Rising demand for chips in 2013 should give a much-needed boost to this U.S. stock.
Investors have been down on AMAT lately.
Applied Materials lowered its guidance for the year just last week, acknowledging concerns over a decline in technology spending. Such worries had already dinged the stock, which had fallen from a 2012 high of $13.21 on Feb. 16 to about $11 July 09.
Since the company announced its profits for the year would come in at 15 to 20 cents per share lower than previous projections, AMAT has slumped further to around $10.39.
But given the company's financial strength, solid position in its market and signs of a turnaround in chip demand for 2013, this pullback could represent a buying opportunity.
"[Applied Materials] is the biggest player in the industry, and it's got a deep and well-established economic moat," writes Jonas Elmerraji of The Street. "That means that once the semiconductor waiting game is over, AMAT should be able to deliver impressive numbers once again."
Santa Clara, CA-based Applied Materials makes most of its money from selling semiconductor chip-making equipment to foundries like Intel Corp. (Nasdaq: INTC) and Taiwan Semiconductor Manufacturing Co. (NYSE ADR: TSM).
Those companies sell chips to the companies that make the computer, tablets, smartphones and other electronic gear, such as Apple Inc. (Nasdaq: AAPL), Hewlett-Packard Co. (NYSE: HPQ) and Samsung Electronics Co. (PINK: SSNLF).
Applied Materials also sells equipment for the manufacturing of solar panels and LCDs, though both of those divisions are significantly smaller than the semiconductor division. Still, the troubles of the solar industry over the past year also have stung AMAT.
But as often happens, it's when things look most glum that investors need to pay closer attention.
Why Applied Materials (Nasdaq: AMAT) Will Bounce Back
The biggest positive for Applied Materials is the inexorable growth of mobile computing.
While the current slowdown in the global economy has put a hiccup in chip demand, it won't last.
Even as it lowered guidance last week, Applied Materials hinted that its current problems will be short-lived.
"Our view of 2013 is still quite positive," said CEO Mike Splinter.
Sales of mobile computing devices are expected to soar over the next several years – devices that will need lots of new, even more sophisticated chips.
According to BI Intelligence, sales of smartphones will double worldwide by 2014. Research firm Gartner Inc. sees media tablet sales rising by 53.5% in 2013 — and tripling by 2016.
Analysts also see a semiconductor turnaround in 2013.
In a report released in late June, Gartner said semiconductor manufacturing capacity would start to rise to 87% later in 2012 after hitting a midyear low of about 80%. By 2013, Gartner expects that number to rise to the low 90s, a level that would trigger capital investment in new fabrication equipment.
Another research firm, Trefis, sees Applied Materials benefiting from its leading technology in the 28 nanometer manufacturing process. Chips using 28nm are vital to smartphones and tablets.
"As the market for semiconductor devices grows rapidly, expanding capacity to meet the needs of the companies which are vying to get 28nm manufacturing capacity will require foundries to buy more equipment," Trefis said in an analysis on its Website. "This will require significant investment in semiconductor manufacturing equipment, which should work in Applied Material's favor."
Memory Breakthrough for AMAT
Looking a bit further down the road, a breakthrough in memory chip design should add more fuel to AMAT's earnings engine by late 2013 and into 2014.
At the end of June, Applied Materials demonstrated a machine that can build memory chips with stair-stepped layers, sort of like a microscopic pyramid.
This new technology will allow memory chips of vastly larger capacity — as in a terabyte. That's 1,000 gigabytes, enough to store hundreds of movies on an iPhone or iPad.
More memory is a major selling point for both mobile devices and PCs. No doubt, chipmakers will be lining up to buy that equipment.
Beyond the semiconductor industry, AMAT has also taken steps to benefit from an eventual recovery of the struggling solar industry. It's planning to move its solar operations from Switzerland to China to cut costs and become more competitive with Chinese products.
Last quarter Applied Materials actually squeezed out a $0.01 profit from its solar division. So any rebound in solar will also help juice the company's bottom line.
Finally, Applied Materials has solid financials, which is at least as important as potential sources of profit.
The company has slightly more cash ($2.17 billion) than debt ($1.95 billion). Operating cash flow increased in its most recent quarter to 24% of net sales. And with a trailing P/E of 10.3 and a forward P/E of 9.93, AMAT is fairly inexpensive.
Applied Materials also pays a respectable dividend of $0.37 a share for a yield of 3.5%. The company has raised its dividend five times in seven years, a promising track record. With a payout ratio of just 31%, AMAT has plenty of headroom for future dividend increases.
The one-year average price estimate for AMAT is $14.25, which represents a 34% gain.
Investors may want to wait on AMAT until the company reports its third-quarter earnings Aug. 15. If the company's profits are down (very likely) and it reiterates negative guidance for its fourth quarter, the stock could sink further before starting to move up.
Or, investors could average into the stock by buying half of their position now and half after the earnings announcement.
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