Applied Materials - Growth Potential Is Already Limited

Ticker: AMAT

Author: Stock Analyst  Date: 2021/04/07

Applied Materials is one of the world's leading manufacturers of semiconductor chip and display equipment.

We rate Applied Materials Hold with a 12-month target price. at $ 150.8, which implies 6.5% growth potential.

In recent years, Applied Materials has recorded strong demand for its products, which allows the company to regularly update revenue and profit records and improve profitability indicators. The latest financial results have also been strong.

Applied Materials benefits from a strong balance sheet and the ability to generate significant cash flows, which allows the company to devote significant funds to shareholder benefits.

The medium-term growth drivers for the industry will be the deployment of 5G networks and such fast-growing areas as artificial intelligence, big data processing (big data), machine learning, cloud computing, virtual / augmented reality and autonomous cars. Applied Materials will remain the main beneficiary of these trends, we expect.

Meanwhile, after the recent growth, the company's shares are already fairly priced by the market, and the potential for their further rise looks limited.

Issuer Description

Applied Materials is one of the world's leading manufacturers of semiconductor chip and display equipment. The company's clients include many tech giants, including Intel and Samsung, as well as contract chip makers such as TSMC and Global Foundries. In fact, all serious technical innovations in the industry (the transition to thinner technical processes and a larger size of silicon wafers in the production of chips, the introduction of FinFet technology, etc.) are taking place with the direct participation of Applied Materials. The company's Sym3 Y etching system for 3D packaging of NAND, DRAM, and microprocessor chips is the most advanced in the world, with 50% of the global market share in DRAM packaging equipment.

In addition, Applied Materials is one of the leaders in diagnostic and control equipment for the semiconductor industry.
Applied Materials' capitalization is about $ 130 billion.The main major shareholders are the Vanguard Group (7.98%), T. Rowe Price Associate (5.1%), BlackRock Institutional Trust (5.07%), State Street Global Advisors (4 , 64%) and Capital International Investors (1.92%).

According to research firm The Information Network, Applied Materials' share of the global semiconductor equipment market in 2020 increased to 16.4% from 15.9% the previous year. At the same time, the company took over the leadership from the Dutch ASML, whose share, on the contrary, decreased to 15.4% from 16.9%. Tokyo Electron (12.3%) and Lam Research (10.8%) are in third and fourth places.

Applied Materials operates in three main segments:

  • Semiconductor Systems, in fact, is engaged in the production of equipment for the production of semiconductor chips and integrated circuits. This segment also develops and implements various technologies used in devices for the production of chips: atomic layer deposition (ALD), chemical vapor deposition (CVD), vacuum deposition (PVD), rapid heat treatment (RTP), chemical-mechanical planarization (CMP), etching, ion implantation, plate inspection, etc. In addition, the division produces various metrological and diagnostic devices.
  • The Applied Global Services segment specializes in services related to warranty and post-warranty maintenance, tuning and modernization of semiconductor equipment.
  • The Display and Adjacent Markets segment produces equipment for the production of liquid crystal displays, OLED, etc.

The semiconductor segment currently generates nearly two-thirds (66%) of Applied Materials' revenues, and the services segment 24% of sales. The role of the display segment in the company's business is still relatively low - it accounts for only 10% of revenues.

Distribution of revenue by segment and geography

Geographically, the largest market for Applied Materials is China, which accounts for about a third of the company's revenue. The second and third places are taken by Taiwan (23%) and South Korea (18%). In general, Japan and the countries of the Asia-Pacific region account for over 90% of the company's sales.

Note that some time ago Applied Materials tried to acquire the Japanese semiconductor equipment manufacturer Kokusai Electric from the investment firm KKR for $ 3.5 billion. However, the company was never able to obtain permission to purchase from Chinese regulators (permits in other countries were obtained), and in March the deal was canceled.

Financial results

Applied Materials' results for the first quarter of fiscal year 2021 ended January 31 were strong, reflecting continued strong global demand for semiconductor equipment. Revenue increased 24% YoY to a record $ 5.16 billion, on the back of double-digit growth across all business divisions and beat the consensus of $ 4.97 billion. Revenue growth was driven by strong sales in China, South Korea , Europe, Japan and Southeast Asia, which was partially offset by weaker sales in Taiwan and the United States. Semiconductor Systems revenues climbed 26.3% to $ 3.55 billion, driven primarily by the strong performance of the DRAM and NAND Chip Hardware Division. Revenue in the Applied Global Services segment rose 15.8% to $ 1.16 billion, and revenue in the Display segment increased 23.8% to $ 411 million.Adjusted EBITDA jumped 36.8% to $ 1.59 bln, and EBITDA margin expanded by 2.9 p.p. to 30.8%. Adjusted earnings per share soared 41.8% to a record $ 1.39, 11 cents above the Wall Street analyst average.

Applied Materials' balance sheet remains strong - the company completed the first financial quarter with $ 6.62 billion in cash and short-term investments, with a long-term debt of $ 5.45 billion. In the reporting period, the company generated operating cash flow of $ 1.42 million (an increase of 44 % YoY), spent $ 121 million on capex and returned $ 201 million in dividends to its shareholders.

Applied Materials management also released very optimistic forecasts for the II financial quarter, which ends in April. The company expects to earn $ 1.44-1.56 per share on revenue of $ 5.39 billion (plus / minus $ 200 million).

Payments to shareholders

Applied Materials has steadily increased its dividend in recent years. At the same time, the dividend yield of the company's shares remains relatively low, at about 0.7%, which, however, is typical for the entire technology industry.

As for the buyback of its own shares, the company spent $ 649 million for this purpose in 2020 against $ 2.4 billion in the previous financial year. Such a sharp decrease in buyback was due to the need to reserve funds for the potential acquisition of Kokusai Electric. However, the deal fell through, and the company decided to restore buyback volumes, already announcing a new share buyback program in the amount of $ 7.5 billion.

Growth prospects

We maintain a positive outlook on Applied Materials stock with the expectation that the company will continue to benefit from the growth of the global semiconductor industry in general and the chip equipment segment in particular.

World Semiconductor Trade Statistics (WSTS) estimates that global semiconductor sales in 2020 increased 5.1% to $ 433.1 billion, despite the overall hard hit by the COVID-19 pandemic to the global economy. During the pandemic, the popularity of remote services skyrocketed, and there was also strong demand for PCs from businesses and end consumers due to the shift to remote work and study. And all the market segments that contributed to this activity have benefited. This, in particular, has led to high sales of processors, NAND flash and DRAM components. This year, global sales of semiconductor chips, according to the WSTS forecast, will add another 8.4% to $ 469.4 billion. At the same time, growth is expected in all regions and product categories, including memory chips - by 13.3%.

In turn, SEMI (Semiconductor Equipment and Materials International), a global association of equipment and materials manufacturers, developers and suppliers of technologies in microelectronics, estimates sales of equipment for the production of semiconductors in 2020 at a record level - $ 68.9 billion, which is about 16% more than in 2019 In 2021 and 2022 the indicator will continue to grow and will reach $ 71.9 billion and $ 76.1 billion, respectively, according to SEMI. Moreover, the rise is expected in all major segments of the market in question. For example, sales of wafer processing equipment this year and next will increase by 4% and 6%, respectively, and chip assembly and packaging equipment by 8% and 5%.

SEMI predicts that China, Taiwan and South Korea will remain the world leaders in chip manufacturing equipment spending in the coming years. The association estimates that large investments in silicon wafer manufacturing and memory chip manufacturing capacity helped China reach first place in the market for the first time last year. However, in 2021 and 2022. South Korea is likely to lead the way with increased investment in logic circuitry and memory segment recovery.

Semiconductor equipment spending in Taiwan will remain stable thanks to investment in advanced contract manufacturing of chips. Most other regions are expected to see growth in the coming years.

As for the more distant future, here too the prospects look quite good. The importance of technology in the modern world is increasing every year, and the coronavirus pandemic has only intensified this trend. The driver of further growth in demand for semiconductor chips should be the deployment of 5G communication networks in the world, as well as rapidly developing areas such as artificial intelligence, big data processing, machine learning, cloud computing, virtual / augmented reality and autonomous cars. ...

Against this backdrop, investment by global semiconductor corporations in equipment upgrades is expected to continue to grow. Thus, the Taiwanese TSMC announced last year that it intends to invest $ 12 billion in the construction of a plant for the production of chips in Arizona, USA. The new facility, slated to launch in 2024, will produce 5nm microcircuits - the smallest, fastest and most energy-efficient chips in production. Prior to this, the South Korean tech giant Samsung Electronics announced its intention to invest 133 trillion Korean won ($ 116 billion) over the next 10 years in the production of the latest logic microprocessors. Of this amount, 73 trillion won will be allocated for research and 60 trillion won for industrial infrastructure. In addition, Samsung Display, a 100% subsidiary of Samsung, announced that it plans to spend 13.1 trillion won ($ 11 billion) to develop and manufacture next-generation displays.

We believe that Applied Materials, given its strong position in the industry, will be one of the main beneficiaries of the trends described above. In addition, the company expects further growth in sales in the segment of equipment for the production of displays, which should be facilitated by the increasing distribution of displays with a resolution of 8K worldwide, as well as the expansion of the use of OLED screens in mobile devices and televisions.

Note that Applied Materials spends significant funds on research and development, which allows it to maintain technological leadership in the industry. At the same time, we expect the company to remain shareholder-friendly and continue to devote significant funds to share buybacks and dividends.

Valuation

We have benchmarked Applied Materials based on forecasted financial results for 2021. Our valuation is defined as the arithmetic mean of estimates based on EV / EBITDA and P / E multiples.

Our estimate of the fair value for Applied Materials over a 12-month horizon. is $138.35 billion, or $150.77 per share, which implies growth potential of only 6.5% from the current price level. The recommendation is "Hold".

The weighted average target price of Applied Materials shares based on a sample of analysts with a historical performance of forecasts for this share of at least average is, according to our calculations, $ 144 (1.7% upside), and the share rating is 3.1 (rating value 5.0 corresponds to the Strong recommendation Buy, and 1.0 - Strong Sell recommendations).

This includes Applied Materials' target price estimate of $ 142 (Buy recommendation), Credit Suisse $ 175 (Buy), Evercore ISI - $ 150 (Above Market), Exane BNP Paribas - $ 140 ( Above Market), Susquehanna Financial Group - $ 143 (Positive), Wells Fargo Securities - $ 145 (Above Market).