Applied Materials (AMAT 8.35%) has been an incredible long-term winner in the stock market but has retreated significantly from its all-time highs.
Applied is the largest semiconductor equipment company in terms of revenue and the most diversified in terms of market reach. Yet, despite the artificial intelligence (AI) boom, which will need lots and lots of leading-edge chips and high-bandwidth DRAM memory (HBM) that Applied's machines help manufacture, investors have still seen the stock retreat over 32% from all-time highs seen back in July.
Now trading at a lower valuation and with AI-powered tech trends still ahead of us, does that make this long-term outperformer a screaming buy?
NASDAQ: AMAT
Key Data Points
Applied's competitive advantages
The semiconductor equipment industry is highly technical and has been consolidated into just a handful of large players. Thus, for each step in the semiconductor manufacturing process, there are really only one or two options. That's a significant competitive advantage for all players involved, affording most semicap companies high margins and returns on invested capital.
In addition to high margins and cash generation, the semiconductor industry has grown faster than the economy over time. This makes sense, as more and more chips go into basically all consumer and enterprise-related devices every year, with artificial intelligence set to only accelerate that trend.
Additionally, as the complexity of leading-edge semiconductor production has increased, capital intensity has gone up, benefiting semicap vendors like Applied. Outsize growth and high returns on capital are why Applied Materials has been such an outsize winner, as you can see:
AMAT 10 Year Total Returns (Daily) data by YCharts.
Why Applied was recently downgraded
Earlier this month, sell-side analysts at Morgan Stanley actually downgraded Applied Materials, sending shares down to a new yearly low.
Why the downgrade? The Morgan Stanley analysts flagged a few overarching concerns. The first is China. Over the past couple of years, China-based trailing logic and DRAM producers pulled forward orders for equipment, apparently trying to get ahead of sanctions in spite of a bad Chinese economy.
That pull forward has helped sustain Applied's revenue and earnings per share (EPS) over the past couple of years, even as other semicap suppliers saw more material weakness. But with new sanctions just put in place, analysts expect China demand to decline next year, as end users digest what they've bought.
Additionally, despite the rise of AI chips and HBM memory, the non-AI portions of chip manufacturing are still not recovering as much as hoped. In response, there appears to have been a dialing back of growth aspirations from foundries outside of Taiwan Semiconductor Manufacturing (TSM 6.29%), which continues to benefit from robust AI-related demand. In particular, Samsung, which has been hoping to rival TSMC, seems to have run into technology execution problems, limiting the amount of new tools it expects to buy.
All in all, the Morgan Stanley team sees Applied having a "transition" year in 2025, with the wafer fab equipment industry as a whole down 6%, albeit with some segments up and others down.
But this sell-off could be an opportunity
Down this much and trading at just around 20 times trailing earnings, Applied looks like a solid buy here. After all, while next year may be "soft" from an equipment sales projection, Applied may do incrementally better than the overall 6% decline, even if that does come to fruition.
Applied has been gaining share in recent years, and its services business, tied to its installed base, should grow each and every year. That could offset a mid-single-digit decline in new equipment sales.
In that "down" scenario, EPS could remain flat or even grow thanks to share repurchases. With high margins and cash generation, Applied will likely continue repurchasing shares at a good rate. The company can also afford to tap into its balance sheet cash, which has ballooned to over $8 billion against just about $6 billion in debt.
While Morgan Stanley may be pessimistic, it's somewhat of an outlier on Wall Street. The current consensus still has Applied's EPS growing to $9.50 per share this fiscal year, up from $8.65 in the recently completed fiscal 2024. That would put the stock at just 18 times next year's estimates, which is a below-market multiple.
Even in its downgrade, the Morgan Stanley analysts admitted that "the longer-term secular drivers of [wafer fab equipment] market growth are intact as supply chain diversification remains top of mind and semiconductor capital intensity is not declining."
So, even Morgan Stanley believes its call is more short term. Yet, with long-term trends toward AI, more complicated chip architectures, countries wanting leading-edge production on their own shores, and Applied maintaining a strong leadership position, investors may want to buy this dip for the long term.
