AMD: Sidelines

AMD (NASDAQ:AMD) had a good Q2, a weak Q3 guide and an implied need for a humongous Q4. The reasons for the Q3 weakness are lingering problems which makes me cautious on their implied guide for Q4. Add to that extra trade war pressure and we decided to move to the sidelines.

Moved To Sidelines

We told subscribers in the after hours we would exit a majority of position sizes.

We were worried about follow through to the downside. The combination of the weak revenue guide vs. the Street along with a chart that looked like it wanted to start breaking down made as cautious.

I've found that technicals may not be a strong predictor of what will happen ahead of earnings but can be a good predictor of follow through after earnings are reported.

Here's what we saw.

With lower highs over the last few days in combination with a weak guide the risk was for a negative follow through.

We said we wanted to cut to a minimum stub position in case there was negative follow through.

After reviewing the next few days we decided to move aside completely in our model portfolio.

Keeping It Simple

Really I try to look at things simply. Upside surprises in the report and guidance is positive. Stocks moving up are positive. Missing and/or guiding lower and stocks moving down are negative. This keeps me out of trouble and tends to drive more consistent performance over time, I believe.

Rather than making things complicated, over-thinking and justifying, I find that simple works. Reacting to "simple" tends to work.

This Is What Bothered Us Most

Source: Models Sourced From

Their guide is for mid-single digit revenue growth for the year 2019. I marked that in yellow above. That's the 5%. They gave you the Q3 guide of $1.8B.

To get to their 2019 revenue target you now need Q4 to show 55% year-over-year growth.

AMD has had new product ramps this year and has more coming in Q4. But to go from a Q3 guide-down to then expect a monster jump in Q4 growth rates, for me sounds tough.

They can do it but it adds risk to the forward numbers. Just the logic of such a huge needed jump keeps me cautious.

In our rating system we need a few things to be at a Strong Buy.

1. We need our quarters at or above the Street.

2. We need 45% 12 month upside potential taking our EPS X an average PE.

3. We need wow.

After a lower guide plus needing a 55% jump in revenues in Q4 to hit numbers takes away my "wow" and also puts risk to our first criteria that our EPS needs to be above the Street.

Our simple guidelines helps us avoid risk. Nothing's perfect of course but our process is intended to find big winners and hopefully avoid big losers. I can miss things on the downside but also on the upside. But what ends up fitting my criteria tends to have a higher hit ratio.

That huge jump needed for Q4 took me out of my criteria.

What's Bothering The Guide?

The company pointed to gaming console weakness as a key part to their weak guide.

They said,

"As we look into the second half of the year, we are seeing additional softness in game console demand, which is now reflected in our full year guidance."

This is a little concerning. I believe that semi-custom can make up as much as 20-25% of their overall business.

There's a gaming console cycle coming. Sony (NYSE:SNE) Playstation launches a new console every 6-7 years. PS4 launched in 2013. Xbox One also launched in 2013.

Microsoft (NASDAQ:MSFT) appears ready to launch for holiday 2020. They already announced a launch which means sales are going to dry up as gamers push off new purchases. Those sales are going to get pushed out a year now. Microsoft had an early announcement. That's going to hurt numbers for the next four quarters. It already hurt the guide for Q3.

AMD said,

"In semi custom, we have extended our game console leadership as both Microsoft and Sony have now both announced they will use custom AMD SoCs to power their next-generation game consoles. We are very proud to power back-to-back generations of the world's highest performing game consoles."

They are getting geared up for holiday 2020 but in the meantime there's a drag to their revenues and also earnings numbers.

China Risk

AMD called out China as a risk. China is about 30%-40% of revenues.

Here's what AMD said,

"Yeah. So we did have a small impact due to China. We have several customers that are now on the US entities list and we stopped shipping to those customers in the second quarter. And so it's a small impact, but there is impact that is offset by some of the positives in the rest of the business."

China's market is slowing. While this wasn't a big bite yet, Trump's latest tariffs likely means this trade war is getting dragged out.

Two Hits To Q3's Guide-Down Linger

So gaming and China were reasons for the guide-down. I think those problems linger, as I explained above. If they linger then the Q3 guide-down may not be so one-off. If so to own AMD you probably need to be ok with the idea that sales will jump in Q4 by 50%-plus.

When asked about their market share targets AMD did seem to hedge a little bit. See here.

"...we feel good about hitting the right target. I'm not ready to update that yet. I think we want to get through. There is a lot of platforms to launch here in the third quarter and in the fourth quarter. We'd like to get through some of that, but we feel that the target is the right target. The product is certainly performing well and now it's about helping our customers get their platforms to market as soon as possible."

They want to give the "right target" could have meant that they are hedging. "I'm not ready to update that yet" could mean both up or down. Also we know they have a huge ramp with Rome and many other products. Still the ramp to 50% growth after weak growth all year and a Q3 guide-down makes me question it.

Net net I don't think they are hedging but it did sound like a hedge. So it doesn't help my "wow" factor.

Conclusion

After a nice run and a weak guide we decided to exit. The next few quarters have some headwinds with consoles and China. Q4 has a big hurdle needing a 50%-plus year-over-year growth rate. We're sidelines for now.