Steady Revenue And Margin Growth Makes Applied Materials Stock A Strong Semiconductor Bet

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Applied Materials

We think that Applied Materials (NASDAQ:AMAT) currently is a better pick compared to Micron Technology (NASDAQ:MU). Applied Materials stock trades at almost 6x trailing revenues, nearly double that of Micron, whose P/S multiple stands at 3.3x. Does this gap in the companies’ valuations make sense? We believe so, and we only expect this gap to widen. While both companies have seen a strong rise in revenues since the lockdowns started being lifted, Applied Materials has seen much stronger and steadier sales growth over the past few years. Applied Materials trades at a higher P/EBIT of more than 20x against MU’s 14.4x but has also seen faster EBIT margin growth lately. Additionally, Applied Materials is in a much better debt position and has a stronger cash cushion.

Having said that, we dive deeper into the comparison, which makes Applied Materials a better bet than Micron, even at these valuations. Let’s step back to look at the fuller picture of the relative valuation of the two companies by looking at detailed historical revenue growth as well as operating income and operating margin growth, along with the financial position. Our dashboard Applied Materials vs Micron Technology: Industry Peers, But Applied Materials Is A Better Bet has more details on this. Parts of the analysis are summarized below.

1. Applied Materials Seeing Faster Revenue Growth

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Both companies’ revenues suffered in FY’19 due to the semiconductor supply glut, and the pandemic further hurt Micron’s sales in FY ’20, but AMAT’s sales have been steadily recovering since FY ’19. AMAT’s sales first dropped from $16.7 billion in FY ’18 to $14.6 billion in FY ’19, before recovering to around $23 billion as of FY ’21 (AMAT’s fiscal year ends in October).

Micron, similarly, saw sales drop from $30.4 billion in FY ’18 to $23.4 billion in FY ’19 and further to $21.4 billion in FY ’20. However, in FY ’21 sales recovered to $27.7 billion (Micron’s fiscal year ends in August), driven by higher DRAM and NAND memory sales.

AMAT saw 17.8% sales growth during the pandemic, as compared to -8.4% for Micron. But Micron’s pre-pandemic sales growth stood at 26.5% vs AMAT’s 12.2%. However, for the most recent quarter, AMAT has seen faster growth of more than 40% YoY, vs MU which saw a growth of 36.6% YoY.

2. EBIT margins: Applied Materials Ahead; And Also In A Better Cash Position

Applied Materials’ P/EBIT ratio stands at around 20x currently, higher than Micron’s 14.4x. This makes sense as AMAT’s LTM EBIT margins currently stand at almost 30%, higher than Micron’s 22.8%, and AMAT is also ahead in terms of LTM margin change compared to the last three fiscal years, with 3.4% growth vs Micron’s 0.1%.

Looking at both companies’ cash position, AMAT’s debt as a % of equity stands at 4%, compared to that of Micron’s 6.7%. Additionally, AMAT’s cash as a % of assets stands at 26.6%, more than that of Micron’s 14.7%.

3. Finally, Applied Materials Is Ahead In Terms Of Expected Returns

Using P/S as a base, due to high fluctuations in P/E and P/EBIT, we believe Applied Materials is the better choice. AMAT’s LTM revenues of around $23 billion are expected to rise at a CAGR of 15% as per our estimates, taking revenue numbers three years out to as high as $34 billion. Assuming AMAT’s P/S ratio to pull back slightly to around 4.7x, this still means that the market cap would rise strongly to $158 billion, an upside of 15% over three years.

In comparison, given historical trends, we expect Micron’s sales to rise at a CAGR of just 1.6%, taking revenue in three years to $29 billion. Considering the P/S for Micron to also pull back slightly to 2.9x, we estimate a market cap of $85 billion for Micron, indicating a downside of around 16%.

While these are both conservative cases, given AMAT’s consistency and relative strength in terms of revenue and margins, combined with its stronger cash position, the stock has a better chance of outperformance.

The Net of It All

Despite Micron’s revenues being larger than that of Applied Materials, the latter has seen stronger and steadier EBIT margin growth and revenue growth along with being in a better financial position. Additionally, our comparison of the post-Covid recovery above, shows that AMAT has shown a much stronger growth than Micron. Due to this, AMAT’s collective performance over the past 4-5 years, warrants a higher multiple than Micron, and we believe that this gap in valuation could widen further. As such, we believe that Applied Materials stock is currently a better bet compared to Micron stock.

What if you’re looking for a more balanced portfolio instead? Here’s a high-quality portfolio that’s beaten the market consistently since the end of 2016.

Returns Dec 2021
MTD [1]
2021
YTD [1]
2017-21
Total [2]
AMAT Return 2% 75% 368%
MU Return 7% 19% 310%
S&P 500 Return 0% 24% 109%
Trefis MS Portfolio Return 1% 45% 291%

[1] Month-to-date and year-to-date as of 12/22/2021
[2] Cumulative total returns since 2017

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