After a spectacular 2010, Applied Materials‘ (NASDAQ:AMAT) 2011 revenue took a hit primarily on account of the slowdown in the global semiconductor industry. As most semiconductor manufacturers reduced their capital spending on lower demand, Applied registered an 8% q-o-q and a 16% y-o-y decline in revenue in Q3 2012. The company is set to announce its Q4 2012 earnings on November 15, and with orders declining by 35% last quarter, we do not expect the situation to be any different in Q4.
Witnessing a steep decline in orders, Applied announced a restructuring plan for its Energy and Environmental Solutions (EES) business to lower its cost structure and the operating breakeven level to approximately $500 million at the start of the year. Last month, the company announced its workforce restructuring plan by implementing a voluntary retirement program & other workforce reduction action. It projects to save $140 million to $190 million annually through this plan which it intends to invest in future key initiatives.
While we continue to have a positive outlook on Applied’s long-term prospects, we believe the macro headwinds will impact its short term growth.
Reduced Semiconductor Capital Equipment Spending
Weak market conditions in the second half of 2011 caused pullbacks in expansion plans throughout the industry as manufacturers adjusted their production levels to match the end-user demand. The conditions persisted in 2012 as well with Applied witnessing weaker than expected demand in its semiconductor equipment business, primarily among foundry customers.
According to research firm Gartner, the worldwide semiconductor manufacturing equipment spending is expected to total 38.9 billion in 2012, a 11.6 % decline from 2011 spending of $44 billion.  However, with increasing stability in economic conditions and a rebound in the global PC market, we expect to witness an increase in utilization levels to support the growing demand.
While the wafer fab equipment (WFE) market saw spending increase by 13.3% in 2011, Gartner forecasts the same to decline by 13.3%, totaling $31.4 billion in 2012. It expects capacity utilization to decline into the low 80% range by mid 2012, before slowly increasing to about 87% by the end of the year. Though the situation is expected to improve in 2013, Gartner does not estimate the market to return to positive growth in the year. 
Excessive Manufacturing Capacity In The Solar Industry
The solar equipment market is dependent on sales of solar PV and thin-film products to solar energy companies and currently the industry is suffering from low demand coupled with excess manufacturing capacity. Revenue from Applied’s energy and environmental solutions division registered a significant decline (62%) in Q2 2013, though net sales remained flat in Q3 2012 largely reflecting the deferred revenue. However, the decrease in orders last quarter point toward a slower than anticipated revival in the solar market, and we expect to witness a significant decline in the solar PV equipment market in the current year.
However, we remain optimistic on the long-term prospects of this segment as there is bound to be an increase in demand for solar power use with growing awareness about the benefits of renewable energy combined with declining costs.
According to the findings of Applied Materials’ fourth annual solar energy survey conducted in China, India, Japan and the United States, we could see higher-than-expected growth in demand for solar power in the future. This means there could be a possible marginal upside to our price estimate if the solar PV equipment market crosses $10 billion by the end of our forecast period.
Smartphones and Tablets To Fuel Growth In Display Segment
With the current slowdown in growth of global PC shipments, the increasing adoption of smartphones and tablets is expected to fuel future growth in the semiconductor industry. Additionally, the global appetite for mobile devices with new features, longer battery life and brighter, higher resolution displays continues to strengthen. As these devices drive demand for leading-edge foundry capacity, the market leaders are aggressively accelerating ramps at advanced nodes.
Applied Materials has a significant presence in the smartphone and tablet market. It expects to generate more than $250 million revenue from products that serve new applications in this area in the future.
We will update our current price estimate of $14.99 for Applied Materials post the Q4 2012 earnings release.Notes:
- Gartner Says Worldwide Semiconductor Manufacturing Equipment Spending to Decline 11.6 Percent in 2012, Gartner Press Release, March 21, 2012 [↩]
- Gartner Says Worldwide Wafer Fab Equipment Spending to Decline 13.3 Percent in 2012, Gartner Press Release, October 1, 2012 [↩]