Applied Materials (AMAT +1.50%) beat the broader market handsomely in 2017 thanks to consistently strong growth in its revenue and margins, primarily driven by the growing demand for its chip fabrication equipment. The company gets most of its revenue by selling this equipment to semiconductor companies, and right now is a good time to be in this business, as evidenced by the company's performance over the past year.
AMAT data by YCharts. TTM = trailing 12 months.
More important, Applied Materials is in on some serious catalysts, including the Internet of Things (IoT) and dynamic random access memory (DRAM) demand, which could help it sustain its impressive momentum. Let's look at Applied Materials' key catalysts, and why it could be a smart bet for investors at its current valuation.
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Lots of growth potential
The booming demand for semiconductors has been a big tailwind for Applied Materials. The company's top line jumped 28% year over year in the first quarter of fiscal 2018 to $4.2 billion, boosting the company's adjusted net income by 55% to $1.13 billion.
Applied Materials' semiconductor systems business played an important role in powering its revenue, accounting for 67% of the top line. Revenue from this business increased almost 33% year over year during the quarter, while operating margin expanded 2.8 percentage points. The impressive performance of this segment was driven by strong demand for fabrication equipment from foundries, as well as makers of DRAM chips and flash memories.
And all these markets have a lot of growth potential. For instance, foundries are investing in more equipment to tackle the growing demand for chips needed to power the IoT, among other things. Semiconductor analyst IC Insights estimates that sales of integrated circuits related to IoT will spike 16% this year to $16.8 billion.
This excludes applications such as automotive, where chip sales are expected to rise 16% to $32.4 billion as connectivity in vehicles increases. Looking ahead, these markets should continue witnessing robust chip demand. For instance, the global IoT chip market is expected to clock an annual growth rate of 15% over the next five years.
Meanwhile, the automotive chip market could grow at 10% a year through 2024. As a result, foundries will have to invest more money to upgrade or expand capacity, boosting Applied Materials' business in the process. Samsung (NASDAQOTH: SSNLF), for example, announced a $1 billion investment last year to expand its Austin, Texas, fabrication facility to make chips based on smaller nodes that will bolster its position in the IoT space.
What's more, Samsung is looking to secure 25% of the global foundry share, as compared to its existing share of less than 10%. As such, the Korean tech giant will be pouring billions of dollars to secure capital equipment to increase market share.
Looking beyond IoT, Samsung is expected to invest $7 billion in DRAM production, with another $14 billion outlined for the 3D NAND flash market.
And memory demand is expected to spike rapidly in the coming years. One estimate puts the growth of the next-generation memory space at 26% a year through 2023, which isn't surprising as memory demand will keep increasing thanks to artificial intelligence (AI) and IoT.
For instance, chipmakers will need innovative memory solutions for powering IoT devices as they need to operate for long time periods, so they shouldn't be power hungry. As such, the likes of Samsung, Micron, Intel, and Taiwan Semiconductor, which together supply around half of Applied Materials' total revenue, will keep investing in new equipment to stay on top of the booming demand.
Is it still a buy?
Applied Materials has outperformed the broader market by a big margin over the past year, but it isn't too late for new investors to get in. The stock's trailing P/E ratio of 22.4 sits well below the industry average of 28.8. What's more, Applied Materials gets cheaper on a forward earnings basis with a multiple of just 13.6.
We have already seen that the company is sitting on strong catalysts that should help it sustain its revenue and earnings momentum. Not surprisingly, analysts expect Applied Materials' earnings to increase at more than 19% a year for the next five years, making it a great pick for investors looking to tap into the semiconductor boom without overpaying.
