Applied Materials (NASDAQ:AMAT) supplies equipments that form the backbone of semiconductor manufacturing. Last year, with a slowdown in the overall semiconductor market, major manufacturers including Intel (NASDAQ:INTC) and Samsung cut their capital expenditure. The decline in spending, in turn, negatively impacted the revenues of equipment manufacturers such as Applied Materials, which registered a 4% decline in its 2011 revenues. (See Our Article: Applied Materials Earnings Raises Hope For A Revival in Equipment Spending)
The stock has witnessed a continuous downfall in its value in the last two months and more recently has been trading close to its 52-week low of $10. However, we remain optimistic of a revival in capital spending starting second half of 2012, and maintain a current price estimate of $ 14.83 for the company. Here’s why we feel that despite a slowdown in equipment spending in the past year, the stocks is worth much more than what the market perceives it to be -
Semiconductor Equipment Spending to Increase Post 2013
The semiconductor market tends to be volatile and prone to swings. Semiconductor equipment spending being dependent on the overall semiconductor market, tends to follow the same pattern. The semiconductor equipment market has decreased in size from 2007 due to the adverse market conditions in 2008 and 2009. However, market has registered an upside since 2009, and almost reached its historical high of $ 45 billion in 2011.
We witnessed a pull back in expansion plans by most semiconductor manufacturers, on account of weak market conditions in the second half of 2011 and expect the situation to persist till the first half of 2012. As per research firm Gartner, the worldwide capital equipment spending market is projected to decline by 11.6% in 2012, from the estimated spending of $44 billion in 2011. 
However, based on the aggressive spending plans announced by major semiconductor manufacturers, we are of the view that the situation will improve in the latter part of the year. As the economy stabilizes leading to rebound in the PC market, the DRAM and foundry manufacturers will have to increase spending to cater to the rising demand.
Based on similar reasoning, the wafer fab manufacturing capacity utilization will decline further into the low 80% range before slowly increasing to around 90% by the end of this year, leading to an overall positive capital investment environment. 
We forecast the sales of semiconductor equipment to continue following the cyclical growth pattern with a period of 2 years, in line with the semiconductor industry’s capital spending cycle. We go along with Gartner’s estimate of equipment market spending declining to around $39 billion in 2012 and reviving again in 2013. According to our estimate, the market will cross the $47 billion mark by the end of our forecast period.
Excess Demand For 28 nm Process
Though, there has been a slight slowdown in the semiconductor market since the latter half of 2011, there seems to be an access demand for TSMC’s 28 nm process. TSMC has been unable to meet the existent demand for chips using the 28 nm process technologies, primarily due to low yields and insufficient production capacities, in turn effecting production capacities of various manufacturers including Nvidia (NASDAQ:NVDA) and Qualcomm (NASDAQ:QCOM).
As the market for semiconductor devices grows rapidly, expanding capacity to meet the needs of the companies which are vying to get 28nm manufacturing capacity will require foundries to buy more equipment. This will require significant investment in semiconductor manufacturing equipment, which should work in Applied Material’s favor.
Sustained Market Share in the Semiconductor Equipment Market
Historically, Applied Materials has enjoyed the highest market share in global semiconductor equipment sales based on its broad product portfolio and global reach. Semiconductor equipment manufacturing is a complex and highly capital intensive industry, and the threat from smaller and niche players remains unsubstantial. Thus, we believe that Applied Materials will continue to retain this dominant position in future.
Moreover, it achieved a number of positional wins last year with the launch of new transistors and interconnect products. Thus, with a leading product portfolio and sustained investment in R&D, we see its market share increasing slightly in the next 2 years and stabilizing thereon.
The equipment manufacturing business contribute close to 57% to our price estimate, thus having a significant impact on Applied Materials overall valuation. The quicker the capacity expansion plans are implemented the better it would be for the company’s stock. However, there could be a slight downside to our estimate if the capacity expansion plans slip from the second half of 2012 to early or mid 2013.
We have a current price estimate of $14.83 for Applied Materials, a premium of almost 43% to the current market price.Notes:
- Gartner Says Worldwide Semiconductor Manufacturing Equipment Spending to Decline 11.6 Percent in 2012, Gartner Press Release, March 21, 2012 [↩] [↩]