Applied Materials (AMAT) FQ4 Preview

by riskreversal November 16, 2016 11:54 am • Trade Ideas

Event: Semiconductor equipment maker Applied Materials (AMAT) reports fiscal Q4 results tomorrow night after the close. The options market is implying about a 5.5% one day move Friday, which is well shy of the 4 qtr one day average move of 8% and rich to the 3.6% 10 year one day average move.

Price Action / Technicals: AMAT is one of the best performing stocks in the entire stock market this year, up 60%, up 93% from the 52 week lows made in February. Since gapping to new 52 week highs back in August following Q3 results that was highlighted by upside Q4 guidance, the stock has been fairly range-bound, spending much of the time between $28 and $30.50:

[caption id="attachment_68197" align="aligncenter" width="600"]AMAT ytd chart from Bloomberg AMAT ytd chart from Bloomberg[/caption]

Volatility Snapshot: Interestingly there was a bullish options trade in the market that caught our attention on Oct 31st that leans a bit on these technical levels:

AMAT: as the semiconductor M&A nears a $150 billion total on they year, at least one trader is positioning for a near term pop in equipment maker Applied Materials. When the stock was trading $29 a trader sold to open 6,000 Dec 28 puts at 88 cents ($528,000 in premium) and bought to open 9,000 Dec 20 / 32 call spreads for 55 cents ($495,000 in premium).  The worst case scenario is that the trader is put 600,000 shares at $28 on Dec expiration if the stock is $28 or lower. Between $28 and $32 the trader would receive the $33,000 credit for the risk reversal, and can make up to $2 between $30 and $32.  To my eye these strikes make sense with nice near term technical support at $28 (but watch out below because there is none till about $26), with a the max profit coming just above the prior 52 week highs at $32.

Despite the stock’s range-bound action, and generally low levels of volatility, short dated options prices in AMAT have exploded, with 30 day at the money implied volatility at 36.6%, well above the levels of the last two earnings reports, at its widest gap to realized volatility (white below, how much the stock has been moving), suggesting options prices are very expensive:

[caption id="attachment_68199" align="aligncenter" width="600"]From Bloomberg From Bloomberg[/caption]

One reason might be the M&A environment, where many of AMAT’s customers have been merging, despite AMAT’s failed attempt in 2013-2015 to merge with Tokyo Electron, and main competitor KLA-Tencor’s (KLAC) recent announcement to scrap their $11 billion acquisition offer for Lam Research (LRCX) given opposition from the Justice Department. Some of the campaign rhetoric regarding mega mergers might suggest that a Trump administration might not be as lenient towards such deals as big business and traditional Republicans might like. But this uncertainty might be one of the reasons for the creep in options prices as the semiconductor equipment space seems ripe for consolidation.

Our View Into the Print: The run in the stock has caused it to trade on a P/E basis above a market multiple for the first time in few years.  If consensus eps estimates for fiscal 2017 prove correct, then the stock is cheap at 13.5x expected eps growth of 27% on sales growth of 13%.

If the company is able to meet the meaningful higher guidance from August for Q4, and actually raise again for the current quarter, the stock will easily be up in line with the implied move of about 5.5%. If the company were to miss Q4 guidance and guide down, the stock will be down through $28 very quickly on its way to the next line of technical support near $26.

Lastly, I suspect management will be asked about consolidation, either them as a buyer or merger target in light of the $200 billion in m&a over the last two years among many of their customers.  I suspect that if acquirer, acquiree or straight merger candidate, the stock trades higher.

We will follow up tomorrow with options trade ideas prior to the print.