Applied’s Confident Of Growth Next Year Despite Slow Weakness This Quarter

Applied Materials (NASDAQ:AMAT) stock price declined marginally in after-hours trading after the company reported lower Q3 2013 earnings and guided a flat Q4 2013 outlook on August 15. At $1.97 billion, Applied’s Q3 revenues declined by 15.7% (y-o-y) and its growth momentum for new orders (gained in the last two quarters) slowed down. The company recorded $2 billion worth of orders in the quarter, a 12% sequential decline on account of lower semiconductor demand which was partially offset by a strengthening display order book.

Within the semiconductor segment, though Applied witnessed a seasonal decline in foundry booking, it marked strong growth in orders for memory and logic. It believes that the slowdown in foundry investment by its customers is a short term trend as they focus on ramping production on the new capacity installed over the past two quarters to meet higher demand during the holiday season. It anticipates investment levels to recover towards the end of the year.

Though declining PC sales might dampen logic investment for the year, the rising demand for mobile devices and larger TVs will drive demand for Applied’s semiconductor and display equipment. The company has a robust pipeline of new products which it believes will help it build momentum for profitable growth in 2014 and beyond.

See our complete analysis of Applied Materials here

Mobility Trend Remains The Biggest Growth Driver

The ongoing mobility trend remains the biggest growth driver for the semiconductor industry. With rapid innovation in the market, mobile devices drive demand for leading-edge foundry capacity as the market leaders aggressively accelerate ramps at advanced nodes. Applied believes that mobile customers will account for approximately 45% of wafer fab spending in 2013.

Applied expects wafer fab equipment spending for 2013 to be low, between $27-$30 billion, but estimates investment to rise by 10% to 20% in 2014. Foundries building out their 20 nm node, increasing investment in 3D NAND capacity and rising DRAM spending are the key factors that will drive demand in the semiconductor equipment market.

– 3D NAND: The rising mobile shipments is driving demand for NAND flash memory with bit growth for 2013 expected to be in the 40%-50% range. In addition to the ongoing mobility trend, the transition to 3D NAND technology is driving demand for semiconductor equipment. Applied expects investment for 3D NAND technology to accelerate in 2014 and 2015 as more manufacturers adopt this technology. The transition from plainer to 3D NAND is driven by deposition and etch and as a result the company expects its available market to grow by about 25% for the first generation 3D NAND devices. It claims to have a clear and sustainable differentiation in the field and expects its share to grow as 3D NAND factories ramp into volume production.

– Transition to the 20 nm Node: As foundries start building their 20 nm technology Applied estimates its severed market opportunity to grows by 25% relative to the 28 nm baselines. The company expects to see close to 30,000 wafer starts capacity in the 20 nm range by the end of this year and anticipates the figure to cross 100,000 in 2014.

– Improving DRAM demand: Within the DRAM space, the market conditions are improving with average selling prices recovering to levels last seen in 2010. Structural changes in the market along with rising bit demand for mobile applications are key factors driving growth in this segment. Applied claims that its DRAM customers are increasing their bit supplies and we can see some additional capacity being added next year as well if market conditions remain favorable.

Accelerating Strength In The TV Market

Q3 2013 was a strong quarter for Applied’s display business as it saw a 26.8% q-o-q and 13.4% y-o-y increase in revenues ($161 million) from the segment. With 282% annual and 31% sequential growth, the display business booked its highest orders in over two years as the company saw rising TV fab investments in China.

Growing TV sales and larger average TV sizes are increasing significantly faster than historical trends and are driving demand for the display equipment. Applied estimates an average increase of two inches in TV sizes in 2013, in comparison to the average annual increase of 0.5 inch in a year. For one inch of growth, one new Gen 8.5 factory is needed to fulfill the incremental area of demand. ^[1]

Applied has invested in a new TV fab in China and has secured 100% of the CVD and PVD business for the new factory. It already has a strong foothold in the CVD market and expects its market share in display PVD to increase by about 25% this year. In its recent earnings call, it mentioned that the rising demand for high-resolution mobile displays expanded the opportunity for its CVD and PVD equipment in the market by more than 30%.

Additionally, the introduction of 4K ultra-high definition and OLED is driving demand for more complex and capital extensive manufacturing processes. The company aims to grow its display business revenue to $1 billion or more in the future.

Building Momentum For Profitable Growth

In an effort to improve its bottom line, Applied is eliminating organizational complexity and reducing its investment in areas with lower returns and reallocating these dollars into product pipeline with highest value opportunities. It saw a 4% y-o-y decline in spending in Q3 2013, aided by a 6% decline in headcount in the solar division and some corporate functions.

Applied increased its R&D expenditure by 8% (y-o-y) to leverage the growth potential in the semiconductor and display segments. Its R&D expenditure as a percentage of total R&D and SG&A expenses has risen from 55% in Q3 2012 to 62% at present. By shifting its overhead expenses the company expanded its annualized funding for 300 millimeter R&D and field support by almost $170 million since the start fiscal 2013.

In the long run, Applied aims to strengthen its competitiveness by investing in key growth areas, stepping up its R&D spending to build a stronger product pipeline and better managing its product portfolio. At the same time it is working towards reducing its operating expenses and organizational complexity to improve profitability.

Q4 2013 Outlook

– Net sales to be flat sequentially: Semiconductor business to be flat to down slightly, AGS to be flat to up slightly, display will be down slightly and EES to be up slightly.

– Non-GAAP operating expenses in the range of $525 million, +/- $10 million.

– Non-GAAP EPS between $0.16 to $0.20.

We are in the process of updating our price estimate of $13.50 for Applied Materials.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Applied Materials’ CEO Discusses F3Q 2013 Results – Earnings Call Transcript, Seeking Alpha, August 15, 2013 [↩]