Applied Materials, Inc (AMAT) 

Current Price (as of 3/22/2024): $210.25

 

Applied Materials, Inc (AMAT) is a technology company based in the United States. They specialize in engineering and providing equipment, support services, and software to customers who utilize them in the manufacturing of semiconductor chips and advanced displays such as LCDs and OLEDs, commonly found in smartphones, TVs, computers, and solar products. Additionally, AMAT supplies equipment used in the production of coatings for flexible electronics. Globally, AMAT ranks as the second-largest supplier of semiconductor equipment by revenue, following ASML. AMAT’s reportable segments for the fiscal year 2023 include Semiconductor Systems (accounting for 74% of revenue), Applied Global Services (22%), Display and Adjacent Markets (3%), and Corporate/Other (1%).

 

AMAT’s Semiconductor Systems segment comprises semiconductor machines utilized in the chip-making process, which are sold to device manufacturers and foundries worldwide. Its clientele includes major chipmakers like Intel, Samsung, and Taiwan Semiconductor Manufacturing Co., among others. AMAT’s semiconductor equipment aids in various processes such as transferring patterns into device structures, transistor and interconnect fabrication, metrology, inspection and review, and packaging technologies for connecting finished integrated circuits die. Additionally, the Semi Systems segment manufactures equipment tailored for specialty markets such as the Internet of Things (IoT), Communications, Automotive, Power, and Sensors (ICAPS).

 

The Applied Global Services (AGS) segment provides services and software used to optimize equipment and fab (short for fabrication, which refers to the factory that manufactures chips) performance and productivity. AMAT’s trained service engineers are strategically located near customer sites to support over 52,000 manufacturing systems worldwide.

 

The Display and Adjacent Markets segment primarily includes products used in the manufacturing of liquid crystal displays (LCDs) and organic light-emitting diodes (OLEDs) for TVs, computers, monitors, smartphones, and tablets. Growth in this segment depends on consumer demand for advanced TVs, high-resolution smartphones, and emerging applications such as virtual reality. Additionally, the Display and Adjacent Markets segment comprises Chemical Vapor Deposition (CVD) technology used in the manufacture of solar energy devices.

 

Positive Outlooks 

 

-       AMAT sees significant growth prospects for its technology, driven by increasing demand from its customers and the semiconductor industry as a whole for next-generation chips, particularly cutting-edge logic chips and dynamic random-access memory (DRAM) chips crucial for artificial intelligence (AI) and the Internet of Things (IoT) applications over the coming years. The demand for chips is closely linked to the rollout of AI applications and the rapid development of AI-integrated PCs. 

 

Regarding the Internet of Things (IoT), Communications, Automotive, Power, and Sensors (ICAPS), AMAT observes rising demand for chips used in internet-connected devices like automobiles (which require thousands of chips to enhance vehicle performance and safety through real-time self-diagnostic tests), manufacturing equipment (where IoT sensors enable predictive maintenance, ensuring timely repairs), smart thermostats (which learn user heating and cooling preferences to optimize energy usage), smartwatches (capable of real-time health monitoring for early detection of health issues), smart cities (urban infrastructure equipped with IoT sensors to gather data on trash management and traffic flow, enabling local authorities to improve public services and traffic management), and more.

 

Consequently, AMAT anticipates sustained growth in its DRAM business as customers increase production of high-bandwidth memory (HBM) for AI applications. In fiscal year 2024, AMAT anticipates a significant increase in HBM packaging revenues compared to 2023, with projections suggesting they will quadruple, reaching a total of half a billion dollars. These favorable opportunities could potentially help AMAT achieve earnings of $8.30 per share by the end of the year.

 

-       AMAT's dedication to research and development (R&D) ensures it remains at the forefront of innovation. For example, the company allocates a significant portion of its sales—approximately 11.7%, which translates to over $3 billion annually—toward Research, Development, and Engineering (RD&E). These investments are essential for sustaining AMAT's growth and market leadership, particularly in the rapidly evolving Semiconductor Systems and Display and Adjacent Markets segments. 

 

-       AMAT is among the leading global providers of semiconductor wafer fabrication equipment. Its customers face substantial switching costs, which provide AMAT with a competitive edge. Bloomberg reports that each machine can cost over $10 million.

 

-       The Display and Adjacent Markets segment is poised to capitalize on the growing demand for OLED display technology, which is utilized in a range of electronic devices like smartphones, televisions, and monitors. These displays offer numerous advantages over traditional LCD (Liquid Crystal Display) screens, including higher contrast ratios, faster response times, wider viewing angles, and thinner form factors.

 

-       AMAT boasts robust operating and net profit margins, both exceeding 25%. Additionally, its annualized growth rate of earnings per share over the last three years has been strong, reaching 27%. The company also generates significant free cash flow, totaling $7.7 billion, a substantial portion of which it is committed to distributing to shareholders over time, aiming to allocate between 80% to 100% through dividends and share purchases.

Negative Outlooks

 

-       U.S. export restrictions on advanced semiconductor chips and related manufacturing equipment to China are hindering AMAT's growth in its largest market. As depicted in the graph below, China accounts for 45% of AMAT’s revenue and is crucial to the company’s success. However, due to national security concerns, the Justice Department has initiated a criminal investigation into AMAT for allegedly shipping hundreds of millions of dollars worth of equipment to China’s top semiconductor producer, SMIC. While potential negative consequences could arise, AMAT’s management asserts that it is cooperating with the DOJ. Nonetheless, the U.S. still permits companies to sell less advanced semiconductors to China, a market segment that AMAT can exploit.

-       Even the loss of a single customer can have adverse effects on AMAT’s operating results and cash flows due to the fact that a small number of customers contribute significantly to its business. Additionally, AMAT may need to write off receivables if customers are unable to fulfill their payables, a situation that has occurred in the past.

 

-       AMAT’s operating ratio stands relatively high at 71%, calculated as (Cost of Goods Sold + Operating Expenses) / Revenues. This means that 71% of AMAT’s total revenues are accounted for by operating expenses, indicating that any decrease in revenues will have a negative impact on operating profit.

 

-       Technology is rapidly changing, and if AMAT is unable to continue to dedicate billions of dollars to R&D and/or successfully develop new equipment to meet demand for new technology, operating results may be materially and adversely impacted.


Financial Results and Outlook

 

AMAT kicked off fiscal 2024 with a strong performance in Q1. Non-GAAP EPS reached $2.13, surpassing the high end of its guidance by 5 cents. Q1FY24 revenue hit $6.7 billion, aligning with the upper end of the company's guidance and surpassing Wall Street estimates by $221.60 million. Overall, net income stood at $2.02 billion, marking a 17.56% year-over-year increase.

 

Looking ahead to AMAT’s business outlook for 2024, the company anticipates sustained strength in its DRAM business, driven by customers scaling up production of high-bandwidth memory, crucial for AI data centers. AMAT forecasts HBM packaging revenues to quadruple compared to the previous year, reaching almost $0.5 billion. Revenue from their advanced packaging product portfolio is expected to grow to around $1.5 billion. The Applied Global Services (AGS) segment is projected to achieve double-digit growth, with AGS demonstrating a promising growth trajectory for the future, having delivered 18 consecutive quarters of year-over-year growth. A significant portion of AGS revenue stems from subscriptions, boasting a high renewal rate of over 90%.

For Q2FY24, revenue guidance stands at $6.5 billion, plus or minus $400 million, with non-GAAP EPS expected to be $1.97, plus or minus $0.18. With this forecast, Q2FY24 is anticipated to remain relatively flat compared to Q2FY2023 revenues of $6.6 billion and non-GAAP EPS of $2.00. Lastly, gross margin is projected to increase by 1%, rising from 46.8% in Q2FY2023 to 47.3% in Q2FY2024.