Advanced Micro Devices Inc. – More market share gains expected July 10, 2023 513
- Significant market share gain in data centre CPU market from ~4% in 2017 to ~20% in 2022. We expect further gain due to more workloads being migrated to AMD-based systems. An opportunity to raise its presence in data centre GPU market as customers look for second source supplier due to increased adoption of generative AI.
- We expect margin to grow post acquisition of Xilinx and Pensando from 45% in FY22 to 48% in FY23e due to growing revenue contribution from Data Centre and Embedded.
- Initiate coverage with ACCUMULATE recommendation and DCF-based target price (WACC 7.4%, g 3.5%) of US$125.00. We expect FY23e revenue to experience marginal growth driven by Data Centre and Embedded segments, offset by the decline in Client and Gaming, with growth re-accelerating in FY24e as Data Centre sales mix shift towards the EPYC 9004 series server CPUs, which we believe to have ~50% higher ASP.
Company Background
Advanced Micro Devices (AMD) designs and sells primarily Central Processing Unit (CPU) that is responsible for the overall management of a system, including personal computers (PC), servers in data centres, as well as gaming consoles. AMD customers are segmented into: Data Centre (26% of FY22 revenue), Client (26%), Gaming (29%), and Embedded (19%).
Investment Highlights
- Tailwinds from generative AI. AMD has gained a significant presence in the data centre CPU market, raising its share from just 4% in 2017 to 20% in 2022. The growing popularity of AMD CPUs in servers is attributed to its superior power efficiency. The company’s EPYC CPUs power 128 of the world’s top 500 supercomputers as of June 2023, compared to just 2 in 2017, and 15 of the top 20 most energy-efficient systems. Further, the adoption of generative AI will expand the need for servers, boosting the demand for AMD’s CPUs. However, AMD still has a relatively small share in the data centre GPU market at only ~8%, significantly lower than that of the largest incumbent who holds >90% share. Despite this, we believe AMD is able to gain share as customers are in search of a second source of supply to mitigate the overreliance on the large incumbent and extended lead times, given the increasing adoption of generative AI.
- Potential for margins expansion. AMD has been able to achieve increased gross margin, from 34% in FY17 to a high 48% in FY21. The company was able to maintain a relatively flat gross margin in FY22 at 45% despite incurring US$1.4bn in acquisition-related amortization as a part of cost of sales and the margin contraction in its Client segment since 2H22. We believe AMD can expand its gross margins as it sells more Data Centre and Embedded products as both segments combined for 54% of 1Q23 revenue compared to 45% in FY22. Net margins have also increased from -1% in FY17 to 19% in FY21, but contracted to 6% in FY22 as AMD assumed the operating expenses of Xilinx and Pensando, incurred amortization expenses following their acquisitions, and experienced decline in its Client business. We view the net margin contraction as short-term in nature and we expect it to expand as AMD achieves higher operating leverage and Client demand recovers.
- Strong intellectual property portfolio enabling flexibility. AMD has a suite of IP that allows it to design semi-custom chips, including ARM-based CPUs. This mitigates the risk of its x86 products getting displaced by its ARM counterparts, which are gaining popularity due to efficiency. Additionally, the acquisition of Xilinx has broadened AMD’s product portfolio in adaptive computing, providing the company with enhanced expertise to offer more optimized solutions in the future.
We initiate coverage with ACCUMULATE rating and a target price of US$125.00 based on DCF valuation, with a WACC of 7.4% and terminal growth of 3.5%.
|
REVENUE AMD posted a total revenue of US$23.6bn for FY22, which signified a 44% YoY growth. Starting from FY22, the company reports in four segments FY22: Data Centre (26% of revenue), Client (26%), Gaming (29%), and Embedded (19%). Prior to that, the company used to report in only two segments, which were Computing and Graphics; and Enterprise, Embedded, and Semi-Custom.
Client: AMD started its business by selling CPUs for consumer PCs. As such, it was the company’s main revenue contributor, consistently making up the largest proportion of its total revenue since its founding until FY22, when it was tied with Data Centre where both made up 26% of the overall revenue (Client accounts for 21% of LTM total revenue as of 1Q23). The Client segment earns revenue by: 1) selling CPUs to PC and notebook makers, referred to as original equipment manufacturers (OEMs), as well as 2) selling those products to the general PC users.
Revenue from this segment was US$6.2bn in FY22, falling by 10% YoY. The drop was due to AMD undershipping products to its retail partners since 3Q22 to help reduce channel inventory levels as demand for PC was negatively affected by the macroeconomic environment. In the company’s latest results announcement for 1Q23, the Client segment saw a 65% YoY and a 18% QoQ revenue decline to US$739mn as it continued to ship significantly below end-user consumption level. AMD indicated that 1Q23 was the bottom for its Client business and is expecting the segment to experience positive QoQ growth moving forward as inventory glut normalizes and particularly in 2H23, where there is seasonal strength.
Data Centre: AMD also sells CPUs that are designed for data centre usage. These CPUs are used for a wide variety of applications, ranging from general purpose computing to high-performance computing (HPC) and artificial intelligence (AI). Apart from CPUs, AMD also sells data centre accelerators for HPC, AI, Machine Learning (ML), and inferencing workloads. The Data Centre segment earns revenue by: 1) selling CPUs and accelerators to cloud hyperscalers and enterprises; and 2) selling these components to server manufacturers/OEMs.
The Data Centre segment is one of AMD’s fastest growing businesses as it grew at a 2-year CAGR of 89%, from US$1.7bn in FY20 to US$6bn in FY22. The significant growth was attributed to the increasing adoption of the company’s EPYC CPUs across both cloud and enterprise customers as well as increasing workload migration to AMD-powered systems. Data Centre revenue was flat YoY in 1Q23 at US$1.3bn as higher sales to cloud customers were offset by lower enterprise sales. The decline in enterprise sales was due to customer demand softening as a result of the near-term macro uncertainty. AMD indicated that the demand for its server CPUs will remain mixed in 2Q23, but is positive on its ability to grow its footprint across both cloud and enterprise in 2H23 as the company is seeing strong customer response on its latest product lineup.
Gaming: Aside from CPUs, AMD sells discrete graphics processing units (GPUs) for the consumer market as well, which are used for rendering high-quality graphics in PCs. AMD also sells semi-custom SoC (system-on-a-chip) for gaming consoles, such as Sony’s Playstation and Microsoft’s Xbox. The gaming segment, therefore, earns revenue by: 1) selling graphics cards to the general PC users, 2) selling GPUs to PC component manufacturing partners; and 3) selling semi-custom chips for gaming console manufacturers.
AMD’s Gaming segment has also experienced substantial growth, with revenue more than doubling from US$2.7bn in FY20 to US$6.8bn in FY22, making it the largest segment in FY22, contributing 29% of total sales. The substantial growth was due to the strong demand primarily for its semi-custom chips that are used in the latest generation of gaming consoles, while also partially helped by the demand for its PC GPUs during the pandemic. However, sales for its desktop gaming GPUs have declined since 2Q22 as consumers cut back on their discretionary spending due to the macro environment. For 1Q23, revenue was down by 6% YoY to US$1.8bn despite semi-custom SoC sales growing double-digit YoY, as it was more than offset by the decline in GPU sales.
Embedded: This segment includes the sale of AMD’s embedded CPUs, GPUs, field programmable gate arrays (FPGA), and networking solutions. The embedded CPUs and GPUs have lower power and cost less than those designed for PCs or servers. These components are used in embedded devices, such as for powering the infotainment system in cars, robotics in industrial machines, medical imaging devices, digital signage, and smart home devices.
The Embedded segment generated a revenue of US$4.6bn in FY22, a significant jump from US$246mn in FY21 due to the inclusion of Xilinx and Pensando revenue following the acquisition completed in February and May 2022, respectively. Revenue also jumped US$967mn YoY in 1Q23 due to the impact of a full quarter revenue from Xilinx. AMD expects the Embedded segment to continue its growth in 2Q23 as it continues to see increasing demand across the embedded markets, including industrial, vision and healthcare, test and emulation, communications, aerospace and defence, and automotive.
|
|
Revenue Growth: We forecast revenue for FY23e to experience marginal growth to US$24bn, which would represent a 3% YoY increase. We expect Data Centre to continue its growth due to increasing AI adoption in enterprises and hyperscale customers continuing to execute their server buildout plans, which would provide tailwinds for server CPU demand. Furthermore, we believe AMD has the opportunity to gain share in data centre GPU market as customers are likely to search for a second source supplier, especially during periods of shortage and extended lead time, to reduce reliance on the major player. We also expect the Embedded segment to grow as customers increasingly adopt AMD’s adaptive computing solutions. However, this growth will be offset by the decline in both Client and Gaming segments, despite the continued increase in semi-custom gaming chip sales, as we expect consumers to purchase fewer PC components (both CPUs and GPUs).
|
RULE OF 40
The “Rule of 40” was first introduced as a benchmark to measure the balance between growth and profitability of SaaS companies, taking into account both revenue growth, as well as profitability (Revenue Growth + EBITDA Margins), with the addition of both metrics needing to exceed the 40% threshold. We have modified this slightly by averaging revenue growth over a 3-year period compared with just a single period growth rate. Adding together AMD’s 3-year average revenue growth of 52% and its FY22 EBITDA margin of 23%, the total of 75% is more than our required threshold of 40% (Figure 4).
EXPENSES
Cost of sales was US$13bn in FY22, up from US$8.5bn in FY21 due to increased revenue and the inclusion of US$1.4bn acquisition-related intagibles amortization expense.
AMD historically has two main operating expenses, majority of which came from the research and development expenses that consistently made up ~70% of the overall OPEX between FY17 and FY21, with the remainder coming from marketing, general and administrative expenses. In FY22, R&D expenses was US$5bn, up 76% YoY, and marketing, general and administrative came in at US$2.3bn, up 61% YoY (Figure 6). The increases were due to headcount growth as a result of the integration with Xilinx and Pensando following their acquisitions and increased go-to-market spending. AMD also started incurring acquisition-related intangibles amortization expenses in FY22, which was US$2.1bn, bringing FY22 total OPEX to US$9.3bn, a 118% YoY growth.
About the author
Maximilian Koeswoyo
Research Analyst
PSR
Maximilian mainly covers the US technology sector. In his strive to be a globalized citizen and get continuous exposure to the fundamentals of companies from various industries, he graduated from Singapore Management University holding a Bachelor’s degree in Business Management.