Applied Materials (AMAT 3.71%) revised its fiscal fourth-quarter outlook on Oct. 12 in response to the Biden Administration's new restrictions on the export of semiconductors and semiconductor equipment to China. It expects those restrictions to reduce its fourth-quarter sales by $250 million to $550 million.

As a result, the semiconductor equipment maker now sees revenue rising 0.5% to 9% year over year in the fourth quarter, compared to its prior forecast for 2% to 15% growth and analysts' expectations for 8% growth. On the bottom line, management is guiding for adjusted earnings per share (EPS) to dip 8% to 21%, compared to its prior expectations for a 6% decline to 12% growth. The analyst consensus called for earnings to rise 3%.

An illustration of a semiconductor.

Image source: Getty Images.

The stock held steady after that disappointing announcement, even as a hotter-than-expected inflation report rattled the broad market. Does that stability indicate the stock has finally bottomed out after being cut in half this year?

Bracing for a cyclical slowdown

Applied Materials generated 71% of its revenue from its semiconductor systems division, which supplies manufacturing equipment to a wide range of chipmakers, in fiscal 2021 (which ended last October). Another 22% of its revenue came from its applied global services division, which installs and maintains that equipment, while the remaining 7% came from its display and adjacent markets division, which supplies manufacturing equipment for LCD and OLED screens.

As one of the world's largest semiconductor equipment makers, Applied Materials is considered a bellwether of the sector. It's also highly exposed to the industry's cyclical slowdowns, which generally occur every few years when the global supply of chips outweighs the market demand.

Those trends are reflected in Applied Materials' trajectory over the past five years. Its growth cooled off in fiscal 2019 due to a weaker smartphone market and the overproduction of memory chips. But it accelerated significantly throughout fiscal 2020 and fiscal 2021 as new 5G devices hit the market, data centers upgraded their infrastructure to accommodate the growth of cloud-based services, and stay-at-home trends during the pandemic temporarily boosted sales of new PCs.

Period

9M 2022

FY 2021

FY 2020

FY 2019

FY 2018

Semiconductor Systems Revenue Growth

15%

43%

26%

(15%)

15%

Applied Global Services Revenue Growth

13%

21%

8%

3%

24%

Display and Adjacent Markets Revenue Growth

(11%)

2%

(3%)

(28%)

31%

Total Revenue Growth

12%

34%

18%

(13%)

19%

Gross Margin*

46.8%

47.5%

45.1%

44.0%

46.1%

EPS Growth*

16%

64%

37%

(27%)

37%

Data source: Applied Materials. *Non-GAAP basis.

But in the first nine months of fiscal 2022, Applied's growth decelerated again as PC sales cooled off. Inflation, rising interest rates, and other macro headwinds also delayed big cloud deals while curbing enterprise spending on major infrastructure upgrades. Ongoing supply chain disruptions exacerbated that slowdown.

Many big chipmakers -- which had been gearing up to produce more chips to address the chip shortage throughout the pandemic -- then hastily curbed their production to avoid flooding the market. All those headwinds have caused another major cyclical slowdown across the semiconductor market. 

The midpoint of Applied Materials' revised guidance implies its revenue will rise about 10% for the full year as its adjusted EPS grows 7%. Those figures both fall short of analysts' calls for 11% and 12% growth, respectively.

Expect that slowdown to continue throughout 2023

Wall Street had originally expected the company's top- and bottom-line growth to be flat in fiscal 2023. However, the new export restrictions against China, which accounted for 31% of its sales in the first nine months of fiscal 2022, will likely cause its revenue and earnings to decline instead.

Applied can still provide some of its products and services to Chinese customers but only for older and less advanced chips. Those restrictions, along with the other macro headwinds for the semiconductor industry, should cause its slowdown to deepen over the next few quarters.

But Applied Materials' stock might still be worth buying

Investors generally don't like to buy a cyclical stock right after it's passed a near-term peak. However, the semiconductor industry should still continue to expand over the long term as more advanced consumer electronics, data centers, cars, robots, and other products gobble up more chips.

Therefore, Applied Materials stock still looks very cheap at 10 times forward earnings, and it pays a decent yield of 1.4% to investors who are willing to ride out the cyclical downturn.

If you're looking for a stock that will bounce back quickly in this bear market, you should avoid Applied Materials. But if you want a solid pick-and-shovel play on the broader semiconductor market that will gradually expand over the next decade and beyond, then Applied Materials is an attractive option, especially while its shares are still on sale.