Uptick In Semiconductor Investments Drive Applied’s Growth In Q1 2014

Applied Materials (NASDAQ:AMAT) started its fiscal 2014 on a strong note with a 39% annual and 10% sequential growth in its Q1 2014 revenues. The company believes that 2013 was a tranformative year as it reduced its overhead expenses, stepped up investment in product development and built momentum for profitable growth. Orders from Applied’s leading foundry customer were the highest in its history in 2013 and it believes the growth momentum will continue throughout 2014 as well, backed by stronger investment from its semiconductor and display customers.

At $2.2 billion, the Q1 2014 revenues were at the high end of Applied’s expectation. It received orders worth $2.2 billion in the quarter (9% growth) backed by growth in the SSG and AGS segment, which was partially offset by a push out of the display orders. Applied anticipates healthy investment by its semiconductor and display customers in the year ahead and believes that the major technology trends will play to its strength in precision materials engineering.

In 2014, Applied aims to drive performance improvements in its financial model, improving product time to market, reducing cost, and driving higher quality. Additionally, its merger with Tokyo Electron will help form a stronger entity, combining two of the largest players in the industry with largely complimentary product offerings.

We are in the process of updating our price estimate of $16 for Applied Materials.

See our complete analysis of Applied Materials here

Merger With Tokyo Electron To Help Form A Stronger Entity

Applied Material announced it merger with Tokyo Electron in September 2013. Both companies supply equipment used to manufacture semiconductors, flat-panel displays and solar photovoltaic products. With the aim of forming a global innovator in semiconductor and display manufacturing technology, the two companies will create a combined entity with an estimated value of $29 billion.

With an estimated combined WFE market share of 34%, Applied believes that its merger with Tokyo Electron will help form a stronger entity.Though both companies are among the largest in the industry, they have little overlap in their product offerings. Applied will also benefit from a broader product portfolio, shared R&D costs and lower cost of developing chips.

The deal has been unanimously approved by the boards of both companies and is subject to customary conditions, including approval by shareholders and review by regulators. Applied expects the acquisition to close in the mid to second half of 2014. After the close, Applied Materials & Tokyo Electron shareholders will own approximately 68% and 32% of the new company, respectively.

Semiconductor Investment Level To Be Stronger In 2014

The semiconductor market slowed down in the latter part of 2012 with capacity utilization declining to 81.2% and 79.2% in Q3 2012 and Q4 2012, respectively. However, displaying a seasonal uptick, industry utilization improved to an estimated 80.5% and 82.5% in Q1 2013 and Q2 2013 respectively. ^[1]

In Q1 2014, Applied’s SSG orders of $1.6 billion were up 13% as the decline in logic and DRAM was more than offset by increases in foundry and NAND orders. Higher volumes and a favorable product mix improved the SSG operating margin to 24.1%.

Applied estimates that the 2013 wafer fab equipment spending was between $27 billion to $30 billion. ^[2] It expects investment levels to be stronger in 2014, up 10% to 20%, driven by higher spending in foundry and memory.

Higher memory spending and the adoption of new technologies such as 3D NAND and FinFET (3D) transistors will help fuel growth in the semiconductor equipment market. Applied derives around 58% of its valuation from the SSG segment alone and an additional 33% is attributable to the Service business, which is largely focused on the semiconductor market.

TV & Mobile Investment To Drive Display Demand

Applied’s display net sales of $159 million in Q1 were flat as customers pushed out orders. However, the company expects growing demand for TV and mobile investments to fuel demand for display equipment in 2014.

Growing global TV sales and larger average TV sizes are increasing significantly faster than historical trends and are driving demand for display equipment. Applied expects the TV segment to grow by low single digit in 2014. The company claims that the average TV size is growing 1.2 to 2 inches annually, which is significantly higher than historic norms. This trend is driving area growth in the 15% range which the company believe is sufficient to support investment in three new Gen 8.5 factories.

In  mobile devices, the screen resolution is becoming an important differentiator and is leading to significant growth in higher definition screens. Applied expects multiple Gen 6 LTPS factories to be built in the next 12 to 18 months to support this demand. The company believes that its has the potential to book $500 million of display orders over the next two quarters.

Increased Investment To Build A Stronger Product Pipeline

Applied accelerated its R&D in fiscal 2013 by increasing its annual investment run rate in 300 millimeter semiconductor product development by $200 million. The company believes that the higher investment level has increased its overall wafer fab equipment share in calendar 2013. It plans to invest over $150 million in capital and new lab capabilities in the future.

In Q1 2014, Applied increased its R&D expense to 64.3% of total R&D and SG&A expense, compared to 57% a year ago. During the same time frame it increased its technical field resources by almost 20%. Through increased R&D investment and focused portfolio management, Applied aims to create a strong pipeline of new highly differentiated products to enable future infections in logic, memory and display.

Q2 2014 Outlook

– Net sales to be up by 3% – 10% sequentially.

– SSG net sales to be up by 6% -10%, AGS net sales to be approximately flat, display net sales to be flat to down 15% and EES net sales to more than double.

– Non-GAAP operating expenses to be in the range of $550 million, +/- $10 million.

– Non-GAAP earnings per share to be in the range of $0.25-$0.29.

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1. Intel, TSMC And Samsung Are Driving Semiconductor Capital Spending In 2013, Seeking Alpha, May 20, 2013 [↩]
2. Applied Materials’ CEO Discusses F1Q 2014 Results – Earnings Call Transcript, Seeking Alpha, February 12, 2014 [↩]