Applied Materials Earnings Preview: Weak Foundry Spending To Weigh On Q4 Growth, But It Can Pick Up Thereafter

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AMAT: Applied Materials logo
AMAT
Applied Materials

Leading semiconductor fabrication equipment supplier Applied Materials (NASDAQ:AMAT) is set to report its Q4 fiscal 2015 earnings on November 12th. (Fiscal years end with October.) The company fell marginally short of the analyst expectations with  Q3 fiscal 2015 earnings report as weak foundry spending weighed on the semiconductor tool division, which constitutes 65% of revenue and 60% of valuation, by our estimation. This factor is expected to negatively impact Applied’s earnings yet again, as slowing economic growth and electronics demand have forced the company’s customers to puch out planned capital investment and optimize usage of existing capacity.  In fact, two of Applied’s key customers, TSMC and Intel have cut their capex targets for 2015 by close to $1 billion each. This will impact the foundry pending in Q4 as well, which can translate to a sequential decline in overall net sales by 7%, according to the company guidance.

While Q4 is likely to remain weak due to the aforementioned short term headwinds, Applied can gain from the strong investment in memory capacity in the coming quarters. Also, the company’s long term outlook remains strong as we expect it to gain from technology inflections due to the increased adoption of 3D NAND and FinFET circuit structures.

Our $19 price estimate for Applied Materials is at an approximate 20% premium to the current market price.

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See our complete analysis of Applied Materials here

Strong Memory Investment Can Revive Growth Next Year

The semiconductor manufacturing equipment market is cyclical in nature, with two years of growth usually followed by two years of slump in demand. During a growth phase, the increase in demand results in higher sales for equipment makers, such as Applied. However, when the demand for devices nears its peak, manufacturers delay investing in new equipment and instead recycle and reuse the existing equipment, affecting the sales of Applied negatively.

Despite the short term pause, Applied reports that leading participants (specifically TSMC, Intel and Samsung) are aggressively pursuing 10 nm technologies, which should provide a key source of equipment demand in 2016. Moreover, the company is expected to gain from the announcement by Intel to invest $5.5 billion in flash memory manufacturing capacity. Applied Material claims to have an edge over the market, both in NAND and DRAM memory equipment manufacturing.

As per the most recent edition of the SEMI World Fab Forecast, front end fab equipment spending (including new, used, and in-house) is projected to increase 5% in 2015 (to US$ 37.0 billion) and another 6.6% in 2016 (to $39.4 billion). Foundry spending is expected to decline by 3% this year but will gain momentum in 2016, with a projected growth of 14%. On the other hand, memory equipment spending is estimated to grow by 16% in 2015.

World_Fab_chart_0915

Technology Inflections To Drive Future Growth

Applied is poised to benefit from the industry shift to 3D NAND and FinFET circuit structures due to the rising need for higher performance in a smaller space in new consumer products. The company expects 3D NAND capacity to exceed 150,000 per month by the end of calendar year 2015. Looking ahead, Applied identifies FinFET technology adoption as the most important growth driver, as it has a high market share in EPI tools, an upgraded version of which will be used for the technology. The management believes that the FinFET technology can increase Applied’s addressable market significantly. [1] And Applied’s focus on technology inflections creates strong revenue and share growth opportunities for the company in the long-run.

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Notes:
  1. Applied Material’s Management Presents at Citi Global Technology Conference – (Transcript), Seeking Alpha, September 4, 2013 []