Share prices of Applied Materials (AMAT -0.91%) are down over 30% this year, roughly in line with the average return for semiconductor stocks in 2022. Investors are fretting over a possible recession in 2023, and some parts of the chip industry (specifically, the parts that rely on consumer purchases of smartphones and PCs) are already in a cyclical downturn.  

With this as a backdrop, Applied Materials' business is doing just fine. The stock has already sharply rallied off of its low in October, but there could be plenty more left in the tank because the company predicts a strong start to 2023.

Don't confuse this downturn with those of the past

Chip stock performance headed into 2023 isn't telling the whole story. Yes, consumer electronics are in a deep downturn, but the chip industry overall is exhibiting resilience and is far from a widespread collapse. On the contrary, cloud computing, AI, automotive, and industrial demand are still strong, and lots more demand is coming in the years ahead. Chip companies and analysts alike see global annual chip sales going from over $600 billion in 2022 to more than $1 trillion a year by 2030. To meet that future demand, new chip manufacturing facilities (fabs) need to be built right now.

That's been a boon for Applied Materials, the leader in the chip fab equipment space. The company doesn't make the high-tech lithography machines that ASML Holding specializes in. However, it has a deep lineup of machines that address plenty of other steps in the chipmaking process, as well as equipment for solar panels and displays (solar panels and device screens are chock-full of semiconductive materials). Applied Materials rounds out its equipment with services and software to help its manufacturing partners manage their fabs.  

One of the causes for the current slump in consumer electronics is an oversupply of digital memory and related components. That's hit companies like Micron Technology especially hard lately. However, Applied Materials only derived 22% of its revenue from the memory market in the last quarter. That contrasts with chip fab equipment peer Lam Research, which attributed 52% of its sales to memory chipmakers in its latest quarter.

Thus, while Applied Materials' growth has certainly slowed this year, it is still growing because it is minimally exposed to the areas of the chip industry that are in a downturn. It's even been able to shake off worry regarding the United States' new export curbs on chip equipment to China, although these restrictions have temporarily eaten into the company's profit margins. Applied Materials' fourth-quarter fiscal 2022 revenue increased 10% year over year, and unadjusted earnings per share fell 2% (though earnings per share rose 5% on an adjusted basis). In all, fiscal 2022 (which ended Oct. 30) was another strong year in spite of a deluge of challenges, as evidenced by the table below.  

Metric

Fiscal 2022

Change (YOY)

Revenue

$25.8 billion

12%

Earnings per share

$7.44

16%

Adjusted earnings per share

$7.70 

13%

Free cash flow

$4.61 billion

(3.4%)

Data source: Applied Materials. YOY = year over year.  

Growth could be headed for a rebound next year

Another catalyst for Applied Materials is the passage of the U.S. CHIPS Act, as well as similar technology bills passed in other countries around the world aimed at boosting semiconductor manufacturing. Many chip fabs are rapidly expanding to meet future demand and to maintain their market share, but the most profitable way to play this trend is via companies like Applied Materials. Lots of new fab equipment will be needed for years to come to support this fab "arms race."

To wit, Applied Materials said it expects revenue to be $6.7 billion at the midpoint of guidance for the first quarter of fiscal 2023. That implies year-over-year growth of about 7%. Adjusted earnings per share should be within a range of $1.75 to $2.11, or a decrease of 7% to an increase of 12% compared to last year. This outlook takes into consideration ongoing supply chain issues and U.S. restrictions on sales to China.

Given the world is potentially headed into an even deeper economic slowdown, I'd say that's a pretty solid forecast. As economic issues and industry-specific headwinds start to ease, Applied Materials' growth and profitability could heat up again later in 2023.

Applied Materials' stock currently trades for 14 times trailing-12-month earnings, or 20 times trailing-12-month free cash flow. If you assume the company can grow its profits at a mid-single-digit percentage rate for the rest of the 2020s, the stock looks fairly valued. Note, though, that it is a prolific repurchaser of its shares, which further boosts future earnings growth potential. Applied Materials returned a whopping $6.1 billion to shareholders last year via repurchases, along with its modest dividend, which currently yields 1% a year.

In my book, Applied Materials is a cheap long-term bet on the chip industry. I remain a buyer headed into 2023.