Applied Materials' (AMAT +0.42%) stock has beaten the broader market significantly this year thanks to a late rally triggered by a strong set of results for the fourth quarter of fiscal 2020.
But those who have missed Applied Materials' gains so far shouldn't be disappointed, as the stock looks set to fly higher in 2021. Let's take a closer look at the reasons why this semiconductor play could deliver explosive growth next year, and why it isn't too late to buy the stock just yet.
Image source: Getty Images.
Applied Materials' biggest business will step on the gas in 2021
Applied Materials closed fiscal 2020 on a high with 18% revenue growth to $17.2 billion. More importantly, the company saw improvements across the board, as its non-GAAP gross margin rose 110 basis points, earnings per share increased from $3.04 to $4.17, and free cash flow jumped 20.5% to $3.38 billion.
The company's outlook for the first quarter of fiscal 2021 suggests that it is about to start the new year on the right foot. Applied Materials expects earnings of $1.26 per share on revenue of $4.95 billion this quarter, according to the midpoint of its guidance range. That would represent a 19% jump over the prior-year period's revenue of $4.16 billion and a substantial gain over earnings of $0.98 per share.
Applied Materials didn't provide full-year guidance, but it won't be surprising to see the company sustain its impressive growth rate throughout 2021 because of an increase in demand for semiconductor equipment that it sells.
Industry association SEMI forecasts spending of $70 billion on semiconductor equipment next year as compared to an estimated $63.2 billion in 2020 thanks to growth across several sectors. More specifically, spending on DRAM and NAND equipment is expected to rise by 20% in 2021. Spending on wafer fabrication equipment is expected to jump 13% as compared to 2020's estimated increase of just 5%.
The foundry and logic equipment market (which accounts for nearly half of wafer fabrication equipment sales) is expected to witness single-digit growth in spending next year. All of this bodes well for Applied Materials, as the foundry and logic, DRAM, and NAND segments together make up its semiconductor systems business, which produced 66% of its revenue last fiscal year.
All told, robust spending on chipmaking equipment next year should ideally lead to an improved performance from the semiconductor systems business because it provides manufacturing equipment for fabricating chips. However, Applied Materials has additional growth engines that could give it a nice shot in the arm next year.
Additional catalysts
Applied Materials gets the remaining third of its revenue from the Applied Global Services and the display and adjacent markets businesses.
Through Applied Global Services (accounting for 24% of the total revenue), the company provides solutions to original equipment manufacturers (OEMs) for maintaining their fab equipment, optimizing them for better productivity, or upgrading them, among other services. Applied Materials also remanufactures legacy equipment apart from providing factory automation software through its services segment.
Services put in a decent showing last fiscal year, recording revenue growth of nearly 8%. While that may not look very impressive at first, investors need to realize that Applied Materials is pivoting toward a subscription-oriented business model in services to ensure long-term growth.
The services business pulled in record revenue last year thanks to the shift. Applied Materials witnessed a 13% jump in the number of tools that are now covered by long-term agreements in the fiscal fourth quarter. In all, 60% of the company's services business now consists of subscriptions. What's more, it claims it is witnessing renewal rates in excess of 90%.
The good news is that Applied Materials anticipates the services business to put in another consistent performance in the current fiscal year. The fiscal first-quarter outlook indicates the same, with Applied Materials anticipating 7% revenue growth over the prior-year period.
Meanwhile, the display business that makes up the remainder of Applied Materials' revenue is also anticipated to step on the gas after a flat performance last fiscal year. Display revenue is expected to jump 20% year over year in the first quarter of fiscal 2021, and it could sustain a high rate of growth in the future as well.
That's because the demand for organic light-emitting diode (OLED) displays is increasing thanks to the launch of 5G smartphones. On the latest earnings conference call, CEO Gary Dickerson noted "higher OLED adoption in the smartphone market, with more than 70% of the 5G handsets launched to date equipped with OLED screens, and foldable OLED handsets approaching a price point that could spur volume adoption."
According to a third-party estimate, the OLED display market could clock a compound annual growth rate (CAGR) of 24.4% through 2024. As a result, Applied Materials could witness an increase in demand for display manufacturing equipment in the future and keep up the impressive growth rate of the display business.
Why now is a good time to buy
It is evident that Applied Materials could see strong growth in several areas next year thanks to favorable end-market conditions. That's why investors shouldn't wait on the sidelines, as Applied Materials is trading at an attractive valuation right now.
The stock's trailing price-to-earnings (P/E) ratio of 21.4 looks quite reasonable considering the growth it is delivering. The forward earnings multiple of 17.8 points toward a better bottom line in the coming year. More importantly, Applied Materials is expected to clock double-digit earnings growth over the long term, according to analyst estimates compiled by Yahoo! Finance.
As such, investors looking to add a top growth stock to their portfolio for the new year should take a closer look at Applied Materials now that it looks set to shift into a higher gear.
