Company Overview: Based in California, Applied Materials, Inc. (NASDAQ: AMAT) is one of the top providers in materials engineering solutions to produce new chip and advanced display across the globe. The company is also engaged in providing implementation and support services associated with the equipment supplied. The company was founded in 1967, with more than 22,000 employees across various parts of different countries. AMAT has executed a distributed manufacturing model under which manufacturing, and supply chain activities are conducted in various countries, including Germany, Israel, Italy, Singapore, Taiwan, the United States, and other countries in Asia.

AMAT Details

AMAT Rides on Portfolio Strength, Growing Investments and New Design Wins: Applied Materials, Inc. (NASDAQ: AMAT) is one of the top suppliers of equipment for the manufacturing of semiconductor, solar photovoltaic (PV) cells, flat panel liquid crystal displays (LCDs), and modules all around the world. The company has three reporting business units namely, Semiconductor Systems unit, Applied Global Services and Display & Adjacent Markets. The company’s Semiconductor segment provides equipment for front-end operations in the silicon manufacturing process. The company has more than 42,500 systems installed, and its Applied Global Services segment goes a long way to safeguard customer satisfaction and support.

The company’s portfolio strength, growing investments in the new playbook, its expanding position in memory and increasing new design wins are expected to be key growth catalysts, going forward. Also, the company’s initiatives from the integration of advanced machine learning capabilities across semiconductor fabs to boost automated defect analysis, has proved to be beneficial for AMAT. Continued expansion of big data and the development of other new computing technologies are likely to aid the company’s financial position.

In FY19, revenues from Semiconductor Systems segment accounted for ~62% of total revenues, whereas revenues from Applied Global Services and Display and Adjacent Markets accounted for 26% and 12%, respectively. Despite the challenging market condition, the company managed to deliver robust FY19 financial results. Further, in each quarter of FY19, the company reported higher EPS as compared to FY13. These implementation and efforts indicate the expansion and diversification of semiconductor demand drivers bridging the gap between consumer and enterprise applications.

Over the period of FY15-FY19, the company has reported revenue CAGR of 10.9%, demonstrating an upward movement on the back of a strong market position and geographical expansion. Net income over the same period witnessed a CAGR of 18.4%.  In addition, the company also achieved record financial results in its services business and continued to increase the number of installed-base systems included by subscription-like service agreements. The company also remained on track to implement cost-cutting measures and invest higher in R&D for new products and capabilities. The company is well-positioned to accelerate its customers’ technology roadmaps and to take advantage of the enormous opportunities ahead.

Past Performance (Source: Company Reports)

The company had started a global rollout of 5G mobile technology, which led to higher demand for semiconductor equipment, which is expected to aid its top-line growth. Further, growth prospects across specialty nodes and the new nodes ramp across foundry, logic, NAND, and DRAM are expected to be a tailwind. Likewise, reduction in inventory across memory and demand elasticity in NAND add to the positives. In addition, the company remains on track to invest higher in its research and development activities, as well as in the enhancement of its next-generation products which, in turn, are expected to aid the Display and Adjacent Markets segment performance, going forward. 

3QFY20 Key Financial Highlights: During the quarter, the company reported non-GAAP earnings of $1.06 per share, which increased 43% from the prior corresponding figure of 74 cents per share. Net sales during the period stood at $4.40 billion, up ~23% from the prior corresponding period. The company witnessed robust impetus from key geographies, namely Korea, Taiwan, and China. Despite, soft demand due to COVID-19 led crisis, the demand for equipment and services continued to be strong during the quarter. During the quarter, non-GAAP gross margin expanded 100 basis points (bps) year over year and came in at 45%. Operating expenses on the other hand increased 12.2% and stood at $847 million. In 3QFY20, non-GAAP operating margin increased 340 bps to 26.4%.

Key Financial Highlight (Source: Company Reports)

Segment-wise Highlights: During the quarter, the company’s Semiconductor Systems Group generated ~$2.9 billion sales and accounted for ~66% of net sales, indicating a rise of 28.3% from the prior corresponding period. Revenues from Applied Global Services segment came in at $1.03 billion, which increased 11.1% from the year-ago period and accounted for ~24% of total revenues. Display and Adjacent Markets revenues for the quarter stood at $425 million, up ~25.4% from the year-ago period and accounted for the remaining 10% of net sales.

Segment-wise Highlights (Source: Company Reports

Geographical Highlights: During the quarter, sales from United States, Europe, Japan, Korea, Taiwan, Southeast Asia, and China came in at $399 million, $196 million, $472 million, $1.05 billion, $687 million, $120 million and $1.47 billion, respectively. These countries contributed 9%, 5%, 11%, 24%, 16%, 2% and 33% of total revenues in 3QFY20, respectively.

Balance Sheet & Cash Flow Highlights: The company exited third quarter with cash and cash equivalent of $4.35 billion compared with $5.28 billion at the end previous quarter. Inventories at the end of the period stood at $3.95 billion as compared to $3.73 billion in the previous quarter. Total debt (short and long) at the end of the third quarter FY20 amounted to $5.45 billion, as compared to $6.82 billion at the end of the previous quarter. The company returned $200 million through stock repurchases and $202 million through cash dividends to its shareholders. Cash flow from operations during the quarter came in at $867million.

Liquidity Position (Source: Company Reports)

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together form around 36.18% of the total shareholding. The Vanguard Group, Inc. and T. Rowe Price Associates, Inc. hold the maximum interests in the company at 8.19% and 6.25%, respectively.

Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)

Key Metrics: During Apr’20, the company reported a gross margin of 44.2%, which is higher than the year-ago figure of 43.2%. EBITDA margin for the same time period stood at 27.1%, higher than the industry median of 18.4% and pcp margin of 25%. Net margin stood at 19.1%, higher than the industry median of 8.4%. The above margins seem well-aligned with the company’s objective to improve overall profitability by attaining a higher rate of growth in revenue than costs. ROE stood at 8.5% as compared to the industry median of 2.4%.

Key Metrics (Source: Refinitiv, Thomson Reuters)

Key Risks: On the flip side, uncertainties related to the COVID-19 pandemic could impact its financial performance. AMAT also faces customer concentration risk as the top 10 companies contributed more than 10% of AMAT’s total sales for fiscal 2019, 2018 and 2017. These companies are Samsung, Taiwan Semiconductor, and Intel Corporation. The loss of any customer may reduce orders, consequently impacting revenues and operating results. Further, the company is exposed to risks relating to foreign operations that are required to be addressed time to time. The company also faces stiff competition from other large equipment makers, such as KLAC and LRCX. 

What to Expect: For the coming quarter, the company anticipates net sales to be $4.60 billion (+/-$200 million). Further, it expects non-GAAP EPS to be in the ambit of $1.11-$1.23 per share. In 3QFY20, AMAT won critical new applications in advanced patterning, in turn bolstering its position in the foundry market. Given the increasing demand for specialty nodes in automotive, power, 5G rollout, image sensor markets, IoT, and communications, the company opines that need for foundry logic will remain strong in the near term. Moreover, the continuing inventory correction in DRAM is a key positive, going forward. The company remains positive that more customers will upgrade their kit, following the 5G rollout, which, in turn, will aid the company’s top-line growth.

Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)

Valuation Methodology 1: Price to Earnings Multiple Based Relative Valuation (Illustrative)

Price to Earnings Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Valuation Methodology 2: Price to Cash Flow Multiple Based Relative Valuation (Illustrative)

Price to Cash Flow Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

Stock Recommendation: The stock of AMAT closed at $55.2 with a market capitalization of ~$50.41 billion. The stock made a 52-week low and high of $36.64 and $69.90, respectively. The stock of the company went down by 7.13% in the past three months. The company remains optimistic about maintaining its financial well-being even in the light of the pandemic. Moreover, the company’s agreement to acquire Japanese semiconductor device maker Kokusai Electric, is in-line with its strategy of strengthening business by expanding in adjacent markets, especially Asia. Considering the robust results for 3QFY20, resilience of the business, modest industry outlook and growth prospects, we have valued the stock using the P/E and P/CF multiples based illustrative relative valuation methods and arrived at a target price with an upside of lower double-digit (in % terms). For the purpose, we have taken peers like Lam Research Corp (NASDAQ: LRCX), KLA Corp (NASDAQ: KLAC), Micron Technology Inc (NASDAQ: MU), to name a few. Hence, we recommend a “Buy” rating on the stock at the closing price of $55.2, down 0.77% on 9 September 2020.

AMAT Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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