August 24, 1995
Applied Materials
NASDAQ:AMAT
Type: Large-Cap Growth (Investing For Growth)
HQ: 3050 Bowers Ave., Santa Clara, CA 95054
Phone: 408-727-5555
Fax: 408-748-9943
Closing Prices, August 23nd, 1995: Bid $112 3/4 Ask: $113
Trailing 12-month revenues: $2.5 billion
Trailing 12-month EPS: $4.07
Last quarter reported: August 1995 (FY: Dec)
Next quarter reported date: 4Q, November 18, 1995
Consensus EPS estimates for quarter: $1.40e vs. $0.73
FOOL ratio: .45
Year-ahead PEG: .58
Trade: Buying 50 shares, August 24th
II. OVERVIEW
Applied Materials (NASDAQ:AMAT) is the largest provider of semiconductor-manufacturing systems on the planet. Essentially, Applied Materials builds, modifies and services the equipment needed in the development of semiconductor chips, which are the brains behind the tens of millions of personal computers that boot-up into Mac- or Mac-duplicated operating systems. But semiconductor chips aren't limited to central processing units (CPUs) in personal computers; they perform memory and logic functions for an array of specialty integrated circuits (ICs) dedicated to sound, video, data storage and retrieval ... just about anything a computer can do. These chips are in ATM machines, cellular phones, security systems, airbags, automobile cruise-control, remote controls, microwaves, video games, automated factory floors and Fool Ballcaps---a feature we haven't as of yet warned FoolMart shoppers.
Sporting over $2.5 billion in trailing sales, the Company is more than twice the size of its nearest competitor. And barring unforeseen global economic slowdown, AMAT should be flaunting nearly 100% sales growth for fiscal 1995, when they close out their year in October. Is this the sort of Foolish growth stock we wrote about in our Motley Fool Investment Primer? Nope. Less than a few hundred million in sales? Nope. Little institutional following? Nope. A Year-ahead PEG below .50? Nope. So why are we buying it tomorrow?
We don't have fingers enough to count the reasons.
But we'll start with the fact that AMAT, along with other semiconductor capital equipment manufacturers, has seen its stock rush higher at an extraordinary rate in recent history. Over the past seven months the stock has more than doubled. Over the last three years, Applied Materials' stock has compounded over 100% annual growth. And over the past five years, the stock has grown at a clip of 60% per year. That looks pretty attractive when stacked up against Beating the Dow, which outperforms the S&P 500, which has outperformed 75% of the universe of mutual funds over the past decade. Outlined in the sentence above is our entire approach to portfolio management. . . beat Beating the Dow.
Please note as well that the PEG on Applied Materials is inspiring for a cash-rich, rapid-growth technology stock in a burgeoning industry. The Company smashed estimates for the second quarter running, and estimates have been upgraded across the board in the last few days. Additionally, we're certainly not disappointed to find that AMAT is an Investing for Growth stock, having spied MF DowMan's oncoming Primer celebrating his model, which has compounded 28.8% over the past fifteen years.
We're pricing the stock, which today sits at $112 3/4, above $175 over the coming twelve months.
II. THE BUSINESS
We're all rambling through nothing less than a phenomenal technological upheaval these days which, as chance would have it, Fools know far better than most. The information revolution is upon us, even if it does mean we have to wade through thousands of Web Sites, the majority of which don't offer much more than a reference desk to a broad variety of company brochures. There is great potential, however, for radical change in the decade ahead, with digitized information and entertainment that goes far beyond anything we've run across in newsprint, on the one-way television screen, on the World Wide Waiting Line, or on any existing commercial online service.
And behind all of this growth and change, all of this software, all of this content, sits the hardware: personal computers, easily-tapped cellular phones, game machines designed to teach our wee ones about automatic weaponry or mathematics and geography---just depends how close a watch on your children you intend to keep. And inside all of these systems sit semiconductor chips. . . something much of our citizenry wouldn't have known had it not been for the Intel Inside advertising campaign, which nearly had the nation musing on "Jordan" and "Intel" in the same television moment---one screen away. Brilliant.
Near to last in line behind the software, the system, and the chip inside stand the companies which supply all the equipment needed to cut the billions of dollars worth of semiconductor chips each year. It used to be that the development and manufacturing of all these chips was done in-house by designers, but over the past decade in particular, companies which deal exclusively in the manufacturing and sale of semiconductor-manufacturing equipment have stormed forward rapidly.
Applied Materials isn't simply in this group. . . in many ways, it IS this group. AMAT was the first chip-equipment supplier to surpass $1 billion in annual sales (1993), and today, the Company holds 20% of this market, which is projected to grow more than 15% per year into the 21st century. In the Company's 1994 Annual Report, management expressed concern about the prospect for slowing growth in the 24 months ahead; in recent months, however, they've recanted, projecting rapid growth into 1997-1998 , while strongly implying that Wall Street underrates earnings potential going forward.
Product-wise, Applied Materials has earned a reputation for being first to market with the most cost-effective and efficient of machines. They typically design systems looking 3-5 years forward, while planning for the next 3-4 generations of semiconductor chips. And this in an industry where to lack innovation is to lack intermediate- to long-term growth prospects.
At its present rate, semiconductor memory capacity is doubling every 18 months. And as we consumers well know, the leading-edge technology of today is useless in less than years. This sort of rapid turnover can be not a little maddening for all involved, and coupled with increasingly precise customer specifications and global service requirements for semiconductor-equipment companies, it makes for a rather high bar to entry into this market. Feast your eyes on the profit margins when you run across these scenarios!
How fast is the Company growing? Applied opened a new factory in Austin, Texas just over six months ago to meet rising demand. It said last week that the Austin plant is now in full production, with thousands of new employees hired and working. There's just one indication of the growth.
III. THE FINANCIALS
But how does the Company look financially? Af ter all, rapid sales doesn't always command rapid earnings growth. And rapid earnings growth doesn't necessitate rapid earnings *per share* growth. And rapid earnings per share growth doesn't always come without a heavy load of debt. Let's look in closer.
First of all, let's consider their second-quarter earnings report, offered up last May. For the six months, sales had increased 57%, earnings were up 60%, and earnings per share (EPS) had risen by 56%, all of which exceeded Wall Street expectations. EPS were more than 20% above expectations. And the growth was ever so pure, with cash & equivalents climbing, accounts receivable and inventories under control, and moderate long-term debt obligations. It was a terrific report which punched the stock higher on heavy volume.
But, as wonderful as it was, it couldn't compare to their third-quarter report, released a few days back on August 15. Take a look:
3rd Quarter (in thousands)
1995 1994 Sales $897,684 $440,228 Earnings $139,212 $58,136 EPS $1.57 $0.68
9 Months (in thousands)
1995 1994 Sales $2,079,231 $1,192,009 Earnings $298,655 $157,598 EPS $3.42 $1.86
Applied Materials outperformed estimates of $1.20 for the quarter by $0.37, or 30.8%.. Profit margins up 2.3% to 15.2% for the quarter. A 10% quarter-over-quarter increase in its backlog. Cash and short-term investments increasing by 73% since last quarter. Receivables growth in line with sales growth. Inventories well under control. And the light debt load reduced. All of a sudden, this $500 million outfit in 1989 is now looking at nailing down $3 billion in sales in fiscal 1995, ending in October. For you statisticians, that makes for a 35% annualized growth rate in sales
It was a stunning quarterly report which led to an immediate $15 climb in the value of AMAT shares, before Monday's steep drop on the much-ballyhooed, but we think trivial, news of an Intel quarterly earnings downgrade. Then, as we were finishing this report at dawn this morning, Applied Materials began to move back, heading up nearly $6 on the day. Ah well, we think there's plenty more from whence that came.
To close out talk on this report, listen in on James Morgan, Chairman and CEO of AMAT, talking about the recent quarter: "Many leading semiconductor companies worldwide have increased capital spending forecasts during the year in an effort to keep up with the strong demand for semiconductor devices. Record new orders from North American and European manufacturers were driven by strong demand for microprocessors, logic and ASIC devices and telecommunication applications. Orders from Japan were near record levels as DRAM manufacturers continued investment in response to tight supply."
The growth is global, and Applied Materials has a terrific global business network in place.
IV. STOCK PERFORMANCE
How has the stock done this past year? Well, last February, Applied Materials was trading at $40 per share. Applied Materials was then boosted in the middle of March by its inclusion in the S&P 500 group. Index fund managers feasted on AMAT shares. Then the Company smashed estimates by 22% in its second quarter. Then they followed up by smashing estimates by more than 30% here in its 3rd quarter announced this past week. International business increased to 70% of Applied's overall business alongside a weakening dollar. Semiconductor stocks zipped ahead. It began to look as if the three to four year semi cycle was a thing of the past. And we truly think of comparable importance: Applied Materials has been an Investing for Growth (IFG) stock.
Now, recently, on August 16, PaineWebber analyst Gunnar Miller raised his estimates for Applied Materials' 1995 and 1996 earnings to $5.10 and $7.43, respectively. Miller also boosted his 12-month target price to $135, up from $100 before Applied's 3rd quarter report. Then Smith Barney upgraded Applied Materials to buy from outperform. And now, The Motley Fool is picking up shares around $111, after Wall Street's assault on the tech group on Monday.
Keep in mind that Applied Materials has compounded 60% growth over the past five years. That means that $20,000 invested in AMAT in August, 1990 is today worth $210,000, pre-tax. Tremendous. With the semiconductor group broadening end-use applications beyond the PC market, with Applied Materials building out a one-stop shopping atmosphere for its global customers while dominating its sector, with the awesome 5-year performance, coupled with a strong cash position and two estimate-smashing quarters in its wake, this stock looks awfully attractive.
And with all of this out there, it's not terribly surprising that today AMAT sits at $111, having appreciated 165% for investors Foolish enough to be scanning the Company's stock folder here in Fooldom. We'll touch on this later but the work in the folder carried out by Skysaxman, LzzardKing, MF Boring (GregUM) and MF Bogey, among many others, has been extraordinary---polite, informative, and profitable. Just the way we like it.
V. FUTURE PROSPECTS AND THE PEG
It wouldn't be terribly Foolish to wrap-up this report before running the PEG together, so let's walk through it. Applied Materials has $4.07 of trailing-twelve-month's earnings per share. Taking Paine Webber's upgraded numbers of $7.43 Est, we get the following.
$4.14 is going to $9.32 in 2 1/4 years.
9.32 / 4.14 = 2.25, or 125% total growth.
Take the 2.25 root of 2.25, and you come up with annualized EPS growth of 43.4%.
That's our multiple, 43.4x earnings.
43.4 x $4.14 = $179 5/8
Now let's try the YPEG (Year-Forward PEG). This is, after all, a $2 billion company. To YPEG it we simply use the 5-year-growth rate of 25.5% as our multiple against earnings of $7.43, approximated a year-forward.
25.5 x $7.43 = $189.50
Our two price estimates for the year ahead are $189.50 and $179.63, or an averaged target price of $184 1/2. With the stock sitting at $112 3/4 today, AMAT is trading at 60% its fair value, or a PEG of .60. Given the strength of the industry, the company's recent performance, the stock's annualized performance, the oncoming demand for more memory as Microsoft et al plows forward with new multimedia applications, and the Company's Investing for Growth (IFG) status, we find the PEG of .60 awfully attractive.
But this doesn't come without a few words of caution, a reminder of things to worry about. The past two decades tells us that chip manufactures are wont to overexpand in the heat of competition, which leaves the equipment suppliers holding the bag. We'll all have to continue to keep a close eye on the monthly book-to-bill numbers presented in timely fashion by MF Chips in his semiconductor folder on the Industry Board and in the Economic Indicators area of the Daily News.
In the end, though, we're not terribly anxious. AMAT management has said that it believes we are on the cusp of a remarkable period, at the crossroads of both a technological and economic revolution, which they believe they are globally positioned to exploit. We believe them. And we invite you over to our Applied Materials folder, wherein sit two hundred posts on the Company dating back to December, 1994. We hold that these notes are as much an indication of the bright future awaiting information technology companies as anything else. Fundamental valuations have been run there by some of the brightest members of the forum, and all for nothing more than America Online's $10 monthly connect fee. We believe in the prospects for a much huger PC market, and in the boom potential in communications and in the likelihood that there'll be a rush into information technology and online media in the coming few years. Just as Applied Materials has held that Wall Street underestimates the fury of the growth, in information technology, so do we, Fools.
And heck, only 60% of all semiconductor chips go into personal computers. The average household, where a mere 18 microchips could be found in the late '80s, had 69 by 1990 and will have an estimated 226 by the year 2000. That is one heck of a lot of coffee makers ... and bread makers, microwaves, alarm clocks, digital watches, home entertainment centers and intelligent thermostats. The horizon is getting broader every day, and we think Applied Materials is in fine position to usurp our vision in the years ahead.
Unbelievable! We got through this report without going into detailed definitions of etching systems, deposition systems, implant systems, single-wafer, multi-chamber semiconductor wafer manufacturing systems! Talk about tongues twisters!
