Applied Materials Applies a Lesson in Lowered Expectations

Typically when companies forecast lower sales or profits, their stocks usually take a hit. It's not always easy to tell whether it's having a fire sale or burning down its house. Maybe it is time to get out -- or maybe it's time to buy more!

Amid an environment of poor computer sales and an inventory glut affecting the solar industry and TV sales, semiconductor equipment maker Applied Materials (NASDAQ: AMAT  ) still managed to surpass analyst expectations for the fourth quarter, though the impact of those factors colored its guidance for the first quarter of 2013. Analysts have been steadily lowering their forecasts, down from as much as $0.12 a share last quarter to $0.10 and then $0.09 per share just before it announced its quarterly results. With Applied Materials guiding to a break-even quarter, or at best showing profits of just $0.06 per share, Wall Street's split the difference and now forecasts the equipment maker will record $0.03 in earnings per share.

Now don't blindly follow those selling (or buying); you still need to do some research. We'll just use the announcement as a jumping off point for additional investigation.

Like lemmings over the cliff
As tax incentives and credits expire, favorable tariffs evaporate, and pricing plummets, leaving the solar industry awash in inventory. Sales in Applied's energy and environmental solutions segment, which primarily houses its solar business, dropped 19% last quarter and for the full year its orders were down 88% from 2011. The TV display segment with a 35% contraction in sales with orders down 57% for all of 2012.

The poor performance of these two businesses led the equipment maker to shake up its operations, ousting the two vice presidents and installing a single person to oversee them. The businesses themselves will remain discrete reporting segments, however.

Yet these are considered non-core operations, and investors watching the results turned in by First Solar (NASDAQ: FSLR  ) or Yingli Green Energy (NYSE: YGE  ) in the solar business, or Corning's (NYSE: GLW  ) results in TV displays -- it's the leading manufacturer of LCD glass for televisions -- could have foreseen the coming contraction at Applied Materials.

Does not compute
More worrisome would be in its primary silicon systems group that suffered a 44% plunge in net sales in the quarter, with orders in the three-month period falling by more than a third. Dwindling computer sales that have plagued Dell (UNKNOWN: DELL.DL  ) and Hewlett-Packard (NYSE: HPQ  ) continue to impact the equipment maker, too. But there again, this wasn't such a surprising turn of events, either, as tablets and mobile computing continue to remain relatively robust.

Even for Applied Materials, the results in its display segment would have been much worse had it not been for its mobile products, such as the films required for fabricating touch screens in mobile devices and other flexible electronic substrates.

The decline in the PC business affects Applied's rivals, too. KLA-Tencor (NASDAQ: KLAC  ) missed expectations as profits fell and margins narrowed in its fiscal first quarter report, while Mattson Technology (NASDAQ: MTSN  ) reported wider losses, even if it beat expectations on the top and bottom line. The one industry bright spot has been Lam Research (NASDAQ: LRCX  ) , which beat Wall Street's forecasts and also provided a fairly rosy picture for the future.

A new morning
Despite chip maker Intel (NASDAQ: INTC  ) also lowering expectations, Applied Materials and the other equipment makers are looking for its Ultrabook to give a boost to demand along with Microsoft's (NASDAQ: MSFT  ) Windows 8 operating system. Other factors also suggest 2013 won't be the bust it's otherwise shaping up to be.

TV sales are expected to rise for at least the fourth quarter and there's no let up in the demand for mobile computing options. Both of those trends have Corning investors hopeful, too. And with orders perceived as bottoming in the fourth quarter, Applied Materials is looking forward to a continuously improving business environment throughout the year.

At 12 times earnings estimates, Applied Materials doesn't trade at much of a premium to its rivals, but with its enterprise value trading at less than eight times the free cash flow it generates, the equipment maker is offering investors a very attractive discount. If you agree the worst of the worst hit in the fourth quarter, then this would be an opportune time to buy.

Looking under rocks
With the explosive growth of smartphones worldwide, many investors thought they would ride Corning's dominant cover glass to massive investment returns. That hasn't played out yet, as mobile growth has failed to offset declines in the company's core business. In this brand-new premium research report on Corning, our analyst walks through the business, as well as the key opportunities and risks facing it today. Click here to claim your copy, and receive a full year of updates as key events unfold.


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