Global demand for semiconductor technologies continues to spike as chip manufacturers fail to meet industry’s needs for the critical electronic component. Production line bottlenecks, pandemic-induced consumer buying habits, and the emergence of entirely new markets – think AI, 5G and the Internet of Things – continue to aggravate the crisis that shows no sign of ending soon.
Unfortunately for investors, the ongoing uncertainty surrounding the chip shortage creates a nightmare scenario when it comes to portfolio management. Many industries have been affected, some for the better, some for the worse.
But predicting how these changes translate into stock price action hasn’t always been easy. For companies on the supply side of the equation, the shortage has actually been a boon for business – chip developer Nvidia (NVDA), for instance, has seen its share price increase almost 4-fold since the crisis began in 2020.
Another company performing well during the shortage is Applied Materials, Inc. (AMAT), a specialist in materials engineering related to the semiconductor industry. AMAT’s patented technology is used in some way in almost every chip made anywhere in the world, and the company has particular expertise when it comes to working with materials at the atomic level.
AMAT Is Shining Bright As Capital Spending Grows
The core of Applied Materials’ business is focused on the semiconductor systems sector, which accounted for 72% of its total revenue in the last quarter.
Most of the revenues in this segment derive from the foundry vertical, which involves the engineering and manufacturing of microelectronics.
Capital spending in the global semiconductor space has exploded the last few years, growing from $29.4 billion in 2010 to what is expected to be $141.9 billion this year.
Key drivers of the market include increased spending in R&D facilities, growing appetite for electric and hybrid vehicles, high semiconductor demand to provide computation power, and the expanding chip industry in Asia and the Far East.
While Applied Materials is involved in supplying chip fabrication services to integrated circuit manufacturers, it also operates in other segments such as advanced display systems, automation software, and solar technologies.
AMAT Earnings Report: A Record Quarter
Applied Materials had what was probably its best earnings card ever, with multiple records broken in some key metrics and a strong outlook to top it all off.
Quarterly revenue hit a record high of $6.20 billion, up 41% year-on-year, and beating Wall Street estimates by $280 million.
Non-GAAP earnings per share (EPS) broke records too at $1.90, again outperforming expectations by $0.12. The company also reported a record operating margin of 32.7%, which was up 6.3 points year-on-year.
Cash from operations generated $1.69 billion, of which AMAT returned $1.72 billion to shareholders in dividends and share repurchases. The firm has returned an excess of cash to investors in 8 out of the last 10 years, so the >100% returns this quarter are not out of the ordinary for Applied Materials.
AMAT upped its guidance for Q4, saying that it expects net sales to be around $6.33 billion versus the consensus of $6.02 billion, and that EPS will be in the range $1.87 to $2.01 versus the consensus of $1.81.
The firm’s share price is trading at record highs at the moment, although it’s been trending sideways since April this year. Its stock is up 140% the last 12 months, and 55% for the year to date.
Dividend And Share Buybacks
During the firm’s latest Q3 earnings call, AMAT’s Chief Financial Officer, Dan Durn, reiterated the company’s commitment to return 80 to 100% of its free cash flow back to investors via share buyback and dividend payout programs.
On the share buyback front, Applied Materials has been especially ambitious, having already repurchased 375 million shares since 2015 with a total value of $12.7 billion.
In fact, the company reduced the number of shares outstanding by 30% in the last 5 years, leaving only 925 million available on the open market.
There was a slight slowdown in buybacks in 2020 because of restrictions to internal trading arising out of its failed takeover of Kokusai Electric, but the board approved a new $7.5 billion buyback scheme in March 2021 which it initiated this last quarter, and still has around $6.5 billion left authorized to purchase in future.
Applied Materials also pays out an annual dividend to investors worth $0.96. Its current yield is low at just 0.72%, but so too is its payout ratio of 23.02% which compensates somewhat.
The company has three years of consecutive dividend growth behind it, and it has increased its dividend at a compound annual growth rate (CAGR) of 16% since 2005. AMAT’s quarterly dividend in Q2 2021 rose 9% with an increase of $0.02.
Sales Concentration In Asia Is A Concern
More than 80% of Applied Material’s revenues are generated from sales in the Asia-Pacific region, with 30% of that coming from China alone.
Furthermore, opportunities for organic growth in the semiconductor space are limited due to capital expenditure spending being restricted to just a few major players in the industry.
The geographical concentration of AMAT’s customer base and the lack of new sources of revenue could be a problem if any material or political shocks were to occur among them.
Will AMAT Stock Go Up?
Estimates put the global semiconductor industry to have been worth around $400 billion in 2020, with the potential to rise to a possible $1 trillion in 2030 – assuming it continues to grow at a predicted CAGR of 8.6%.
It goes without saying that this is a huge opportunity for all firms involved with the chip manufacturing business, but especially so for AMAT. Its market cap of $123.24 billion makes the company one of the biggest players in the market, and the outfit’s longevity and expertise – Applied Materials was founded in 1967 – affords it a deep moat almost unique in the semiconductor space.
As the digital transformation gathers pace across the world, the demand for AMAT’s services will only grow further.
The data-driven era that is just beginning will see the company’s revenues explode at rates that can’t yet be anticipated. The company is already fairly valued at a price to sales ratio of 5.18 – but in light of how the industry will develop this looks to be almost cheap.
With AMAT expecting to increase its operating margin by about 600 bps by 2024 – a target which seems reasonable in light of its recent record-breaking performance in this metric – and its divided continuing to compound 16% annually, the company appears ready for long-term value appreciation.
AMAT has been trading in a tight range recently, but this could be about to change. When it does break out, its price action could skyrocket, making right now the perfect time to buy.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.