Applied Materials (NASDAQ:AMAT) reported a 16% increase in revenues in Q2 2012 earnings on a sequential basis. The slowdown in equipment spending by semiconductor manufacturers took a toll on the company’s results for the previous two quarters. The second quarter of 2012 offered some respite and lifted hopes for an early revival in equipment spending. (See: Applied Materials Earnings Raises Hopes For a Revival in Equipment Spending) However, the stock is down 20% in the last year and flat year to date.
We maintain our price estimate of $15 for the company, which is at a premium of around 40% to the current market price. Here, we look at certain current trends that we believe have negatively impacted the stock price.
Slowdown in Semiconductor Equipment Spending in 2012
The semiconductor equipment market has decreased in size from 2007 due to adverse market conditions in 2008 and 2009. However, the market has registered an upside since 2009 and almost reached its historical high of $45 billion in 2011, as manufacturers continued to add capacity to support end-user semiconductor demand.
However, we witnessed a pull-back in expansion plans by most semiconductor manufacturers, on account of weak market conditions in the second half of 2011. We expect the situation to persist in the first half of 2012 and foresee a decline in demand by equipment manufacturers. As per research firm Gartner, the worldwide capital equipment spending market is expected to decline by 11.6% in 2012, from an estimated spending of $44 billion in 2011. 
However, based on the aggressive spending plans announced by major semiconductor manufacturers such as Intel (NASDAQ:INTC) and Samsung, we are of the view that the situation will improve in the latter part of the year and continue to follow the two-year cyclic pattern that is inherent to the semiconductor industry’s capital spending. We forecast the global equipment spending to rise in 2013 to $43 billion and cross $47 billion by the end of our forecast period.
Low Capacity Utilization To Result in Declining Margins
Last year, the weak market conditions led to a demand-supply mismatch, which in turn reduced the capacity utilization of most semiconductor manufacturers. Consequently, the wafer fab utilization rates are showing a downtrend as manufacturers are further cutting capacity to reduce supply. Generally, manufacturers tend to add new capacity when utilization rates are above 90%.
According to Gartner, 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.  Thus, there is decreased demand for semiconductor equipment from manufacturers. This might put pressure on semiconductor equipment manufacturers like Applied to cut prices, in order to push their product sales. As a result, we expect to see a slight downward pressure on gross margins in the current year.
Overcapacity To Lead To Slowdown in Solar Manufacturing
The net sales from Applied’s energy & environmental solutions division was down 62% in Q2 2012, reflecting excessive manufacturing capacity in the solar industry. In 2010, the global photovoltaic (PV) market demand grew by 84%. However, the slowdown in global solar market has led to overcapacity and, consequently, the industry growth dropped down to 32% in 2011.
The capacity expansions taken up by PV manufacturers during the past two years have caused the global manufacturing capacity to significantly exceed demand. Consequently, the uncertain demand outlook combined with overcapacity has led to substantial cuts to capital spending by PV manufacturers. Hence we expect the solar market to register a significant drop this year; but, as the market dynamics correct, we estimate a marginal y-o-y increase for the rest of the forecast period. We do not believe that the drop in revenues from the solar division are due to reasons intrinsic to the company, and we thus estimate its market share to be constant for the period under review.
Anti Dumping Import Tariffs on Solar Cells Manufactured in China
With falling subsidies and weak demand hurting the industry in Europe, Asia is expected to overtake Europe as the largest solar power generation hub, mainly by lowering manufacturing costs. Applied Materials recently announced its decision to move its solar equipment plant to China to cut costs and tap into the growing appetite for clean energy in Asia.
The imposition of around 31% anti-dumping duties on solar cells manufactured in China is expected to impact the supply chain. While the Coalition for American Solar Manufacturing (CASM) claims that the unfair level of subsidies by the Chinese government gives leverage to Chinese manufacturers to dump their products at below cost of production in the American market, the Coalition for Affordable Solar Energy (CASE) feels that the subsidies fulfill the overriding goal to make solar energy as competitive as possible.
Low-cost Chinese panels have figured prominently in the race to make solar energy competitive with fossil fuels. Panel prices have dropped by 50% last year, and the growth has spurred an installation boom that many in the industry feel is unsustainable if prices spike. How the import tariffs effect the solar industry demand and consequent prices is yet to be seen.
We have a price estimate of $14.46 for Applied Materials, a premium of almost 40% to the current market price.Notes:
- Gartner Says Worldwide Semiconductor Manufacturing Equipment Spending to Decline 11.6% in 2012, Gartner Press Release, March 21, 2012 [↩] [↩]