The semiconductor downturn that began in 2018 -- especially in the hypersensitive digital memory segment of the industry -- has hit Applied Materials (AMAT +5.78%) especially hard. The company ended its 2018 fiscal year on a sour note, and the negative trend has continued so far in 2019. Even after a rally to kick off the new year, shares are off 22% in the last trailing 12 months as of this writing.
The company's second quarter of its 2019 fiscal year wasn't as bad as feared, though, and even a prolonged trade standoff between the U.S. and China is unlikely to completely derail Applied Materials. Business could be showing signs of life again, and now may be the time to start paying attention to the semiconductor equipment and system manufacturer. Here are three reasons why.
Data source: Getty Images.
1. Sales are down and profits are falling faster
The headline numbers are ugly for Applied Materials, but second-quarter results were near the top end of management's guidance provided earlier in 2019. Nevertheless, a 23% drop in the quarter was an acceleration from the 11% drop notched in the company's first quarter.
|
Metric |
Three Months Ended April 28, 2019 |
Three Months Ended April 29, 2018 |
YOY Increase (Decrease) |
|---|---|---|---|
|
Revenue |
$3.54 billion |
$4.58 billion |
(23%) |
|
Gross profit margin |
43.2% |
44.9% |
(1.7 p.p.) |
|
Operating profit margin |
21.9% |
28.2% |
(6.3 p.p.) |
|
Earnings per share |
$0.70 |
$1.06 |
(34%) |
Data source: Applied Materials. YOY = year over year. P.p. = percentage point.
The downturn could be bottoming out, though. For the third quarter, management called for revenue of $3.525 billion, plus or minus $150 million. At the midpoint, that would be a 21% decline from the year prior. Adjusted earnings should be $0.67 to $0.75, down 44% to 38% year over year. Quarter over quarter, though, it looks like business is stabilizing. Sooner or later, the downtrend will give way to the next run higher, and Applied Materials continues to wax positive on its prospects as 2019 progresses.
2. Ho-hum chip investment
Primary responsibility for the deterioration in sales are memory chips and displays. The former was down 25% and the latter 52% during the quarter as manufacturers continue to delay investment in new systems and work through an excess of inventory.
|
Business Segment Revenue |
Three Months Ended April 28, 2019 |
Three Months Ended April 29, 2018 |
YOY Increase (Decrease) |
|---|---|---|---|
|
Semiconductor systems |
$2.18 billion |
$2.91 billion |
(25%) |
|
Applied global services |
$984 million |
$945 million |
5% |
|
Display and adjacent markets |
$348 million |
$719 million |
(52%) |
Data source: Applied Materials. YOY = year over year.
Applied Materials is a great way to get a read on the health of the semiconductor industry as a whole, but it also suffers to a great degree as the chip business goes through its cycles. Given the situation surrounding memory in particular, inventory remains elevated -- which in turn means further investment will be subdued for the remainder of this year. However, management said it expects spending on equipment to pick back up by the end of the current fiscal year and into 2020 as memory and display makers begin investing in new and greater production capacity.
There are a few upshots: Applied Materials has a hand in the OLED display-making process, which could be a significant growth driver in the years ahead. The OLED marketplace has begun to pick up steam again as of late, as demonstrated by recent results from materials supplier Universal Display. Plus, Applied Materials doesn't just sell equipment, it also services existing systems that are in place. CFO Daniel Durn said that the company has over 40,000 systems installed globally, and 40% of semiconductor revenues will be derived from that installed base this year. Thus, though the business looks volatile, Applied Materials is actually on solid footing, as it plays an integral role in the manufacturing process for the chip industry.
3. Cars, AI, and the cloud
In the meantime, Applied Materials is handily in the black. The current downtrend is different from times past as operations remain profitable (they weren't during prior bear markets).
Data by YCharts.
Part of that has to do with the growing complexity of chips and the end markets that need them. Notably, Applied Materials thinks computing powered by artificial intelligence, data centers, 5G mobile networks, and automotive technology will drive growth in the years ahead. CEO Gary Dickerson had this to say on the last earnings call:
We see a new industry playbook for semiconductor design and manufacturing emerging that includes five key components: new architectures, 3D structures and scaling techniques, novel materials, new ways to shrink feature sizes, and advanced packaging including new ways to connect chips together. We see Applied's breadth and depth as a key strength as we collaborate broadly to address the technology challenges that will enable this new playbook. Our strategic priorities are to accelerate innovation for our customers while finding new ways to create sustainable value with our technology.
Investors who think chip manufacturing will remain relevant -- specifically in the aforementioned areas of development like AI and 5G -- should give Applied Materials a look. Though the company is managing difficult times, the tumble in share price has the stock trading at a mere 13.6 times trailing-12-month price to free cash flow and forward expected price to earnings of 10.5. For those with a long-term outlook and who don't mind the wild swings, now could be the time to nibble on Applied Materials.
