Advanced Micro Devices Inc. (AMD, Financial) has solidified its position as a key player in the semiconductor industry through its strategic initiatives and robust product portfolio. Leveraging technological advancements and continuous product innovation, the company has expanded its reach globally, capturing a diverse audience of users, developers and advertisers. Despite recent challenges in the gaming and embedded segments, as evidenced by its first-quarter earnings, the company's impressive growth in the data center sector and its strategic focus on artificial intelligence technologies position it well for sustained success.
Figure 1: AMD's data center revenue growth
Source: YCharts
A significant driver of AMD's growth is its data center segment, which has seen remarkable expansion. In the first quarter, data center revenue almost doubled, driven by higher sales of its Instinct GPUs and fourth generation EPYC CPUs. This growth trajectory is expected to continue, with AMD projecting data center GPU revenue to exceed $4 billion in 2024, up from the $2 billion guidance shared last year. Notably, AMD implied this was a conservative guidance, as Chief Financial Officer Jean Hu suggested the company has the "supply commitments in place to drive revenues significantly above the $4 billion target for the year."
Figure 2: Nvidia revenue growth spike
Source: AppEconomy
I am impressed by the company's rapid progress in this segment, given that it had little to no AI data center GPU revenue previously. As per S&P, AMD's data center segment will drive the company's improved performance in the next few years with support from its growing presence in the AI GPU market as its MI300 platform ramps up and becomes a viable competing product to Nvidia's (NVDA, Financial) GPUs for AI workloads.
While Nvidia remains the dominant player in the AI chip market (as I mentioned in my analysis of Nvidia - competitors like AMD and Intel (INTC, Financial) are at least one generation behind), AMD's advancements in AI and data center technologies are promising. Nvidia's first-quarter earnings report highlighted the AI hype that has turned into a sustainable AI upcycle, bolstering investor confidence in AI infrastructure stocks and benefiting peers like AMD. Nvidia's strong traction among cloud and enterprise customers, coupled with supply constraints expected to persist through 2025, presents an opportunity for the company to capture market share if it executes effectively.
Figure 3: Global AI and semiconductor market growth projections
Source: Research&Markets
Despite Nvidia's dominance, AMD's growing presence in the AI market cannot be overlooked. The size of the hardware-related AI market could increase tenfold over the next decade, unlocking enormous opportunities for the company. There is a misconception that Nvidia's competitors will not benefit from the AI boom; however, this is not accurate. While Nvidia is capturing a significant portion of the market share, AMD and other competitors will also share in the growth. This dynamic should provide substantial opportunities for AMD as it remains one of the chip juggernauts powering the AI revolution.
Key financial factors
Figure 4: First-quarter 2024 data segment results
Source: AMD Investor Relations
AMD's latest 10-Q report, released on May 1, highlights a modest 2% year-over-year increase in revenue (up $120 million). The data center segment was the standout performer, with an 80% year-over-year increase in revenue, reaching $2.30 billion. The client segment also saw an 85% surge, contributing $1.40 billion in revenue. However, the gaming and embedded segments experienced significant declines due to macroeconomic concerns, excess inventory and the lack of gaming system product refreshes. S&P notes they do n0t expect revenue growth in the gaming and embedded segments until 2025. The decline in gaming revenue, which almost halved, was primarily driven by a decrease in semi-custom revenue and lower Radeon GPU sales. Embedded revenue demonstrated a similar dynamic, with a massive decline as customers continued to manage their inventory levels. This has led to margin deterioration, indicating the company is prioritizing data center growth at any cost. However, this prioritization is justified given the segment's high growth potential and gross margin profile.
For 2024, I anticipate AMD's revenue to rebound by a low-teens percentage, accelerating to the high-teens in 2025. This growth will be driven primarily by the data center segment, supported by the ramp-up of the MI300 platform and new product launches such as EPYC Turin, Ryzen AI processors and Instinct GPUs. In line with this, I expect AMD's gross margin to expand sequentially throughout 2024, improving from 52% in the first quarter - driven by an improving business mix, including growth in server CPU revenue every quarter and recovery in embedded revenue in the second half of the year, as well as normalization in data center GPU gross margins.
S&P expects Ebitda margins to improve to about 26% in 2024, driven by better operating leverage stemming from accelerating revenue growth in the data center segment and modestly improving PC volume growth. This improvement will be partially offset by continued weakness in the embedded segment, which has above-corporate-average margins. Over time, higher volumes on new product launches are expected to support a better mix, aiding further margin improvements.
Valuation perspective
Figure 5: Discounted cash flow analysis
Source: Author's compilation
In my valuation, I have used revenue growth rates for 2024 and 2025 of 13% and 17% - reflecting the expected rebound from the cyclical decline in the PC and data center markets experienced through mid-2023. This rebound is driven by increasing demand in the data center segment, particularly as AMD ramps up its MI300 platform and new product launches. For the subsequent years, the growth rates are set at 10%, reflecting a more stable and sustained growth trajectory as AMD consolidates its position in the market.
In terms of the Ebitda margins, I expect improvements from the 26% level in 2024 to 34% by 2028 as AMD increases its revenue share from the higher-margin data center segment, overall margins are expected to benefit. In addition, higher volumes from new product launches, including EPYC Turin and Ryzen AI processors, will support a better revenue mix and margin expansion. In terms of capital expenditures, I have estimated it at 6% of revenue, consistent with AMD's historical levels as it is necessary for sustaining growth, especially in the high-demand data center and AI segments. The DCF model suggests an upside potential for the stock, with an intrinsic value per share of approximately $170. This valuation is supported by the company's strong growth prospects in the data center and AI segments, improving margins and strategic positioning in the semiconductor industry.
Comparing AMD's valuation metrics with its peers further supports the investment thesis. Despite Nvidia's dominant position, AMD's price-earnings ratio and price-sales ratio remain attractive relative to its growth prospects. As of the latest data, AMD's price-earnings ratio is approximately 35, while Nvidia's is around 45, indicating potential for valuation expansion as the former's AI and data center segments grow.
Figure 6: AMD share price pulls back to the $140 to 160 range
Source: Google Finance
Based on the analysis, I recommend a "buy" rating for AMD. The company's strong growth prospects, particularly in the data center and AI segments, and its attractive valuation relative to peers, make it a compelling investment opportunity. Investors should consider entering a position at current levels, especially during periods of market correction. The recent pullback to the $140 to $160 range presents a favorable buying opportunity.
Wrapping up
AMD's strategic focus on the data center and AI markets, coupled with its robust financial performance and competitive positioning, make it an attractive investment opportunity. Despite near-term challenges in the gaming and embedded segments, AMD's long-term growth prospects remain compelling. With a well-rounded investment strategy, investors can capitalize on AMD's potential for significant appreciation in the coming years. The company's data center segment is expected to be the primary driver of growth, supported by the ramp-up of the MI300 platform and new product launches. As AMD continues to expand its presence in the AI market, it is well-positioned to benefit from the investment cycle. The DCF analysis indicates an intrinsic value of approximately $170 per share, suggesting upside potential from current levels.
