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Economy, Investing  | January 25, 2019

For the first time, Apple (NASDAQ: AAPL) CEO Tim Cook cut Q1 revenue guidance, citing poor iPhone sales in China. Cook's rare move ignited a widespread worry of a trade war-induced recession. The fear of recession was further confirmed by Samsung Electronics' (OTC:SSNLF) subsequent guidance of a lower quarterly operating profit for the first time in two years, as a slowing Chinese economy also erodes demand for its chips and handsets. The worrisome Q2 2019 guidance from Micron’s (NYSE: MU) CEO Sanjay Mehrotra also included news that the tariffs would squeeze profit margins; the company has said it would take “three to four quarters” to adjust to the tariffs. In a recent CNBC interview, Advanced Micro Devices’ (AMD) CEO Dr. Lisa Su mentioned that “we are seeing some loss of revenue from China.” Even the long-term SA AMD bull, Adaveinus2 has acknowledged that, “Market will give grace points for crypto revenue loss but not for China trade loss. This will be new information during this quarter. Both Nvidia and AMD will fall after Q4 2018 earnings. I think the CEOs did not adjust their guidance for revenue loss from China in their guidance.” Amid these warnings, AMD has reacted harshly, down 9.5% on the day of Apple’s announcement (1/2/2019).

On the other hand, for a while now, crypto-related demand has been attributed to the rise and fall of AMD share prices. With the agreement that crypto impact has been quickly reduced, AMD’s recent sharp reaction to Apple’s non-crypto warning may suggest another possibility that China's slowdown can quickly proliferate from the supply chain through the demand chain and turn into a global slowdown, considering that AMD generated more than 30% its revenue from Greater China region. In this post, I looked into this possibility.

AMD's China Relevance

You would assume that when talking about China, tariffs affecting AMD’s supply chain or import cost must be the obvious starting point. However, it has been developed in many previous posts that the tariff impact may be mitigated. The issue of interest here is on the demand side of the equation. If China, one of AMD’s major customers, is experiencing a significant slowdown, a natural question is that if AMD’s future revenue will be affected.

To answer this question, first I want to examine how important China is to AMD in terms of size of the relationship. Historically, most of AMD's revenue comes from five geographical segments: China (33%), the U.S. (26%), Japan (23%), and Europe (5%) (Figure 1B). China has been the largest source of revenue booked since 2006 except briefly during 2015-2016 when AMD lost most of its CPU market share to Intel (NASDAQ:INTC). In 2011, China's revenue has once reached near $3.5 billion or 60% of AMD's total revenue (Figure 1A and Figure 1B).

Furthermore, if adding the second largest Japan into the Greater China segment, the "Asia influence" cannot be underestimated because it would account for close to 56% of AMD's revenue. Other than its growing size, China's presence becomes even more relevant as the economies in the rest of the world become increasingly more correlated with China's economy. Therefore, China's recession will not be confined to China. In fact, for AMD's shareholders' perspective, Asia's impact on company's revenue is much more important than the U.S. or Europe's impact, as AMD’s total revenue growth is more affected by Asia's revenue growth than by the U.S. revenue growth (Figure 2). The closer Asian influence can be easily explained, especially in recent years, by the largest bitcoin mining farms located in Asia (China).

Crypto Out, China In

The real bad news is that, if China's slowdown may be to blame for part of AMD's Q4 revenue downside guidance, the potential damage to AMD's shareholders will not be the end of it. Considering that AMD's China revenue growth has been increasingly correlated with AMD's U.S. revenue growth (Figure 3), China's slowdown in demand or trade war weakness may soon be transmitted to the U.S. in the form of global recession. As seen obvious in Figure 3, China and U.S. revenue growths, which were not perfectly correlated prior to 2016, became almost perfectly synchronized in the 2017’s rise and 2018’s fall (circled portion in Figure 3).

The recent common movement may be most likely a result of the crypto-related activities affecting mainly in China and less in the U.S., but the correlation in 2018 becomes worrisome since the crypto effect has been believed to dissipate in 2H 2018. Thus, the China/US/Europe correlation begs a real possibility that China's declining demand will turn in U.S.' declining demand (Figure 3) and Europe’s declining demand (Figure 4). Therefore, the negative impact on AMD's total revenue will be further compounded, considering that AMD has another 31% of revenue from the U.S. and Europe (Figure 1B).

Of course, there is always a silver lining. The high correlation on the downside is that Japan is the only AMD revenue source which counteracts China, the U.S. and Europe’s revenue growths in a meaningful way, as Japan segment contributes about 23% of AMD total revenue (circled part in Figure 4).

AMD Revenue Impact from China Slowdown

To AMD shareholders, maybe the more important question is how the correlated revenue growths affect AMD stock prices. Using the above relationship, we were able to estimate the correlated impact on all four AMD segments in terms of their segment revenue growths, assuming 1% drop in China revenue growth rate. The way to read the table below is like this: For every 1% decrease in China revenue growth rate, U.S. segment will also lose -0.02%, and Europe will lose -0.29% but Japan will gain 0.27%, instead. In short, 1% China revenue loss will result in AMD's total revenue loss of about -0.29%.

However, to make this estimate more meaningful, Q4 China revenue growth change needs to be estimated from Q3’s 23%. Admittedly, this is a hard task since many companies have yet to report Q4 financials or cite China revenue impact.

At this point, without further information about AMD’s China slowdown, we can only afford to do some inference and guessing. Say, when Tim Cook lowered the Q1 revenue guidance from the original $89-94 billion range to $84 billion, or approximately a 6% reduction, he cited the miss was mainly due to China's revenue loss. As AMD has over 33% revenue exposure from Greater China region, while Apple has about 25% China revenue exposure, it may be “likely” that AMD can risk a 6-8% reduction in revenue in the coming quarters. Given that China has a 0.29 total revenue multiple, a 6% total revenue loss is equivalent to about 20% China revenue growth reduction from Q3’s 23%. In other words, AMD’s Q4 China revenue will have practically no growth from Q3’s level. Admittedly, this is a rather aggressive prediction and most likely AMD's Q1 guidance will not be adjusted downward that drastically. Yet, investors should acknowledge that China slowdown is real and AMD's revenue growth will be affected in 2019.


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