Comments made by management about future conditions are taken as gospel by
eager investors looking for any indication of what the future might hold.
Should Applied Materials beat earnings estimates or make positive comments
about how business is booming, a rally is sure to follow. Should Applied
Materials miss estimates or make negative comments about the future -- well,
folks, look out below. As the market raced toward today's close anticipating
results from Applied, the tension became palpable.
At 16:01 Eastern Daylight Time, the tension cracked. Applied Materials reported
quarterly earnings of $0.77per share, nine cents higher than the consensus
estimate. The highest estimate was looking for only $0.70 per share. Although
the initial wire stories carried news that the company had made $0.98 per
share, this number included both a one-time gain for the settlement of the
patent litigation with NOVELLUS SYSTEMS(Nasdaq: NVLS) and a one-time
loss associated with some bad debt from Submicron Technology plc. In spite
of the fact that the $0.77 EPS were down from $0.92 EPS a year ago, Applied
Materials shares raced up to $92 in after-hours trading. The initial euphoria
need only be confirmed by positive comments from Applied Materials management
in the conference call slated for around 5:30 or 6:00 p.m. EDT, and tomorrow
it could be off to the races again.
Looking at the results, there are some factors that could warm the hearts
of even the most skeptical investors. Revenues for the quarter were only
down 5.2% from a year ago, the second-highest revenue level ever achieved
by the company. Gross margin was 47.2% during the quarter, only down 0.6%
from last year's results, which occurred near the peak of the semiconductor
equipment cycle. If Applied revenues and gross margin can approach the levels
it last achieved when business was absolutely exploding, the company obviously
has an excellent handle on its cost structure and could gain higher gross
margins on solid sales. New orders were up 22.2% to $1.24 billion from last
quarter with backlog increasing 11.4% sequentially to $1.65 billion over
the same period, indicating that the company was operating at close to peak
Even the company's balance sheet looks excellent. The company's store of
cash and short-term investments increased almost $100 million in the quarter,
another testament to the company's resiliency during the recent business
drop-off. Accounts receivable and inventories are up, but given the fact
the company does extensive business overseas where reimbursement time takes
longer, the levels are not unreasonable. With new orders up 33.1% from last
year, one can only imagine that Applied management will say that business
is good. The company received new orders of $100 million from White Oak
Semiconductor and $135 million from Taiwan Semiconductor Manufacturing Co.
(TSMC) alone, rather large commitments only a year and a half since the
semiconductor manufacturing business topped. What could possibly be wrong?
At risk of being incorrect for the third time on Applied Materials, it is
difficult to imagine that much of the good news has not already been discounted
into the company's current price. Here at $92, the shares are well above
the $59 7/8 peak they struck back in August of 1995 when all things looked
wonderful. Why is the euphoria so strong only five quarters after the business
peaked and two quarters after the company's revenues hit their low? The downturn
was not nearly as bad as everyone expected and certainly not as bad as it
has been in previous years. In fact, given that Applied remained solidly
profitable and orders never slipped below levels seen in early 1995, one
might even say this was not a downturn but more like a vacation. Things never
got as bad as investors were expecting when Applied traded as low was $21
3/4 in July 1996.
If the downturn was not as bad as expected, however, does it really make
sense to model future revenue growth on what has been seen in previous upturns?
When Lehman Brothers forecasts peak EPS of $7.50 in 1999 or 2000, this would
be equal to the 76.7% annualized profit growth the company reported from
1991 to 1996 coming out of the prolonged downturn in the business in the
late '80s. In the past twelve months, Applied has posted $1.87 per share
in earnings, meaning that if it hits $7.50 per share by 2000 it will have
48.7% compound annual growth. Had business completely fallen off a cliff,
expectations of rapid growth to this level would make perfect sense. However,
what is remarkable about Applied over the past few months is that in spite
of the downturn, business did not fall off a cliff.
The industry trade group Semiconductor Equipment and Materials International
(SEMI) still seems "difficult" times until the year 2000 for the business.
The trade group admitted that it could be wrong, however, and pointed out
that if it was, the compound rate of growth for the business would actually
end up being slower than what most industry analysts are currently looking
for. If business returns to levels near the 1996 peak by late 1997, it is
hard to say that they will then be set to explode into the year 2000. To
have an large up cycle in a partially cyclical business, you need a large
down cycle to set it up. Ironically, those who claimed in 1996 that the business
had actually stabilized to become a more mature growth business with reasonable
year-to-year variations in retrospect were not actually that far off, at
least as it relates to revenues.
At $92 and 29.9 times the company's annualized revenues from this quarter,
even as estimates for fiscal 1998 are raised tomorrow, it may become increasingly
hard to put the 28 times earnings multiple on peak earnings that Lehman Brothers
is looking for. If the business grows sales around 15% to 25% overall, it
would easily double or triple the growth rate of the best classical capital
equipment businesses. Seeing a multiple of 20 to 25 on 1999 earnings of $5.00
per share would give an investor $100 to $125 over the next two years, or
about market growth. At some point, Applied has to discount the peak earnings.
All that said, investors should probably keep in mind that this is exactly
what was written in this space back in November and January when Applied
was in the $50 to $60 range. As the share price will tell you, this has has
been quite wrong over the past half year. However, considering whether or
not Applied will have the huge up cycle anticipated given the lack of a
significant down cycle may be worthwhile.
[Note: This article originally appeared in the August 12, 1997
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