A Solid Short Ahead of Earnings

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

With a few exceptions such as Qualcomm, 2012 was a brutal year for semiconductor stocks. But beleaguered chip giant Advanced Micro Devices (NYSE: AMD) took the depths to another level, losing roughly 55% of its value. But it could have been worse. Since reaching a bottom at $1.81 two months ago, shares have surged 53%. But was it deserved? And heading into the AMD’s Q4 report, I expect those gains to be given back – making the stock a solid short.

There’s Just Too Much to Overcome

With so many names in the chip industry, AMD is battling not only negative perception, but also a dying PC business. As with Intel (NASDAQ: INTC), AMD struggled to adapt to new markets and was unable to anticipate the rise of mobile devices that led to the recent dominance of Qualcomm and ARM Holdings.

While Intel has shown signs of improvement, AMD’s situation has gotten worse. The company has posted two consecutive quarters of negative cash flow due to declining revenues. In its most recent quarter, the company posted 10% sequential revenue decline while posting a net loss of $157 million. Unfortunately, the company doesn’t have the ammo to reverse this trend.

If there’s a positive sign for AMD, it’s that Intel reported slightly better than expected Q4 earnings. While the Street was looking for earnings per share of 45 cents, Intel posted EPS of 48 cents – beating estimates by 3 cents with revenues coming in at $13.477 billion. For AMD however, investors can only hope for “less bad.”

Intel and Nvidia are Much Better Value

In Q3, AMD announced a restructuring plan. Management said this was in an effort to strengthen the company’s competitiveness while reducing its expenses. Conversely, in Intel’s Q4, expenses grew, including in R&D, which jumped 14% year-over-year. I suggested that this was a welcomed signal that Intel is not resting on its hands. Disappointingly, AMD has chosen a different route.

Meanwhile, there are other chip stocks that deserve more consideration – despite their struggles. Nvidia (NASDAQ: NVDA) is the perfect example. But unfortunately, the company is finding it difficult to convince Wall Street that it can transform itself from a legacy video chip operation that relies on PCs into a legitimate mobile player.

Although the Nvidia’s Tegra chip line has gained traction, it has not been enough to please analysts. This is even though in the company’s most recent quarter, Nvidia beat on both its top and bottom lines. That the company is able to grow revenues and net income suggests that Nvidia is stealing share from AMD.

Likewise, Nvidia’s better than expected earnings performance should serve as evidence that the company is able to do exactly what the Street says it can’t. So it begs the question as to why shares of AMD have surged over 50% the past two months. What has been the catalyst?

Although restructuring efforts are encouraging, neither AMD’s Trinity notebook shipments nor its introduction of Opteron chips in the server market have moved the needle. And even if they were enough to propel the stock higher, astute investors should realize that only a “sell the news” scenario remains.

Bottom Line

Chips have always been one of the best derivative plays on the market. This was the case when Intel and AMD rode the coattails of Microsoft in the '90s. Today it’s a different story. Mobile devices rule and those that are on the outside will continue to have it tough.

Unfortunately, this is where AMD finds itself. The company does not have any competitive advantage that is meaningful. And going into its Q4 report, I would be a seller or a short. If shares should fall back under $2.00, I will reconsider.

rsaintvilus has no position in any stocks mentioned. The Motley Fool recommends Intel and NVIDIA. The Motley Fool owns shares of Intel. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus