Semiconductor stocks are having a great run on the market in 2023, which is evident from the 41% jump in the PHLX Semiconductor Sector index, and this explains why shares of Applied Materials (AMAT 2.98%) have shot up 53% this year despite a decline in the company's revenue and earnings.
The company, known for supplying semiconductor manufacturing equipment to chipmakers and foundries, has struggled due to a big decline in spending in this industry. Gartner estimates that spending on semiconductor capital equipment could decline 22.5% in 2023 to $136 billion, as chipmakers have been pulling back spending on account of an oversupply and a weak macroeconomic scenario.
However, Applied Materials' fiscal 2023 third-quarter results (for the three months ended July 30, 2023), which were released on Aug. 17, suggest that the semiconductor glut may be easing. Let's see why that may be the case.
Applied Materials' fortunes could turnaround soon
Applied Materials reported fiscal Q3 revenue of $6.4 billion, down 1% over the prior-year period. The company's non-GAAP (adjusted) earnings fell 2% from the year-ago period to $1.90 per share last quarter. Wall Street was expecting a bigger decline as analysts would have settled for $1.74 per share in earnings on $6.15 billion in revenue.
The company's revenue and earnings were at the higher end of its guidance range thanks to an improvement in its share in the memory equipment market as well as new opportunities opened by the growing adoption of artificial intelligence (AI) and the Internet of Things (IoT). For instance, Applied Materials claims that it has "gained significant share" in DRAM (dynamic random access memory) patterning and has become the largest supplier of advanced packaging solutions for high-bandwidth memory (HBM).
These are also the reasons why Applied Materials' guidance for the current quarter turned out to be significantly better than expectations. The company anticipates earnings of $2.00 per share on revenue of $6.51 billion in the fiscal fourth quarter. That would translate into a sequential improvement in the top and bottom lines. What's more, the forecast is significantly better than analysts' expectations of $1.59 per share in earnings on $5.87 billion in revenue.
It is worth noting that spending on semiconductor equipment is expected to increase by 1.3% in 2024, so Applied Materials could return to growth sooner than later. Analysts, for instance, anticipate the company's revenue to start growing in the second half of 2024. With semiconductor capital equipment spending expected to increase by 9.5% in 2025, it won't be surprising to see further acceleration in Applied Materials' growth over the next couple of years.
AMAT Revenue Estimates for Next Fiscal Year data by YCharts.
But then, don't be surprised to see Applied Materials grow faster than the chart above indicates, as the growing adoption of AI is likely to drive stronger growth in semiconductor capital spending.
AI could be a major long-term catalyst for the company
Applied Materials management discussed in detail on the company's latest earnings conference call how AI could drive greater demand for semiconductor manufacturing equipment. For example, the demand for HBM, which is deployed in AI servers, could increase at an annual pace of 30% in the long run.
The company estimates that HBM currently accounts for less than 5% of DRAM capacity. Applied Materials also adds that the die of an HBM is 25% larger than DDR5 DRAM, which means that memory manufacturers will need to upgrade their equipment to meet the growing demand for these chips. Applied Materials expects this potential upgrade to increase its addressable market by 5%.
However, this is just one way in which AI could be a growth driver for the semiconductor industry. Applied Materials estimates that the sector-wide revenue impact of AI, along with IoT, could be worth almost $500 billion through 2030. The company points out that the semiconductor industry generated $573 billion in revenue in 2022, a figure that's expected to jump to $1 trillion by the end of the decade.
The AI chip market alone is expected to hit $227 billion in annual revenue in 2032 as compared to just under $17 billion last year, clocking annual growth of almost 30% over the next decade. All this indicates that Applied Materials' addressable market should ideally keep expanding in the long run, help the company come out of the slump it is in, and deliver robust growth.
Analysts are anticipating Applied Materials' earnings to increase at an annual pace of 12% for the next five years. The catalysts discussed above could help this semiconductor stock clock faster growth, which is why it may be a good time for investors to buy it before it soars higher and becomes expensive. Applied Materials is trading at 20 times trailing earnings right now, a nice discount to the Nasdaq-100 index's price-to-earnings ratio of 30, but it may not be available at such a cheap valuation for long, given the improving sentiments in the semiconductor equipment space.
