Applied Is Worth $17: Factors That Will Drive Growth In 2014

Applied Materials (NASDAQ:AMAT) provides manufacturing equipment, services and software to semiconductor manufacturers, and is the world’s largest semiconductor fabrication equipment supplier based on revenue. On account of lower capital spending in the cyclical industries it serves, Applied’s revenue and net income declined in 2012. The semiconductor equipment and display equipment segments experienced periods of capacity absorption and the restructuring charges produced net losses as the company re-positioned its businesses. However, Applied gained growth momentum in fiscal 2013 as customers resumed equipment purchases to satisfy strong demand for the integrated circuits (ICs) that power high demand smartphones and tablets.

Applied believes that 2013 was a transformative year for the company as it reduced its overhead expenses, stepped up investment in product development and built momentum for profitable growth. The company claims that orders from its leading foundry customer were the highest in its history in 2013 and it anticipates the growth momentum to continue in 2014, backed by stronger investment from its semiconductor and display customers. Applied has a robust pipeline of new products for pending technology transitions which it believes will drive its growth in the future.

Our price estimate of $17 for Applied Materials is at a 10% discount to the current market price. We believe that we have factored in the growth potential in our price estimate. In this article, we discuss key trends that will spur Applied’s growth in 2014.

See our complete analysis of Applied Materials here

Semiconductor Demand To Improve In Fiscal 2014

An uncertain macro environment last year combined with soft demand for consumer devices forced many chip manufacturers to reduce or postpone their expansion plans. Global semiconductor capital equipment spending declined by 16.1% annually, reaching $37.8 billion in 2012 and research firm Gartner estimates the same to have declined further (by 8.5%) in 2013. ^[1]

However, the accelerated changes in device technology and the adoption of new materials in the industry are expected to re-accelerate demand for semiconductor equipment in the next two years. Gartner estimates capital equipment spending in the semiconductor industry will increase by 16% and 17% in 2014 and 2015, respectively.

Rising mobile shipments, a recovering DRAM market, growing NAND demand and the pending technology transitions (22nm and 16 nm, FinFET,and 3D NAND) are key factors driving demand for semiconductor equipment.

Applied To Retain Its Market Share in the Semiconductor Equipment Market

Applied derives around 55% of its valuation from the SSG segment alone and an additional 34% is attributable to the Service business, which is largely focused on the semiconductor market. Accounting for approximately 15% of the market, Applied is the No. 1 semiconductor equipment supplier.

The company anticipates healthy investment by its semiconductor customers in 2014 and believes that the major technology trends will play to its strength. With a robust pipeline of new products, the company believes that it is well positioned in the semiconductor market, and will see profitable growth in 2014 and beyond.

Intel (NASDAQ:INTC), TSMC and Samsung (OTC:SSNLF), which together account for more than half of the total capital spending in the industry, have indicated strong capital investment plans for 2014 with the aim of enhancing their technological capabilities. Samsung and Intel are each forecast to spend approximately $11 billion this year, whereas TSMC is expected to spend slightly less than $10 billion. ^[2] Samsung, Intel and TSMC have been the top three customers for Applied for many years, and thus the company will benefit from the high capital spending by these companies this year.

TV & Mobile Investment To Drive Display Demand

Applied expects the 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 digits 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 believes 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 it has the potential to book $500 million of display orders over the next two quarters.

Increased Investment To Build A Stronger Product Pipeline

Applied lowered its operating expenses from $2.9 billion in 2012 to $2.6 billion in 2013. During the course of the year, the company reallocated dollars from solar to semiconductors and from overhead to products. It lowered its solar spending by approximately $130 million in 2013 and shifted the savings plus an additional $40 million in overhead savings to R&D programs within the SSG business.

Applied intends to invest additional dollars in R&D to strengthen its technology and product pipeline, especially in disruptive products which expand its addressable market and are key drivers for future profitable growth. Its R&D expenses as a percentage of R&D and SG&A expenses increased from 54% in 2012 to 60% and 64.3% in 2013 and Q1 2014 respectively.

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. The company is also working to lower its material costs and believes that higher volumes in 2014 can help absorb its fixed cost.

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1. Gartner Says Worldwide Semiconductor Manufacturing Equipment Spending to Decline 8.5 Percent in 2013 , September 19, 2013 [↩]
2. Samsung, Intel, TSMC Dominate Semicon Capex in 2014, PCB Design, March 26, 2014 [↩]