AMD Shares Look To Recover From Trade War Thaw

(Seeking Alpha) – Other than the semiconductor sector that has been the “poster child” of the trade war between the U.S. and China, Advanced Micro Devices (NASDAQ:AMD) was particularly singled out for its unique exposure to China. In May, the U.S. banned US companies and affiliate countries from transferring technology to China’s Huawei. As a result, AMD has stopped shipping CPUs for laptops from Huawei, which only represents a small portion of AMD’s revenue. On the other hand, AMD has been more concerned by the slowing demand in the server space as data centers need to first absorb the excessive channel inventory which was built up amid the trade war.

As a strategy to mitigate the trade war risk, AMD has been adjusting its supply chain. AMD chips are manufactured in Taiwan, and its back-end manufacturing, testing, and assembly are done in Malaysia. Unlike other semis to deal with trade war risk, AMD has the unique advantage in launching new products such as 7nm Ryzen and EPYC which have helped offset the slowdown and increase the server market share to 3.2%. While AMD’s share has tried to advance based on the new found growth, the performance has been often interrupted by the uncertainty of the trade talks.

Unlike most other semis, it may appear that AMD did not behave like a trade-war beaten stock. Since the first tariff in early 2018, AMD share price has increased more than 150%, while its archenemy, Nvidia (NVDA), has lost close to 30%. AMD’s superior performance has been attributed to (1) the continuously increasing market share from the new product launch, (2) the U.S. tariff cost, and (3) the uncertainty on the timely resolution of the trade talks. In this post, I set to identify the portion of the stock loss attributable to the tariff cost which pressures the margin and the price discount due to the risk premium trade war uncertainty. The attribution of AMD’s current stock performance should be relevant to investors. For the portion of the stock return (loss) which was due to the cost increase from the 25% tariff, it is a sunk cost and thus not recoverable. In contrast, if the share price discount is a result of higher uncertainty for the final resolution of the ongoing trade talks, it can be recaptured once the trade talk is settled.

1.3% Direct Tariff Cost

Given more than 41% cost exposures from Asian tech imports (10Q), AMD has a lot to lose with Trump’s 25% tariffs. At the first approximation, AMD may increase its cost by 10%. Since AMD only has 13% U.S. sales, the immediate net cost increase for AMD will be around 1.3%, though the 1.3% contraction in margin has been contradicted by the financial record, as AMD’s gross margin has actually increased from mid-30s from 1Q 2018 to low-40s in 1Q 2019 (Figure 1A). The difference is because of the offset from AMD’s Ryzen and EPYC, which have a higher margin in server market.

Given the strong and surprising stance of Trump’s tariffs, there have been retaliations from China. So, while AMD may not be significantly affected by Chinese retaliation on the supplier side, it has a much larger stake on the Asian revenue side. On this front, AMD is vulnerable as it has more than 66% revenue exposure from that region. The imposition of China tariff on AMD will invariably have a negative impact on AMD revenue front, as shown by the significant decline in AMD’s revenue from December 2018 to April 2019 (Figure 1A).

An AMD Without Trade War

To compute how much market discounts AMD’s share because of its trade war risk, I need to “create” an AMD stock traded with the same financials but in an alternate reality without trade war. Then, I will compare the no-trade-war AMD share with the actual AMD share price which is in a trade war reality. The difference in prices has to be due to the impact of trade war. If you think this process has merit, a valuation model has to be developed.

From many previous posts, AMD share price has been shown to correlate with the estimates of revenue, EPS, free cash flow, and capital expenditure. Therefore, I used the 3-year data from 2016 to 2018 to build a no-trade-war relationship between AMD stock price and these four forward financial metrics. The purpose of this model is to find AMD’s fair price (not fair value) which corresponds to the same time forward-looking financials. I then used this relationship to estimate the share price in the period from June 2018 to October 2019, which is considered the tie period during which the trade war impact has been prevalent. The estimated price, no-trade-war price will be the likely AMD price if there were no trade war effect, since the relationship was estimated in the pre-trade war period.

In Figure 1, we showed that the estimated no-trade-war AMD price is currently at $38, while the actual price is around $31, about $7 higher. Note that two prices have moved fairy closely until September 2018 when the actual price finally dropped off the floor, reacting to Trump’s first call for the 25% tariff to all Chinese imports. It is important to note the no-war price and actual prices were closely related in the early of 2018 until the tariff was announced, suggesting the model has approximated really well with the actual price. This gives us comfort to use the same model to estimate subsequent prices. Further, the subsequent no-war price didn’t move with the actual price, suggesting that the actual price did not respond to the forward financials anymore but fluctuated more with the progress of the trade talks. As it stands now, the market has taken a $7 (or around 22%) discount off AMD’s financial fair price for the trade war risk premium.

Takeaway

In a similar post on Nvidia, a poster, “chaochaoqi” commented:

“You can literally pick any stock and say it will jump if the trade war ended today. This is literally saying the sky is blue. … The overall market 10-20% over a few trading sessions if the trade war ended. It’s such a non-statement to say this single stock might see 20% gains if the trade war ends.”

While this poster brought up an obvious point that my previous estimate on Nvidia’s 20% is a trivial observation, an average stock has lost 10-20% supposedly due to the trade war news. In this post, I hope I demonstrated a counter, non-trivial example of the same question: Almost tripled in share values during the last two years, AMD may be the last stock you would call a victim of the trade war. Yet, AMD bulls would also tell you that the new 7nm products alone should have quadrupled the share price if it was not for the trade war. So, this post did show that, after factoring in the significant improvement in the underlying financials, there is still a 22% discount (or $7) currently applied to AMD’s value which is related to investors’ lack of confidence on the resolution of the trade talks. While the 22% risk discount is significantly higher than the 1.3% tariff impact on AMD’s margin, the pleasant difference is that the 1.3% margin loss is a sunk cost, which is not recoverable, but the 22% risk discount is readily recoverable if trade war thaws.