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Here’s Why You Should Be Buying AMD Stock’s Latest Pullback

Harsh Chauhan, The Motley Fool

Advanced Micro Devices (NASDAQ: AMD) investors wasted no time in pressing the panic button after the company slashed its annual guidance. AMD stock sold off after management warned that its top-line growth for the year will now be in the mid-single digits as compared to the earlier forecast for high single-digit growth.

At first glance, it would seem as if AMD stockholders have made the right move by booking profits. After all, shares of the chipmaker have shot up substantially this year, and it made sense to take some money off the table at the first sign of distress. However, AMD's problems shouldn't last for long, because the challenges it's facing are only short term in nature.

A die with buy, sell, and hold written on three sides.

Image Source: Getty Images.

AMD's problems are temporary

AMD's second-quarter results weren't all that great, considering that its revenue fell 13% annually while operating margin shrank by four percentage points. This weakness is a result of the oversupplied graphics card channel inventory in the aftermath of the cryptocurrency bust, but the outlook suggests that AMD is about to get its house back in order.

The company anticipates $1.8 billion in third-quarter revenue at the midpoint of its guidance range, which would be an increase of 9% as compared to the prior-year period. However, the forecast is lower than the $1.94 billion top line Wall Street expected.

AMD pins this weaker-than-anticipated top-line guidance on the sluggish demand for its semi-custom chips. CFO Devinder Kumar pointed this out in the latest earnings conference call:

For the full year, we now believe revenue will increase mid-single-digit percent over 2018, driven by significant sales growth of our new Ryzen, EPYC and Radeon processors, partially offset by lower-than-expected semi-custom revenue. Revenue, excluding semi-custom, is expected to increase approximately 20% year over year.

So why is AMD's revenue from semi-custom chips going to take a hit in the second half of the year instead of increasing? The answer to this question is not too difficult to find.

Console manufacturers are prepping for the next generation

The semi-custom chips that AMD makes are used by Microsoft and Sony in their gaming consoles. Ideally, demand for these consoles should have picked up the pace going into the holiday season, but that's not going to be the case this time.

Consumers are actually more likely to reduce their console purchases thanks to the impending launch of new-generation hardware next year. Sony's next PlayStation console is rumored to hit the market sometime in November 2020. Similarly, Microsoft is expected to launch the next-generation Xbox in the fall of 2020.

So it isn't surprising to see that gaming enthusiasts are holding off on purchasing new consoles. This was probably the reason Sony recently announced that it's cutting its fiscal 2020 PlayStation 4 sales forecast by one million units. In light of that decrease, the Japanese electronics manufacturer has no option but to reduce orders for AMD's semi-custom chips.

But once the next-generation consoles from Sony and Microsoft go into production next year, AMD will have a new tailwind to count on.

Don't miss the other positives

Short-term weakness in demand for semi-custom chips will hold AMD back for now, but investors shouldn't overlook the progress the company is making in other segments.

AMD's Ryzen processors are proving to be a tailwind for the company in the central processing unit (CPU) space. AMD believes that the launch of the company's latest 7-nanometer Ryzen CPUs will allow it to gain more market share, claiming that their low power consumption and superior performance as compared to competitors will be an advantage.

Moreover, AMD has started shipping its new server processor -- Rome -- and there's good reason to believe that the chip will help the company make a bigger dent in the server market. AMD CEO Lisa Su points out that compared to the company's first-generation processors, Rome has "more than twice the number of platforms in development with a larger set of partners" and "four times more enterprise and cloud customers actively engaged on deployments prior to launch."

So it won't be surprising to see AMD's data center sales increase at a faster pace in the coming months thanks to the groundwork the company has put in place prior to the launch of Rome.

Meanwhile, AMD's GPU revenue increased by a double-digit percentage as compared to the first quarter thanks to an increase in channel sales and the launch of a new product family. This indicates that AMD is witnessing a potential turnaround in graphics card demand as well.

In all, AMD has a lot going for it right now barring the semi-custom business. So it will be a good idea for investors to take advantage of any pullback, because the missing piece of the jigsaw puzzle is expected to fall into place next year and supercharge the company's growth.

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Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Microsoft. The Motley Fool has the following options: long January 2021 $85 calls on Microsoft. The Motley Fool has a disclosure policy.

This article was originally published on Fool.com