After a spectacular 2010, Applied Materials’ (NASDAQ:AMAT) growth rate in energy and environmental solutions (EES) segment slowed down considerably as the solar industry was plagued by persistent overcapacity in the market. The capacity expansions taken up by photovoltaic (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, which has led to a decline in demand for Applied’s equipments.
Applied’s EES revenue registered a significant decline (62%) in Q2 2013, though net sales remained flat in Q3 2012 largely reflecting the deferred revenue. However, on account of the slower than anticipated revival in the solar market, Applied’s EES division marked a 19% decline in Q4 2012. Considering the drastic decline in orders, the company expects revenue to drop by more than 30% this quarter. (Read: Applied Materials Earnings Could Have Bottomed This Quarter)
While the dismal solar demand is leading to a decline in Applied’s solar equipment sales, the mounting costs is putting a downward pressure on margins. However, we continue to believe that the solar market offers huge long-term potential and it is important for the company to continue investing in this segment.
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With increasing awareness about the benefits of solar energy, Applied could see a revival in solar sales next year. Additionally, we believe the company’s growing efforts to contain its cost base will help the EES division return back to profitability next year onward.
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. In 2010, the global photovoltaic (PV) market demand grew by 84%. However, the slowdown in global solar market led to overcapacity, and consequently industry growth dropped to 32% in 2011.
We forecast the solar PV market to significantly decline in 2012, but grow at an average annual rate of 5% for the remaining period under review.
Restructuring Program To Reduce Cost Base
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 break-even level to approximately $500 million, at the start of the year. The company has also initiated a 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.
Applied agrees that the much-needed consolidation within the industry is occurring at a slower pace than expected. So, as the overall industry continues to cope with excess capacity, Applied has moved its solar equipment plant to China to cut costs and tap into the growing appetite for clean energy in Asia. Additionally, it is scaling back its development program at the LED unit.
As the demand in the solar industry remains sluggish, it plans to take additional steps to reduce its cost base and minimize associated losses.
End Market Will Continue To Increase Over Time
Though the timing of solar equipment recovery still remains uncertain, we believe the fundamental trends in solar energy adoption provide a solid, long-term platform. According to the findings of Applied Materials’ fourth annual solar energy survey conducted in China, India, Japan and the United States, we see higher-than-expected growth in demand for solar power in the future. (Read: Applied’s Solar Energy Survey Indicates Solar Power Adoption Is Taking Off)
Applied promises to offer state-of-the-art technology that can enable an increase in cell efficiency and lower cost per watt. The company claims that given a reasonable solar demand, it can add around $100 million per gigawatt of new capacity.
With growing awareness about the benefits of renewable energy combined with declining costs, we believe that there is bound to be an increase in demand for solar power use in the years ahead.
Expanded Portfolio With Varian’s Acquisition
In November last year, Applied completed its acquisition of Varian Semiconductors (NASDAQ:VSEA), a leader in ion implantation equipment, a market that represents an annual opportunity approaching $1.5 billion.  The acquisition of Varian enhances Applied’s extensive portfolio and it is likely to become the industry leader in transistor technologies, enabling it to support customers with complementary solutions for advanced chip manufacturing.
The partnership can also be expected to increase its revenue from the environmental and energy solutions group as Varian’s technology has a great potential in solar cell manufacturing. We estimate Applied Material’s share in the environmental and energy solutions to go up slightly in 2012 and stabilize thereon till the end of our forecast period.
We do not believe that the drop in revenues from the solar division are due to reasons intrinsic to the company, and thus estimate its market share to be constant for the period under review.
Our price estimate of $12.02 for Applied Materials is at a premium of over 10% to the current market price.Notes:
- Applied Materials Completes Acquisition of Varian Semiconductor Equipment Associates, Press Release, November 10, 2011 [↩]