Monday, August 24, 2009

Advanced Micro Devices (NYSE:AMD): Upgraded to Buy at Citigroup

Citigroup is upgrading Advanced Micro Devices (NYSE:AMD) to Buy from Hold and raising price target to $5.50 (prev. $4.25).

Firm notes they are upgrading AMD, given what they believe is a favorable risk/reward profile. They are raising our price target based on a sum of the parts of Global Foundries ($0.45) and Product Co ($5.08). Firm' estimates are tweaked given their more rigorous model for Global Foundries.

Deep Discount to the Sector — 3Q09 QTD, AMD shares are down 4.4%, underperforming the broader chip industry (SOXX up 14.5%, S&P up 11.6%). Citi recognizes that AMD’s competitive position is poor and its net debt position classifies the company as “low quality.” However, now trading at just 1.25x EV/sales, a 45% discount to the group (2.3x), they see risk/reward as favorable.

Elements of Stabilization Evident — 3 fundamental factors are contemplated in their upgrade: 1) AMD’s competitive position with its major customer is likely bottoming, supported by recent platform wins; 2) AMD’s gross margin is expected to rise off bottom quintile 2Q09 levels, correlating well with share price; 3) 2010 consensus estimates are likely conservative, noting that AMD tends to outperform the current consensus growth rate 75% of the time in periods of improving PC growth.

Not Without Risks — 1) 2H09 back-to-school selling season could be a disappointment, impacting the entire sector; 2) AMD is highly likely to refinance its 2012 debt—while not expected to be via equity, dilution is a possibility; 3) OEM’s are increasingly looking to non x86 providers of CPU’s (notably Qualcomm), creating a potential long-term threat to AMD.

Confident in Improving Gross Margin. Firm is increasingly confident in gross margin improvement for AMD—noting that 2Q09 GM was in the bottom quintile of AMD’s historical margin performance. As they chart below, such improvement correlates positively with share price improvement:

Citigroup's confidence is derived from:

1. In 1H09, Global Foundries gross margin averaged ~15%, hampered by sub-50% utilization rates as sales fell 18% 1H09/1H08;. However, AMD’s clearance of 65nm inventory in 2Q09, ahead of seasonal growth in 2H09, has paved the way to increased utilization. Firm has confirmed that production levels are increasing, benefited by lower cost 45nm production. They note that as sales increase 9% 2H09/1H09, we expect corporate gross margin to increase from 29.0% in 2Q to 38.6% in 3Q on higher utilization.

2. On its recent earnings call, HP commented that as AMD-based servers from 3-4 years ago are coming up for refresh, HP expects its recent share gain to slow. While this reflects poorly on AMD’s roadmap, headlined by its recently introduced Istanbul processor, Citigroup nonetheless assertsd that AMD’s server sales have bottomed.

3. They expect new consumer products to positively contribute to AMD’s gross margin. In particular, AMD’s Congo andRV870 graphics platform are accretive margins.

Notablecalls: In the end even the dogs get upgraded.

AMD is bound to trade up towards $3.90-$3.95 range (gut feel) today on this call. It is likely to pull back from there but I will not be a buyer. There is too much liquidity around in AMD, making bounces tough to play.

If the tape remains strong I would not be surprised to see AMD trade towards $4.25+ but that's more of a market call.

All in all, not my cup of tea. But it's out there.

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