Avoid This Semiconductor Stock

Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Chipmaker Advanced Micro Devices (NYSE: AMD) had more bad news for investors this month as the company revised its sales estimates for the third quarter of the year. AMD’s management now believes that sales were down 10% from the second quarter of 2012, when previously they had expected a decrease in the range of 1%. Considering that Q2 2012 revenues were down 10% from Q2 2011, the company is saying that the decline of its business has been getting sharper. The stock price fell over 10% on the day of the announcement, pushing it down about 50% year to date. We can see a number of factors behind the fall in sales: lower PC demand as consumers increasingly shift to tablets, increasing difficulty keeping up with Intel (NASDAQ: INTC) in the chip market, and a temporary hit to PC sales as consumers wait for a new version of Windows.

When revenue declined 10% in Advanced Micro Devices last quarterly report compared to a year earlier, earnings fell 39% in response (from $61 million to $39 million, with earnings per share falling from $0.08 to $0.05). Applying that same relationship to the quarter over quarter decline the company just announced, earnings for the third quarter would have come in at $24 million, and quarterly EPS would be $0.03. That compares poorly with the $0.15 per share it earned in the third quarter of last year; in addition, annualizing a $0.03 per share quarter generates a P/E of 24 after the stock’s decline today to a market cap of $2 billion. Analyst estimates, pre-announcement, imply a forward P/E of 9.

Hedge funds generally didn’t have very large positions in Advanced Micro Devices at the end of June. D.E. Shaw, a large hedge fund named after its billionaire founder, had increased the size of its position during the second quarter to 5.1 million shares, but this was in fact a small amount of exposure for the fund (see where D.E. Shaw had more of its funds invested in). The largest position recorded in our database of 13F filings belonged to Kerr Nielson’s Platinum Asset Management. Platinum had owned 22 million shares of AMD, but it had cut its stake by 5% over the course of the quarter; it is possible that the fund sold more shares at considerably higher prices than where the stock is currently trading. Research more buying and selling activity from Platinum Asset Management.

We’ve mentioned Intel as AMD’s leading competitor, though the tech giant is in many other markets as well. Intel- whose market capitalization is just over $100 billion- trades at 9 times trailing earnings and 10 times forward earnings estimates. Obviously there is an expectation here that Intel’s business is in decline as well, even if it's not as sharp of a decline as AMD’s; certainly a weakening PC market would hit the larger company as well. However, Intel’s revenue and earnings in the second quarter of 2012 were both within 5% of the same figures for Q2 2011, and there is a 4.1% dividend yield to boot, which should give investors a little more confidence. 

AMD can also be compared to tech giant IBM (NYSE: IBM),as well as to component manufacturers NVIDIA (NASDAQ: NVDA) and Micron Technology (NASDAQ: MU). IBM’s business has also been about flat compared to a year ago, and we think that its valuation multiples (trailing and forward P/Es of 15 and 12, respectively) are roughly accurate, reflecting a stable business with a modest 1.7% dividend yield.

Nvidia and Micron have forward P/Es of 12 and 9, which are premiums to where AMD trades even though these companies are likely in about as big trouble as the others we've mentioned. Their reports for the second quarter show that while Nvidia’s revenues were narrowly up versus a year earlier, earnings were down 22%; Micron’s revenues fell 8%, and the company is actually unprofitable on a trailing basis. We don’t think that these two competitors are much more attractive than AMD.

AMD’s most recent reports seem to demonstrate that the combination of industry dynamics and competition from Intel- we’re not yet sure which is playing the bigger role- is having a severe effect on its business. We would stay out of the stock.

This article is written by Matt Doiron and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool owns shares of International Business Machines and Intel. Motley Fool newsletter services recommend Intel and NVIDIA. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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