The world's largest and most diversified semiconductor equipment company, Applied Materials (AMAT 2.98%), reported earnings last week, showing its resilience to some of the more cyclical elements of the market.
While the chip sector is currently in a downturn -- especially leading-edge chips and memory -- Applied still guided for sequential growth, signaling its very mild dip in revenuE may be over.
In a world of economic turmoil, Applied's resilience could lead to multiple expansion for the stock. If that's the case, then even more upside could be coming, even beyond the 50% gains the stock has already made this year.
Applied's breadth of products offers an advantage
Because of Applied's diversification across leading-edge and trailing-edge foundry/logic, DRAM and NAND memory, advanced displays, and packaging, the company is able to identify strong growth trends early and invest behind it. That diversification allows Applied to pivot toward higher-growth parts of the chip market and also design co-optimized solutions that include multiple tools.
For instance, five years ago, management saw the upcoming growth in trailing-edge nodes serving the high-growth auto and Internet of Things industries, which have remained resilient through this downturn. In response, Applied formed a dedicated division it calls its ICAPS group to focus on this segment, introducing 20 products over the past five years. While memory and leading-edge are down significantly this year, the growth of the ICAPS portfolio is now sustaining Applied's equipment sales.
In addition, Applied has also launched advanced and integrated solutions for DRAM, which is coming out of the memory downturn thanks to the demand for high-bandwidth memory for artificial intelligence. Of note, Applied said its market-share gains in DRAM have come from introducing logic chip characteristics to memory, such as advanced in/out speeds and backside power. So again, this is another example of Applied's diversification advantage, as it seems the company was able to take a technique or learning from one part of chip sector and apply it to innovate another.
Finally, Applied also noted its growth in advanced packaging for heterogeneous integration, a technique required for the "chiplet" architecture used in Advanced Micro Devices' upcoming MI300 AI accelerator. Seeing that upcoming need for new packaging techniques for chiplet designs, Applied just introduced five new packaging products in July.
So even though the overall memory industry is in its worst downturn since the Great Financial Crisis and leading-edge chips, except AI GPUs, are also in a downturn due to the declines in PC and smartphone markets, Applied only saw its equipment sales dip by about 1% last quarter, and forecast sequential growth for its upcoming Q4. That suggests this chip downturn, which is historically bad by some measures, only led to a mild dip in Applied's revenues.
Image source: Getty Images.
Services add stability to the portfolio
Besides diversified and resilient equipment sales, investors shouldn't overlook Applied's somewhat-recurring services revenue, which made up about 23% of revenue last quarter and actually grew year over year.
Over the years, Applied has developed services for its installed base that can help machines run more efficiently, lowering defects and increasing yields. Again, this is where Applied's depth and breadth of knowledge is yielding results. While the services segment does include spares and services that are more transactional, management has grown the subscription portion of the services business to over 60%.
Given that Applied's services revenue is largely tied to its installed base, it's hard to imagine services declining in any one year. The exception was two quarters ago in Applied's fiscal first quarter, which ended in January. But that was the quarter in which the U.S. introduced new rules on selling and servicing advanced memory equipment to China. So, a portion of Applied's tools were taken offline all at once in a one-time event. Yet services revenue began to grow immediately thereafter, growing 3.1% year over year in the recently reported quarter.
Encouragingly, management noted it expects the global services division to grow double digits annually when the environment normalizes. That recurring and high-profit revenue stream should also bolster future results.
Could boring old stability be a catalyst?
In decades prior, the semiconductor capital equipment sector was very, very cyclical, leading to low multiples across the industry. However, with industry consolidation, diversity beyond PCs and smartphones to IoT, electrification, and AI, and the growth of recurring services tied to the installed base, semicaps generally and Applied specifically appear to be more stable than in years past.
Applied still trades at less than 20 times earnings; but if this mild decline has marked its cyclical bottom, a 20 P/E on bottom-of-the-cycle earnings is still really attractive. Thus, despite strong year-to-date gains, I'd expect Applied stock still has room to run.
