To All, FYI:
AMAT: PREVIEW OF 4Q98-WE EXPECT MODEST SEQUENTIAL IMPROVEMENTS BUT THIS COULD ALREADY BE
REFLECTED IN THE STOCK
Subject: Applied Materials (AMAT-38 11/16)--OTC
SEMICO
INI COM EPS OPINION
Current: ACCUMULATE
Analysts: John W. Pitzer (212) 778-5252 Prior:
Risk: MODERATE
12-Month Target Price: $45
Ind. Div.: -- Yield: -- Shares: 378.1 mil. 52-Wk.Range: 40-21
EPS FY Year P/E 1Q 2Q 3Q 4Q
Actual 10/97 $ 1.38
Current 10/98 $ 1.09E 35.5X $ 0.52 $ 0.37 $ 0.17 $ 0.02E
Current 10/99 $ 0.58E 66.7X $ 0.05E $ 0.09E $ 0.19E $ 0.25E
Current 10/00 $ 1.50E 25.8X
INVESTMENT HIGHLIGHTS:
1) AMAT is due to report 4Q98 results on Nov 17 after the market close.
2) We expect an in-line revenue and operating EPS for the quarter.
3) Operating EPS excludes one-time restructuring charge.
4) Key metric to monitor is bookings. Bookings in 4Q98 should come in slightly
better than previous guidance of $600 million, up slightly from 3Q98 bookings level
of $608 million.
5) We believe that Company will guide the street to modest sequential
improvements in bookings for 1Q99.
6) Recent stock action leads us to believe that much of the incremental news may
already be reflected.
7) Near-term stock is in a trading range, longer-term, stock continues to look
attractive versus 2000 estimates.
DISCUSSION:
Preview Of The Quarter-Inline. Applied Materials is due to report results for
4QFY98 (Oct.) on November 17th after the close of the market. We believe that the
Company will meet our estimates for 4Q98 of $650 million in revenue and operating
EPS of $0.02, in-line with street consensus. Our operating EPS estimate does not
include the effects of a $285 million or $0.56 per share one-time charge associated
with restructuring and reserves.
Table 1
Applied Materials - 4Q98 Estimates
4Q98E 3Q98A 2Q98A 1Q98A
Revenue $650.0 mil $884.5 mil $1,176.3 mil $1,307.6 mil
Gross Margin 43.5% 44.6% 47.1% 48.1%
Operating Margin 0.7% 10.3% 17.9% 22.6%
Net Income $7.7 mil $64.9 mil $141.2 mil $197.8 mil
Operating EPS $0.02 $0.17 $0.37 $0.52
Reported EPS $(0.54) $0.17 $0.37 $0.52
Source: Company Reports, Prudential Securities Incorporated Estimates.
Breakdown Of One-Time Charges. The restructuring charge of $285 million for the
quarter includes $50 million for employee severance and benefits related to a 2000
person head-count reduction completed in August, $50 million for the consolidation
of facilities, $70 million for write-down of impaired assets and $65 million reserve
regarding a doubtful receivable from a lawsuit settlement with ASM International
(ASMIF-4 7/16, Not Rated). In addition, the Company will incur an after-tax charge
of $50 million associated with the discontinuance of operations of Applied Komatsu
Technology. The magnitude of the write-down is directly proportional to the severity
of the downturn. The Company has returned to bookings and revenue levels that were
prevalent in 1993 and needed to react accordingly to re-size its infrastructure. We
believe that the restructuring will reduce expenses by approximately $40 million per
quarter and have adjusted our estimates accordingly.
Table 2
Breakdown of Restructuring Charge
Reason Charge
Head Count Reduction $50 million
Facility Consolidation $50 million
Impaired Assets $70 million
Doubtful Receivable $65 million
Applied Komatsu $50 million
TOTAL $285 million
Source: Company Reports, Prudential Securities Estimates.
Bookings Are The Key Driver Of The Stock. The key stock driver for Applied
Materials is bookings. In 3Q98, the Company reported gross bookings of $608 million.
Net of cancellations, new bookings in 3Q98 were $470, down over 60% from peak levels
established in 4Q97. Our estimate for 4Q98 bookings is $615 million, a slight
improvement with 3Q98 gross levels.
Table 3
AMAT Bookings Performance Chart
(in millions) Q197 Q297 Q397 Q497 Q198 Q298 Q398 Q4E98
Billings $836 $901 $1,057 $1,280 $1,307 $1,176 $885 $650
Booking* $905 $1,015 $1,240 $1,350 $1,290 $1,028 $608 $615
Book-to-Bill 1.08 1.13 1.17 1.13 0.99 0.87 0.69 0.94
*Represents Gross Bookings
Numbers based on fiscal year ending Oct.
Source: Company Reports, Prudential Securities Incorporated Estimates.
We Believe That Applied Should Guide To Modest Sequential Gains. The focus for
investors will be bookings guidance for F1Q99. While visibility to our bookings
estimates is not high, we believe that 3Q98 and/or 4Q98 represent a bookings trough
for Applied Materials. Technology buys associated with the semiconductor industry's
transition to 0.18 micron processing should allow for modest bookings improvements
for Applied in 1HFY99. An absolute bottom in bookings should provide downside
support for the stock-incremental information that end market demand for
semiconductors is strong should transition investor's focus from trough valuation to
peak earnings potential. However, meaningful sequential gains in bookings will not
occur until late 1999 when capacity buys should begin to resume in earnest.
Valuation, Approaching A Near-Term Trading Top; Longer-Term The Stock Still Looks
Attractive. Stocks in our universe have begun to react positively to investors
sentiment that the industry is approaching a bottom. As a result, of late our
universe has seen significant stock appreciation. The magnitude of the recent run-up
forces us to be somewhat cautious and advocate and near-term trading mentality-let
the stocks find levels of support before committing new capital. However, we do
believe that the industry is at or near the trough of the current cycle and
incremental news should be positive-albeit modestly-a stabilization of equipment
fundamentals against the backdrop of good semiconductor demand will increase the
likelihood that stocks in our universe will begin to trade off of earnings potential
estimated during the next growth cycle-calendar 2000 and 2001. We believe that
Applied Materials can earn $1.85 in calendar 2000E and $2.50 in 2001E. Because the
Company is the industry leader, we believe the stock will support a higher multiple
to the peer group. We have established a 12 month price target of $45 or 25 times
our 2000E estimate. We believe that this is a conservative multiple in relation to
historical multiples as the industry has re-established growth. As we see more
conclusive evidence that the industry has turned the corner we would expect
multiples for industry leaders to reach 28-30 times the out year.
1Q99 Demand Environment Is Critical For Further Stock Appreciation. Increased
visibility will be a function of positive incremental news on: (1) PC unit sales,
(2) IC unit growth and (3) commodity memory pricing. In the current environment as
the industry prepares for the Christmas selling season, all three metrics have
turned positive. The key question is whether or not this environment is just
seasonal or whether current strength is sustainable into 1Q99-it is still too
earlier, given the amount of turns in business, to gather definitive data. It is our
contention that the first two weeks of December will be a critical junction as wafer
starts at this time should give a good indication of expected demand in 1Q99. A
positive bias on demand in 1Q99 should provide the basis for multiple expansion
against our 2000 estimates.
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