Advanced Micro Devices, Inc.

Moat: 2/5

Understandability: 4/5

Balance Sheet Health: 3/5

Advanced Micro Devices, Inc. (AMD) is a global semiconductor company that primarily designs and manufactures microprocessors, graphic processors, and related technologies, competing in highly cyclical and competitive markets.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

AMD is a fabless chip designer that creates complex and high-performance semiconductors, and has achieved growth through partnerships with manufacturing partners like TSMC. But it faces intense competition and has yet to fully diversify revenue streams, and has had a volatile history which hurts its moat.

Business Overview

AMD operates in the highly competitive semiconductor industry, which is subject to rapid technological advancements and cyclical demand patterns. Here’s a detailed look:

Revenue Distribution: AMD reports in four segments:

  1. Data Center: Primarily includes server CPUs, GPUs, FPGAs, Adaptive SoCs and data processing units. This segment accounts for a large portion of AMD’s revenue and is seeing rapid growth in recent years.
  2. Client: Primarily includes processors for desktop, notebook, and handheld personal computers. This segment is the largest by revenue for the company and is facing headwinds due to PC downturn and macroeconomic climate.
  3. Gaming: includes graphics processors, consoles, and game graphics cards. The market has been highly volatile and it is facing headwinds lately. 4. Embedded: Primarily encompasses embedded CPU, GPU, FPGAs, and Adaptive SoCs for a broad range of industries.

Recent Revenue Trends: * For 2023, the data center segment was the primary growth driver, particularly due to increased AI adoption. * Client segment has had decreased revenue due to decreased demand for PCs * The gaming segment has also seen declined revenue due to reduced gaming industry demand.

Industry Trends: The semiconductor industry is characterized by:

  • Intense Competition: Fierce rivalry exists among players like Intel, NVIDIA, and TSMC.
  • Technological Disruption: Continuous innovation and technological shifts drive rapid product obsolescence.
  • High Capital Expenditures: Manufacturing facilities, R&D, and equipment upgrades require massive capital investment.
  • Economic Cyclicality: Demand for semiconductors fluctuates with global economic cycles and consumer trends. This is shown by fluctuations in revenue in different segments depending on the year.
  • Geopolitical Sensitivity: Trade tensions, export controls, and chip manufacturing locations are subject to geopolitical forces. This factor introduces significant volatility to operations

AMD has a wide diversification of product categories, meaning that its revenue is less tied to the success of one particular technology. However, the industry still plays a big part in the business performance.

Competitive Landscape: AMD competes with:

  • Intel: In CPUs for both PC and server markets. AMD often competes on price-performance ratio, but Intel’s strength lies in its market position and brand recognition.
  • NVIDIA: In the GPU market. While AMD continues to improve, NVIDIA holds a significant market share due to its higher performance, brand, and software features.
  • Other competitors: In specific niche markets including TSMC and other fab companies in semiconductor manufacturing, and Samsung in microprocessors.

Differentiation and Moat Analysis: - AMD creates and sells innovative microprocessors, graphic processing units, and accelerated processing units. Some of the company’s major technological competencies include chiplet architecture, and x86 design. They work with TSMC as their main fabrication partner.

  • Intangible Assets: AMD has a significant portfolio of patents and intellectual property but relies heavily on its manufacturing partners. Also, those assets are under constant threat of technological shifts.
    • Customer Switching Costs: Switching costs are moderate to high based on client integration with hardware and software. Especially large customers will tend to use same vendor products to reduce their complexity and their engineering team will use the existing tooling. These costs however are not so high as to create a moat.
  • Network effects: Limited network effects. However, if AMD software were to become the de facto standard to run AMD hardware, this could be a catalyst for long-term value.
  • Cost Advantages: Although AMD partners with manufacturing foundries it has limited control of its supply chain. Furthermore, it does not have proprietary processes or technology to significantly reduce its manufacturing costs, unlike the fab based competitors like Intel and TSMC.

Overall, I rate AMD’s moat a 2 out of 5 because while it has shown innovative abilities and strong brand recognition, it still faces high competition and lacks control over its manufacturing and cannot generate higher and more stable returns over a long period of time. It can generate above-average profits for a few years, but this advantage can quickly fade.

Financial Analysis

Here’s an overview of AMD’s financials: - Net income: This is volatile, and depends heavily on customer demand for its products, mainly CPU and GPU. For the past few years, the net income was strongly affected by the pandemic and the subsequent changes in macroeconomic climate. - Gross Margin: In line with revenue and profitability, the gross margin has also fluctuated significantly over time. It has increased slightly in recent periods as demand for high-end products like Data Center solutions increases.

  • Cash from Operations: As is common with semiconductor manufacturers, there is a significant amount of investment in R&D that reduces cash flows from operations. But in the short term, they are mostly positive.
  • Debt: Although it has increased in recent times, the total debt for the company is not that significant for the company of its size. It is likely to go down as operating cash flow will improve.
  • Inventory: In the last few quarters the amount of inventory is increasing in the balance sheet, mostly due to lower demand for its products from customers. This could be the basis of a possible future writedown of assets.

Margins: AMD has improved its gross margins over time due to changes in its product line. Gross margin went up from 45% in 2021, to almost 50% in 2022 and early 2023. The margin is still under significant pressure because of the cyclical nature of the industry. Operating expenses also have increased as the company is developing new products and expanding into different markets.

Key Financial Ratios - Net Income/Margin: Volatile because of cyclicality. Affected by operating margins and cost of sales. - Average Net Margin: In the range of 10% to 20% in recent years, but it fluctuates with industry and demand.

-  **ROIC**: In general, ROIC was negative in previous years, it is recovering in 2023 due to increasing margins. But the company needs to show consistency on profitability.
- **Leverage**: Moderate.

Balance Sheet Health: I’d rate AMD’s balance sheet health as a 3 out of 5. It has some debt, and the increasing inventory, plus the effect of the volatile industry, create some risks in its balance sheet. The company also doesn’t have very large cash reserves compared to other players in the industry.

Recent Concerns and Management Discussion

  • Recent downturn in PC market is affecting AMD sales. AMD management expects that the overall demand will increase in the near future.
    • The competitive pressure from competitors like Intel and Nvidia is putting pressure on its growth and margin.
    • AMD’s partnership with manufacturing companies has also caused supply chain problems that led to increased lead times.

Management has emphasized the strong performance of its Data Center segment and the growth in embedded products in recent earnings reports, as well as a long-term expansion on AI. They also stressed how their products are becoming a preferred choice by many large corporations.

AMD has also increased its share buyback program and has reduced its debt to improve its profitability and increase shareholder value.

Understandability Rating

I rate the understandability of AMD a 4 out of 5. While the business model of a fabless designer is somewhat more complicated, its products and technology have very clearly defined markets and have been discussed many times in the mainstream media. However, the complex manufacturing agreements and competition dynamics are a little harder to understand and follow.

Conclusion

AMD has made impressive progress over the past few years, but its business remains risky and volatile and still tied to the performance of the semiconductor industry. AMD is improving its competitive position, but still has many challenges to overcome. A prudent investor will carefully evaluate its technology and its partnerships along with the macro climate before investing.