Artificial intelligence (AI) is having a massive impact on the semiconductor industry, and this technology is highly dependent on advanced chips with huge computational capacity that can be power-efficient at the same time.
Companies have been lining up to buy powerful chips from Nvidia and its peers to train and deploy large-language models, which are the backbone of generative AI applications such as ChatGPT and Bard. The demand for AI chips is forecast to increase at a robust annual rate of 38% over the next decade, generating $384 billion in annual revenue by 2032.
This is where Applied Materials (AMAT 2.98%) comes in, as a provider of semiconductor manufacturing equipment and services to major chipmakers and foundries.
Shares of Applied Materials delivered respectable gains of 37% in 2023, but they pulled back 12% in the past three months, presenting an opportunity to buy this potential AI winner at an attractive valuation. Let's see why investors might want to capitalize on the stock's dip.
How AI could be a key catalyst for Applied Materials
In fiscal 2022, Applied Materials got 42% of its total revenue from three semiconductor companies: Samsung, Taiwan Semiconductor Manufacturing (or TSMC), and Intel.
TSMC was its largest customer, accounting for 20% of its revenue, and it is now investing aggressively in advanced chipmaking equipment to increase output of AI chips. The foundry increased orders for chip-on-wafer-on-substrate (CoWoS) packaging equipment by 30% in September, according to media in China.
CoWoS is used for manufacturing high-performance chips because it allows chipmakers to place multiple types of chips or chiplets on a single platform so that they can deliver improved performance with reduced power consumption and lower costs. TSMC management said on its October earnings conference call that it plans to double its CoWoS capacity by the end of 2024 and continue increasing it in 2025.
Applied Materials is in a strong position to take advantage of this thanks to the solutions that it introduced. In July, the company announced that it deployed materials and technologies that help chipmakers integrate chiplets into advanced semiconductor packages. This will allow its customers to pack a greater number of transistors into a chip to drive greater performance along with efficient power consumption.
Intel is also looking to ramp up its advanced packaging infrastructure by quadrupling its capacity by 2025, and it will be building a new factory in Malaysia to achieve its target. The company is already investing $7 billion in a chip assembly and testing facility in that country. TSMC decided to invest $2.9 billion in an advanced chip packaging plant in Taiwan.
All this explains why the advanced chip-packaging market is expected to grow from annual revenue of $44 billion this year to $79 billion by 2028, a secular growth opportunity for Applied Materials as foundries line up to buy more of its advanced packaging equipment.
Stronger growth could be on the cards
Applied Materials' third-quarter results (for the three months ended July 30) showed that revenue fell 1% year over year to $6.43 billion, which can be attributed to weak semiconductor equipment spending in 2023. Industry association SEMI estimates that equipment spending could decline nearly 19% this year to $87 billion.
Analysts anticipate the company's fiscal 2023 revenue to drop nearly 4% to $24.8 billion. However, things could turn around in the new fiscal year and get better in the following one.
AMAT revenue estimates data by YCharts.
As foundries and chipmakers ramp up spending on new chipmaking equipment thanks to AI, Applied Materials could see faster growth. The stock now trades at just 17 times trailing earnings, which is lower than its five-year average multiple of 18 and the Nasdaq-100's earnings multiple of 29.
That's why investors looking to buy an AI stock relatively cheaply would do well to take advantage of Applied Materials' recent dip -- it could regain its mojo and start heading higher once again.
