Applied Materials (AMAT) fQ1 Preview / Call Calendar

by Dan February 15, 2017 1:02 pm • Trade Ideas

Applied Materials (AMAT) will report fiscal Q1 results tonight after the close. The options market is implying about a 4% one day move tomorrow which is below the 4 quarter average one day move of about 7%.

AMAT is up 10.5% on the year, today trading at a new 52 week and 17 year high, up 130% from its 52 week lows made last February:

AMAT 5yr chart from Bloomberg

I guess the stock’s rerating makes some sense as consensus estimates are calling for 39% yoy eps growth and 17% sales growth, and the stock is only trading 14.7x expected, well below a market multiple.

While multiples in the semi-space have expanded in the last year or so due to the nearly $200 billion in m&a over the last two years, semi-equip companies have been unsuccessful in merging as AMAT’s deal with Tokyo Electron called off their proposed merger in April 2015 and late last year competitors Lam Research (LRCX). and KLA-Tencor (KLAC) scrapped their proposed merger due to competitive concerns from the justice department, per the WSJ in Oct:

“The proposed transaction presented concerns about the ability of the merged firm to foreclose competitors’ development of leading edge fabrication tools and process technology on a timely basis,” said Renata Hesse, acting assistant attorney general of the Justice Department’s antitrust division,

Will the new administration take a different view on such deals? That remains to be seen, but it is likely to be less onerous at the very least, and if off shore cash repatriation were ever really on the table companies like AMAT & KLAC, with very strong balance sheets and most of their sales overseas, could once again be in the m&a mix, which would likely be supportive of current valuations.

Expectations are not exactly low heading into the quarter for AMAT though, as can be inferred from Credit Suisse’s preview note to clients:

We expect the Company to at least meet street estimates for JanQ, and guide AprQ EPS to $0.70-$0.75 (above Street at $0.63). We also expect orders to be better than expected (both Semi and Display). While stronger-than-expected results could lead to “peak” concerns (just as it has been since stock was at $25), we argue that structurally this is a better industry with more growth (CapEx to Revs increasing for Semis) and less cyclicality. Our FY17/FY18 EPS estimates of $2.70/$2.71, are 10%/5% above Street estimates of $2.45/$2.57. AMAT is trading at only 13.5x on our CY17 EPS, versus S&P/Semis at 17.7x/17.1x – we see potential for multiple expansion to inline with market.

Wall Street analyst as a group are overwhelmingly positive on the stock with 19 Buy ratings, only 5 Holds and No Sells, with an average 12 month price target of $38.20.

Despite the implied move well below the recent average post earnings move, short dated options prices are very expensive relative to recent movement, with 30 day at the money implied volatility (the price of options, blue line below) just below 30%, vs realized volatility (how much the stock is actually moving, white line below) very near 52 week lows at 18.6%:


So what’s the trade?

For those inclined to play for higher highs, I might look for the stock to consolidate recent gains, especially given the stock’s recent price action and high expectations, but also take advantage of expensive options prices. In this scenario buying a call calendar, targeting the implied earnings move could make sense:

AMAT ($35.67) Buy Feb 17th / April 37 call calendar for 70 cents

-Sell to open 1 Feb 17th 37 call at 27 cents

-Buy to open 1 April 37 call for 97 cents

Break-even on Feb 17th expiration (Friday):

Gains if the stock is at or near 37, losses is the stock is significantly lower or higher than 37. Small gains if the stock is unchanged.

Rationale – This is an inexpensive way to play for higher highs that defines risk around the earnings event. If the stock is basically in the same place, or slightly higher on earnings, any gains above 37 following February expiration will have great risk reward as the entire risk on the trade is just .70. If the February calls expire worthless the premium at risk can be further reduced in April by turning the April 37 calls into a call spread. The ideal situation is for the the stock to be higher on earnings, near 37, with the February calls able to be closed for next to nothing or allowed to expire worthless. On a big move lower the most that can be lost is .70, and it’s unlikely all of that would be lost under most scenarios, allowing time for the stock to make another run at new highs between now and April.