Advanced Micro Devices

Here at The Kelly Letter, we’ve had our eye on Advanced Micro Devices (AMD) since it was over $21 in November. Since then, it has fallen some 24%, a full 8.5% just this week. Our initial buy target was $20, from which it has steadily dropped as I’ve monitored the stock and felt that it had further to fall. Our current buy target is $15, which is 7.5% below Friday’s close.

AMD’s Q4 was tough. It’s been fighting hard against a reinvigorated Intel (INTC) and it also acquired ATI, a manufacturer of graphics chips.

Together, those factors resulted in a $574 million loss. That’s -$1.08 per share. In Q3, the firm made $134 million, or 27 cents per share. Its revenues rose 3%, but even that good news fades when considering that it’s usually 10% during the holidays.

Last week, I provided subscribers with a look at Intel that showed the company’s margins under pressure. It’s not alone. AMD’s gross margins fell from 52% in Q3 to 40% in Q4. Naturally, the cause is falling chip prices, particularly server chips.

In its conference call, AMD said that the pricing environment will continue to be “incredibly challenging” all year, and especially so in Q1. Despite that, it thinks it can get margins back up to 50% thanks to its “maniacal focus on costs”. It has high hopes for its line of quad-core chips scheduled for a midyear release, and thinks Microsoft’s (MSFT) new Vista operating system will drive unit volumes across the board.

Yet, AMD remains firmly in the crosshairs of a none-too-happy Intel which is going all-out against the upstart that dared to take away market share a year ago. Longtime Kelly Letter subscribers remember my articles from this time last year in which I predicted this very scenario of the pendulum swinging back the other way. We’re seeing that now, and we’ve put money in place to benefit from it, but we must always look ahead to succeed in this business.

Looking ahead, I see AMD getting ATI fully integrated, continuing its proven ability to produce market-leading chips at a lower price than Intel, and faring well in the long-term margin war through tight cost controls.

This sharp, determined company will have its day again, but not soon. The near-term favors Intel, which is why we own it. The medium-term could see a reversion back to AMD, however, and for that potential we continue to watch for an attractive entry point.

Our thesis remains: own Intel while it prospers and raises its stock price while pushing AMD’s lower. When AMD gets low enough, invest for its eventual recovery. Watch Intel, and when it looks to have done as well as it can on this up cycle, sell for a tidy profit.

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