Share prices of semiconductor manufacturing equipment maker Applied Materials (AMAT 2.98%) soared after its latest quarterly update. On the surface, the financials were nothing to be excited about. Some hype surrounding generative artificial intelligence (AI) coming to smartphones, PCs, and an app near you (a growth cycle Applied Materials most certainly participates in) might offer some explanation for the stock price running higher.
But what's the real reason this stock is up over 60% in the past year?
It likely boils down to the business managing to sidestep not one, but two different cyclical downturns for the semiconductor industry. It also helps that it fully expects more profitable growth in 2024. Here's why Applied Materials looks to be an exceptional AI stock this year and beyond.
Flat revenue about to finally turn higher?
After a sizable jump in sales during the pandemic (when manufacturers were trying to increase their semiconductor output to meet demand for all things electronic), Applied Materials' revenue has been lackluster over the past 18 months or so. At the midpoint of expectations for fiscal year 2024's Q2 (which will end March 2024), the company expects revenue to be flat to slightly down year over year -- or up a low-single-digit percentage at the high end of guidance. Not very exciting.
However, when you compare that to its longtime industry peer Lam Research (LRCX 2.65%), which was hit by a decline in consumer electronics and enterprise compute spending in the wake of the pandemic, Applied Materials' sales have actually held up well.
Data by YCharts.
You see, historically Applied Materials' revenue focused on logic chip manufacturing. But in recent years, it pivoted its portfolio to address "mature" semiconductor manufacturing processes related to power, sensors, and other less advanced technologies (but still integral to the whole AI narrative). These chip types remained in high demand last year thanks to electric vehicles and other industrial market strength, helping the company bridge what would have otherwise been a severe downturn similar to what Lam experienced.
But making that pivot to industrial chip manufacturing equipment cuts both ways because now demand for electric vehicles and power chips is expected to be in decline through at least the first half of 2024. Applied Materials' should be expecting a downturn, but management remains upbeat and optimistic. How?
Thanks to its well-diversified portfolio of tech and manufacturing machines, the company is now pivoting back to advanced logic chips (and related memory) to catch the coming wave of AI infrastructure and on-device AI applications. Top chip fabs like Taiwan Semiconductor Manufacturing are ramping up production this year to meet demand from AI system designers like Nvidia and Advanced Micro Devices, and Applied Materials is ready to fuel the growth cycle.
Yes, the soft demand from its power and other analog chip fab partners is going to bite, but the point is this: Applied Materials has now bridged two industry downturns, and is eyeing a new growth supercycle -- when power and analog chips, and advanced logic and memory begin to grow in tandem with each other in the second half of 2024 and into 2025.
The Applied advantage
This teased return to growth is all fine and well, but the real reason it is exciting for Applied Materials shareholders is what it could mean for the bottom line. Equipment sales have remained a high-margin business, with an operating profit margin of 35.5% last quarter, offset by lower margins in the services and digital display segment, and the company invested in new machinery tech. If the next upcycle for equipment sales is right around the corner, this bodes well for Applied Materials' profitability overall.
Data by YCharts.
And over the last year, Applied Materials has been replenishing its balance sheet in preparation for the next semiconductor bull market. Cash and short-term investments stood at $7.5 billion at the end of January 2024 (compared to $6.9 billion three months prior), long-term investments were $2.9 billion ($2.3 billion three months prior), and total debt remained about the same at $5.6 billion. The company is geared up and ready to go for the AI chip era.
At 22 times trailing-12-month earnings per share as of this writing, Applied Materials stock trades for a higher premium than it has over the last couple of years. But deservedly so, as the business and the chip manufacturing industry overall could be entering a new growth cycle later in 2024. I'm more than happy to continue holding my investment for the long term.
