How Applied Materials Got Hit by Supply Chain Disruptions

Applied Materials (AMAT 0.73%) has been a big winner on the stock market over the last decade, but like other semiconductor stocks, it has also been impacted by supply chain challenges.

In this segment from the "Beat and Raise" episode recorded on Dec. 1, Fool contributors Jon Quast and Bill Withers discuss Applied Materials' latest earnings report and what those supply chain disruptions mean for the future.

Brian Withers: Yeah, I love Applied Materials. They're the company that makes the equipment that makes the chips.

Jon Quast: Yeah, they make the stuff that makes the stuff, and they also service those pieces of equipment too, so they have that service revenue. They just reported, about two weeks ago, their fourth quarter of fiscal 2021. They're one of those companies that has the weird fiscal quarters where it's offset six months, and it makes it a little bit confusing. Just want to make sure we're all talking about the same thing here -- the fiscal fourth quarter is the most recent. That was a couple of weeks ago. Big market cap, $141 billion. This is a very big company. Basically, not completely a duopoly, but a lot of overlap here with a company called Lam Research. But very similar in what these guys offer.

Revenue came in at $6.12 billion, that was up 31% year over year, so very nice growth. However, this was just meeting management's previous guidance. It was toward the low end of the guidance range that they had given. On the low end of guidance, they guided for $6.08 billion, so barely squeaking in there, but meeting that guidance. However, they did miss expectations. Analysts were hoping for a little bit more toward the middle of the previous range that management had given as far as revenue went. What management cited here was supply chain issues. We've all heard it. Basically, what they're saying is they weren't able to get materials in a timely fashion to be able to do what they needed to do. They say that that cost them roughly $300 million in the quarter. If you do the math, they would've come in above analysts' expectations had it not been for the supply chain issues.

Now, astute investors who know both of these companies will note that Lam Research did not note any supply chain issues in their quarter. However, Applied Materials says it happened toward the end of the quarter. They're reporting here a little bit later than Lam Research, so maybe that's what is going on. Maybe Lam Research was a little bit earlier, and therefore, it doesn't overlap 100%. That's why Lam Research didn't see it and Applied Materials did. That's something to watch going forward.

Basically, met their guidance, missed a little bit on the expectations as far as non-GAAP EPS. They had guided for a range of $1.87 to $2.01, they came in right smack dab in the middle of that at $1.94. That also missed expectations. Analysts were hoping for just a penny more. But either way, up 55% year over year, and we'll talk about that in a minute.

Outlook for the first quarter -- so this is the quarter that is coming up -- they're expecting between $5.91 billion and $6.41 billion, would be up 19% year over year at the midpoint. This also missed analysts' expectations. They hadn't given previous guidance here for the first quarter, but analysts were hoping for $6.5 billion. If you look there on the top line, the bottom line, and in the forward outlook, all coming in short of analysts expectations. And yet, across the board, analysts raised their price targets for Applied Materials stock. An interesting dynamic here, the stock has been trending upwards since, beating the market handily over the past year or so.

Some highlights from the quarter -- incredibly strong demand still going on. This is important because many investors will know that semiconductors have historically been very cyclical. I think that the cyclicality is dying down, that's a personal opinion, because we have so many more devices and things that are using the stuff that is from the semiconductor market, and Applied Materials -- that is very good for them. The demand is no problem. The problem is having enough supply to service the demand, that's the problem. Soaring profit margins -- and I do want to share here a little chart that I think is so important for investors to be aware of. This is profit margins here over the past three years. The blue line is net income, the purple is operating margin, and then the orange, their gross profit margin. Because the demand is so strong for these things, this really helps their profit margins. They're able to get a little bit of pricing power out of that. That's just a normal in semiconductors.

Any concerns? They're returning a lot of capital to shareholders. That is good. Is it sustainable? They actually returned more to shareholders in buybacks and dividends in the most recent quarter than they actually had from operations. If you look over the course of the year, they returned about 84% of cash from operations back to shareholders in buybacks and dividends. That's a really high, that's good. Is it sustainable? They'll need to keep growing that revenue, keep growing their earnings. I think it's very possible given the tailwinds in the semiconductor industry, but something to keep an eye on.

Brian Withers: I worked in Austin, Texas, in the early 2000s when I was at Dell, and Applied Materials was one of the other major employers in the area. I remember, I knew a number of people at Dell who had left Applied Materials and came over. They always seemed to be in a boom-or-bust phase, but to you, Jon, I think too, the world can't get enough silicon. I'm not going to be the one ... I don't know the industry super-well, but I don't see the demand for chips slowing down anytime soon. As you pointed out, these guys are in effect part of a duopoly. Over the last 10 years, I looked. This stock has 14-bagged, so it's a good long-term play.

Jon Quast: Yeah, I totally agree with you. Over the last three years, I think 300% return. And Lam Research is about the same, they're neck in neck there. I'm not sure which one is the better one, but they're both pretty good.