in the foregoing analysis, making potentially cheaper valuations ahead a compelling entry opportunity for longer-term gains.
Be the first to comment