AMD Stock: AI GPU Underperforms with Major Catalysts (Upgrade) (NASDAQ:AMD)

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Shares Advanced Microprocessor Devices, Inc. (NASDAQ:AMD) are up more than 41% over the past year, but they still lag far behind Nvidia Corporation (NVDA), which completely crushed expectations last year. Although AMD lags behind Nvidia in terms of its GPU offering, the company is expected to debut new products and increase shipments of the Instinct MI300X accelerator in fiscal 2024, which is expected to support AI workloads. AMD is also accelerating its GPU roadmap and aims to launch new Instinct chips in Q4 2024, as well as in fiscal 2025. These products are expected to generate significant revenue and free cash flow benefits for AMD and could help narrow the valuation gap between AMD and Nvidia!

Previous review

In February 2024, I rated AMD stock as a “hold” — AMD could It will soon have its “Nvidia moment” — as AMD seizes an inflection point in AI… meaning companies are accelerating spending on their companies’ AI chips to scale their own businesses. AMD last month revealed two more processors that will launch, the AMD Ryzen AI 300-series processors, which are built on AMD’s XDNA 2 architecture, and the AMD Ryzen 9000-series desktop processors, which are built on AMD’s Zen 5 architecture. AMD is also accelerating its efforts to expand its Instinct accelerator offerings, which could lead to significant increases in free cash flow.

The introduction of new products is expected to be a challenge for Nvidia

AMD is set to launch two processors in the near future: the AI 300 series for laptops (scheduled to launch July 17, 2024) and Ryzen 9000 processors for desktops (shipping August 2024). The AI 300 series is aimed at content creators who need to handle demanding AI workloads. Both processors could be drivers and catalysts for the company’s core processor business.

More importantly, AMD said in Q2’24 that it’s accelerating its GPU production pipeline to become more competitive with Nvidia’s H100. AMD already launched the Instinct MI300X accelerator earlier this year, which is intended to directly challenge Nvidia’s leading position in the datacenter GPU market. Nvidia leads the market by a mile, which has resulted in a sharp increase in profits for the chipmaker: Profits explosion and stock splits change the rules of the game.

According to Wells Fargo, Nvidia still has a massive 94% share of the Data Center GPU market. AMD is far behind with a market share of just over 4%, but AMD’s growing AI offering density could challenge Nvidia and take some market share away from it in the coming quarters.

Wells Fargo, Eric Flaningham

I say this because the demand for AI GPUs is skyrocketing and Nvidia alone is unable to meet the demand. Since demand outstrips supply, AMD could be a big beneficiary here as it accelerates its own product release pipeline, with shipments of MI300 accelerators likely to pick up in Q2 2024. AMD is also targeting the AMD Instinct MI325X accelerator in Q4 2024 and the AMD Instinct MI350 series in fiscal 2025.

The MI350 series, according to information provided by AMD, offers “up to 35x increase in AI inference performance over the AMD Instinct MI300 series,” which could make AMD’s chips increasingly interesting as an alternative to the pricey H100 chips that Nvidia sells. The AMD Instinct MI400 series is set to debut in fiscal 2026, which means AMD is approaching a one-year release cycle for its GPU products.

AMD Expects Massive Free Cash Flow Growth

AMD said in its latest earnings report that it sees strong demand for its Instinct MI300 accelerator, and the chipmaker could be on track for some serious free cash flow growth over the next few years. Its data center GPU revenue guidance is over $4.0 billion for fiscal 2024, and I wouldn’t be surprised if GPU-related revenue doubled next year given how strong demand for these products is right now.

AMD saw year-over-year revenue growth of just 2% in the latest quarter, while Nvidia crushed it with year-over-year growth of 262%. However, since AMD accelerated shipments of the Instinct MI300 in Q2’24, AMD can expect significantly higher revenue and free cash flow than it did in the latest quarter. This isn’t to say that AMD will overtake Nvidia in the data center GPU market anytime soon, but AMD’s free cash flow growth potential may be potentially underestimated here.

AMD generated just $379 million in free cash flow in the latest quarter, or an FCF margin of 7%, while Nvidia crushed the competition with $14.9 billion in FCF and a margin of 57%. However, AMD’s free cash flow margin improved from 4% in Q4 2023 to Q1 2024, thanks in part to shipments of its high-margin Instinct MI300 processors.

With GPU revenue potentially doubling next year to $8.0 billion (my personal estimate, given the massive supply-demand imbalance in the GPU market), AMD is also expecting a significant improvement in its free cash flow. AMD’s consensus forecast for next year is for a 28% year-over-year increase and $33 billion in revenue.

The free cash flow margin increase to a moderate ~15%, which is not an aggressive assumption given the strength of data center GPU demand, could therefore imply a total free cash flow potential of close to $5.0 billion in fiscal 2025. This free cash flow margin increase could be primarily driven by increased shipments of the Instinct MI300 (and the launch of the aforementioned new processors) as well as pricing power of data center GPUs.

Since AMD only achieved about $1.1 billion in free cash flow in fiscal 2023, the chipmaker could be on track to quadruple its free cash flow by the end of fiscal 2025. In my opinion, this implied increase in AMD’s free cash flow may be underestimated as the market is mostly focused on Nvidia’s leading revenue growth rates and FCF margins.

AMD, millions of dollars	Q1 23	Q2 2023	III quarter 23	4Q23	Q1 24	Growth YoY
Income	5353 dollars	5359 dollars	5800 dollars	6168 dollars	5473 dollars	2%
GAAP net cash flow from operating activities	486 PLN	$379	421	381	521 dollars	7%
Real estate and equipment purchases	(158 dollars)	(125 dollars)	($124)	($139)	($142)	-10%
Free cash flow	328 dollars	254 PLN	297 dollars	242 PLN	$379	16%
Free Cash Flow % of Net Revenue	6%	5%	5%	4%	7%	13%

Nvidia, millions of dollars	1Q 24	Q2 2024	3rd quarter 24	4Q 2024	1Q 2025	Growth YoY
Income	7192 dollars	$13,507	18,120 dollars	$22,103	$26,044	262%
GAAP net cash flow from operating activities	2911 dollars	6348 dollars	7333 dollars	$11,499	$15,345	427%
Real estate and equipment purchases	(268 dollars)	($300)	(291 dollars)	($282)	($409)	53%
Free cash flow	2643 dollars	6048 dollars	7042 dollars	$11,217	$14,936	465%
Free Cash Flow % of Net Revenue	37%	45%	39%	51%	57%	56%

(Source: Author.)

AMD valuation

I like AMD mainly because of its outsider status and lower valuation compared to Nvidia. AMD is expected to grow EPS faster than Nvidia in the long term, mainly because I think AMD’s GPU development pipeline lags Nvidia’s. So AMD has significant “catch-up” and revaluation potential. The same is true for Intel (INTC), which only recently launched its own AI accelerator, the Gaudi 3 AI, aimed at the enterprise market. In Intel’s case, I think the market is way too bearish, as reflected by the company’s low P/E.

AMD stock is currently trading at a P/E ratio of 29.5X, which Nvidia is beating with an earnings multiple of 35.6X. Intel is by far the cheapest chipmaker with a P/E ratio of 15.8X, but Intel has had its own issues, including delayed CPU launches. Nvidia has grown its data center and consolidated revenue much faster than AMD and Intel in recent quarters, but AMD is catching up and has a very attractive risk setup given its Instinct MI accelerator pipeline.

I believe AMD could trade at Nvidia’s 35-36X P/E if the company executes well on its Instinct releases, GPU demand remains strong, and AMD sees a significant free cash flow margin catalyst from the accelerating Instinct accelerator pipeline. AMD’s 35-36X P/E implies a fair value range of $195-$200. The aggressive product roadmap for GPU releases and the associated FCF catalyst is why I’m upping AMD’s stock price to Buy.

AMD Risks

AMD is lagging Nvidia in terms of GPU revenue and market share growth, but AMD has an opportunity to close the gap with its fiercest competitor with the next batch of new Instinct chips… which are hitting the market at a time of growing demand. Since AMD has still not benefited from the growth in Instinct MI300 accelerator sales (given that shipments only began in Q1 ’24), the company is poised for a major free cash flow boost going forward. My opinion of AMD would change if the company saw a slowdown in demand for its flagship Instinct MI300 chips, and AMD and Nvidia saw GPU prices drop dramatically.

Final thoughts

AMD is currently an outsider in the AI GPU market, which Nvidia easily controls and dominates. However, AMD is not asleep at the wheel and is poised to debut several AI-focused processors, which could lead to an acceleration in the company’s revenue/free cash flow growth and help the chipmaker close the gap with Nvidia. Importantly, I believe AMD has a valuation advantage over Nvidia, although the chipmaker is not growing revenue as fast as its closest rival in the market.

I really like AMD’s underdog status in the AI market and believe the upcoming launch of AI-enabled CPUs and new Instinct GPUs could make AMD more attractive from a free cash flow perspective. At a P/E of less than 30X, AMD’s risk profile is very tilted to the upside!