Applied Materials (AMAT 0.73%) pulled out all the stops and delivered exceptional financial results for the final months of calendar year 2022 (its fiscal 2023 first quarter, which ended Jan. 29, 2023). Revenue was $6.74 billion, up 7% year over year. Adjusted earnings per share (EPS) were also up 7% year over year. Neither financial metric broke growth records, but both were near the high end of the guidance the company provided a few months ago.
Chip sales, especially in consumer electronics, are down double-digit percentages as the pandemic-fueled consumer spending spree on devices wears off. Given how ugly it's been for parts of the semiconductor industry have been lately, Applied Materials' quarter was quite good. The outlook for the rest of the year is even better, signaling it's still time to go shopping for top semiconductor stocks.
A false signal to quit semiconductor stocks
Applied Materials is a leader in the semiconductor manufacturing equipment industry. Applied is the biggest name on the block as measured by annual sales, with chip equipment specialist ASML Holding -- which has a monopoly on specialized machinery used in the most advanced chip manufacturing processes -- not far behind.
But where ASML is a specialist, Applied Materials excelled at building the broadest portfolio of equipment needed to make chips and electronics of all types, and at all stages of production. This might sound like a bad position to be in, considering estimates are pointing toward a sizable downturn in chip fab equipment sales in 2023. Many of its customers are dealing with flagging sales, so Applied itself is forecasting a downturn in the next year for overall chip manufacturing equipment.
However, even when factoring in a downturn, global chip wafer fab equipment (WFE) sales were estimated to be in the ballpark of $95 billion in 2022 and will be down by a double-digit percentage in 2023. However, that's tens of billions of dollars more than it was pre-pandemic. The chip industry (which provides the building blocks of the digital economy) is more important than ever before. Even though smartphone and PC sales are down in the dumps, other markets like industrial and automotive are picking up the slack. Since Applied services all of these areas, it should be able to shift its resources to capture growth from other end markets while other parts of the chip world slide.
Chart by author. WFE = Wafer fabrication equipment.
Additionally, Applied Materials also has a growing services business, which provides software and other ancillary recurring revenue streams it can sell to customers that already have Applied equipment installed in their manufacturing operations. These highly profitable services were 20% of total revenue in Q1 fiscal 2023, and are expected to expand at a healthy clip in the year ahead despite equipment sales weakness.
The strength of Applied's business shows up in its guidance for Q2 fiscal 2023 (the three months that will end in April 2023). At the midpoint of expectations, management expects revenue to be $6.4 billion, up 2% year over year. Adjusted EPS is expected to be flat compared to the year-ago period. Again, not exceptional growth, but certainly not bad considering the overall industry is in the midst of a slump. Paired with its high profit margins even in a downturn, Applied has been a long-term market outperformer.
Data by YCharts.
Is the stock a buy?
Applied expects to outperform many of its peers in its fiscal 2023, and it has its sights set on continuing this outperformance once chip industry spending picks up speed again, likely toward the end of calendar year 2023. When this happens, I don't expect Applied to become a high-growth business because of its broadly diversified portfolio of equipment and services. But it doesn't need to be.
Rather, Applied is a growth and income stock. It already plays a critical role in the chip industry, and thus its research and development costs are quite low. With a hefty stream of free cash flow constantly rolling in ($1.98 billion last quarter, a lucrative free cash flow profit margin of 29%), Applied pays a steadily growing dividend and repurchases lots of stock.
Put simply, Applied Material's management team is exceptionally good at allocating capital with an eye toward rewarding shareholders. When the industry was booming in 2021, the company got judicious with its use of cash. Now that the semiconductor world is in turmoil, Applied has been aggressive in putting liquidity to work.
Data by YCharts.
Shares of the company have been off to the races since hitting depressed lows in October 2022. The stock is up over 50% since then. At this juncture, Applied Materials stock trades for 15.5 times trailing 12-month EPS, or 22 times trailing free cash flow. It isn't quite the exceptional value it was a few months ago, but I still believe it to be a fantastic buy now if you believe the semiconductor industry will continue to expand for the foreseeable future. I remain a buyer of this stock amid the current chip industry downturn.
