Applied Materials caught my attention for 3 reasons. First, it reports earnings this week, on Nov. 14th after the close. Second, the stock is one of the better performing Nasdaq 100 stocks in 2013, up 54% year-to-date. Third, the stock made a new 5 year high in late Sept after the announcement of its merger with Tokyo Electron (AMAT shareholders will own almost 70% of the combined company), and the stock has held that breakout ever since:
AMAT’s core business makes the equipment that semiconductor manufacturers use to make the end-market chips. The company’s description from its 10-Q:
Applied provides manufacturing equipment, services and software to the global semiconductor, flat panel display, solar photovoltaic (PV) and related industries. Applied’s customers include manufacturers of semiconductor wafers and chips, flat panel liquid crystal and other displays, solar PV cells and modules, and other electronic devices.
Its two largest customers are Taiwan Semiconductor (accounting for almost 30% of sales), and Samsung (around 15% of sales). The company also sells a substantial amount of product to Chinese and Japanese manufacturers – Asia Pacific made up about 75% of its revenues in the most recent quarter, with the U.S. around 18% and Europe around 8%.
Applied Materials is relatively well-diversified on the product front, with 4 major reporting segments:
- Silicon Systems Group (60-70% of revenues): Semiconductor equipment segment. Within the segment, mobile is the key to future growth. From the 10-Q – the mobility trend remains the largest influence on industry spending, as it drives device manufacturers to deliver high-performance, low-power processors and affordable solid-state storage in a small form factor.
- Applied Global Services (20-30% of revenues): The spare parts and services division that caters to the company’s existing customers who purchase equipment.
- Display (5-15% of revenues): The equipment used to manufacture LCDs, OLEDs, and other display technologies for TVs, PC, tablets, smartphones, etc.
- Energy and Environmental Solutions (1% of revenues): Equipment for manufacturing solar photovoltaic cells and modules, with long-term emphasis on lowering the cost of solar power products.
Recent trends over the past year have favored the Display segment, due to a pickup in LCD TV equipment over the past 6 months. The Silicon Systems segment has struggled since semiconductor manufacturers cut back on foundry orders, though some analysts are of the view that the trough in the semiconductor chip cycle has past, with brighter days ahead for the industry (based on low levels of inventory, and demand pickup).
Of course, the product mix is going to change somewhat due to the merger with Tokyo Electron (if it wins antitrust approval, which is viewed as likely given that neither company sells into a consumer end-market). This helpful WSJ article summarizes the key points of the merger:
Applied was already No. 1 in sales of chip manufacturing gear in 2012, the research firm Gartner estimates. Tokyo Electron ranked third. Together, their combined revenue would dwarf other players in the market.
Though the two companies sell similar kinds of machines, analysts said one or the other tends to have much bigger market share for specific manufacturing chores in semiconductor or display factories. They both make devices used to etch material from wafers, for example, but each specializes in a different stage in that process.
The industry’s maturation is leading to consolidation. However, much more important than the respective product mix or merger synergies will be the macro environment for the overall semiconductor industry going forward.
Despite an improved global economy, the semiconductor cycle turned lower in 2012 due to overcapacity. To get a sense for how much such cyclicality can affect a supplier like AMAT, here are the annual EPS numbers over the past 10 years: $0.22 in 2003, $0.90 in 2004, $0.67 in 2005, $1.12 in 2006, $1.25 in 2007, $0.62 in 2008, $0.03 in 2009, $1.03 in 2010, $1.18 in 2011, $0.67 in 2012, and expected $0.70 in 2013.
A lot of seesawing back and forth, with growth during macro upswings, and contraction during macro downswings. Analyst consensus projections are for $1.12 in EPS for 2014, $1.35 for 2015, and $1.79 for 2016. If AMAT can actually fulfill those projections, then the stock is most certainly cheap. Given that the company has not been able to string together more than 2 consecutive years of earnings growth in the past decade though, the odds of such future consistency seem quite low. At 25x 2013 EPS, AMAT hardly feels like a bargain, with plenty of uncertainty to boot.
The chart I showed at the start indicated the 5 year weekly breakout. But on the longer-term monthly chart, the picture looks much less optimistic:
[caption id="attachment_32509" align="alignnone" width="600"]
Monthly chart of AMAT, Courtesy of Bloomberg[/caption]
This stock is unchanged over the past 10 years. Perhaps the next 10 years will be much more fruitful, but I see far better opportunities elsewhere in the investment universe.