Weaker Silicon Systems Sales Subdues Applied’s Growth In Q1’16, But Major Technology Inflections Will Drive Future Growth

Leading semiconductor equipment manufacturer Applied Materials (NASDAQ:AMAT) reported its Q1 2016 earnings on February 18th. (Fiscal years ending with October.)  With a 7% year-over-year revenue growth in the services segment, the company witnessed a record number of orders in the segment in Q1. However, the overall sales and non-gaap adjusted net income for Applied declined by 4% and 11% respectively in Q1, primarily due to weakness in the silicon equipment sales that constitute a major portion of the revenues for the company. Further, according to reports, weakness in semiconductor capital spending is likely to prevail in 2016. Despite the ongoing macroeconomic weakness, Applied sees significant revenue and gross margin improvement opportunities in the second half of 2016 driven by major technology inflections such as 3D NAND transitions, 10 nanometer conversions and OLED displays.

Our $19 price estimate for Applied Materials is at an approximate 10% premium to the current market price.

See our complete analysis of Applied Materials here

Semiconductor Equipment Spending Will Likely Remain Weak In 2016

In fiscal 2015, foundry spending was lower than expected due to sluggish economic growth and its impact on the demand for electronic equipment, in particular, smartphones. This forced Applied’s customers to cut planned spending and optimize usage of existing capacity. The company anticipates that semiconductor equipment spending will pick up in 2016 due to major technology transitions. However, considering factors such as cost effectiveness of these new technologies and a weaker macroeconomic outlook for 2016, the timing of these transitions is uncertain.

Further, weaker demand for electronic equipment may well persist throughout 2016, owing to a slowdown in the consumer electronic device sales. A report from the Consumer Technology Association (CTA) of the U.S, which forecasts a two percent drop in global consumer electronics spending in 2016, further supports our point.

Additionally, according to Gartner, the semiconductor equipment market might have entered a down cycle in 2016, due to a mismatch between supply and demand in the DRAM segment. Further, the report also expects a decline in wafer level manufacturing and semiconductor capital spending on the backdrop of sluggish electronics demand. The aforementioned factors will weigh heavy on Applied Materials’ growth in 2016. Gartner’s forecasts for the worldwide semiconductor equipment spending can be found in the table below:

Inflection Driven Investments Can Spur Growth In 2016

Despite a slow growth forecast in semiconductor equipment spending in 2016, Applied can manage to maintain its profitability in the year by gaining share from major technology transitions. The three major technology transitions that can boost the company’s revenues in the near future are 3D NAND technology, 10nm processor conversions, and shift to OLED displays.

Applied will benefit as its major memory customers plan to ramp up 3D NAND technology into volume production later in the year. NAND Flash memory is the key component in SSD (Solid State Drives) that are supplanting HDD (Hard Disk Drives) in many applications and offer higher access speeds. However,  3D NAND imposes technological challenges and the timing of adoption is unclear.

Further, Applied reported that its leading customers are aggressively pursuing 10 nm process technologies, which should provide a key source of equipment demand in 2017. In addition, the company will benefit from the transition to OLED displays in fiscal 2016.

Applied’s focus on technology inflections and new products create strong revenue and market share growth opportunities from a long term perspective. The industry is still in the early stages of these inflections and as they play out over the next several years, they can strongly complement the company’s growth.

Q2 2016 Guidance

– Net sales to be up 7.5% sequentially at the midpoint, with silicon system net sales up by 11% to 17%, AGS net sales to increase 2.5% at the midpoint, display net sales down by 20% to 30%, and EES net sales of approximately $55 million.

– Non-GAAP gross margin to remain flat.

– Non-GAAP operating expense of $565 million, +/- $10 million.

– Non-GAAP EPS in the range of $0.30 to $0.34.

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