From AG Edwards (thanks Gottfried):
Investment Premise: Applied Materials is the largest WFE (wafer fab equipment) manufacturer
in the world, with revenue in FY01 at $7.3 billion. We believe that AMAT’s sheer size and
breadth of products that span several of the key chip making processes, will enable the company
to once again trade at the upper end of its historical valuation range (excluding outlier years such
as 1999 and 2000). We have selected a price target that is within the company’s historical 5-year
price/sales and price/book range. Our price objective of $33 (7x price/sales) represents the upper
end of the historical 5-yr trading range of 2x-7x (excluding 1999 and 2000, when it reached 11x
and 13x, respectively. On a price/sales basis, our price target represents 10x sales, which, again,
is at the upper end of the 2x-10x range (excluding 2000 when it reached 17x). We believe
AMAT can reach these historical average highs again, because we expect revenue growth to re-accelerate
in 2003 and 2004 as the semiconductor cycle turns positive. Also, AMAT remained
profitable last quarter (we believe it was the trough quarter), which we believe was impressive
given the size of the company’s world-wide infrastructure. We think AMAT’s next revenue
peak could be in 2004 or 2005, depending on how strong the economy returns to robust growth.
We are positive on AMAT for the following reasons:
AMAT’s cost controls are likely to produce more earnings leverage when up-cycle accelerates.
AMAT reported F02Q1 EPS of $0.01 per share versus our estimate of a loss of $0.01 and the
street’s breakeven consensus, largely because the company executed its cost containment
program surprising well, especially given the size of the company’s infrastructure. Operating
costs were down 16% sequentially and down 31% year/year, as Applied pared its headcount and
consolidated operations. We believe the continued focus on costs, both from an infrastructure
standpoint and from a production standpoint (as cycle times continue to come down) will enable
the company to achieve margins above the 52% peak in the last cycle. In addition, we believe
the company’s 300mm gross margins will experience higher gross margins earlier than the
competition because they will have been in the market longer than others in the next up-cycle
(AMAT was the first to introduce production-ready 300mm tools, and therefore should be further
along the learning curve than others). The company mentioned in its conference call that it has
already begun to see higher margins in 300mm.
At last, AMAT is likely turning the corner as orders are likely to experience sequential increases as the next peak nears.
We believe that there is increasing evidence, shown through company quarterly results and the
SEMI monthly book to bill figures that the order trough is now past and the pace of an upturn is
the bigger question. While we still believe the turn (in revenue, not orders) will be slow, we
believe AMAT will continue to achieve strategic wins at major accounts, enabling it to take
market share in the next 12 months. Recent wins have occurred in its CMP, etch, implant, pvd
barrier/seed, thermal processing and dielectric CVD products across accounts in Taiwan and
China. With the continued trend towards fabless manufacturing, we believe these regions, in
which AMAT’s service and support is quite strong, will be the fastest-growing regions in the
next few years.
Capacity utilization for leading edge processing is running at high levels currently, and increased demand from here will likely result in capacity-related orders in the next 12 months Watch Taiwan, Europe and the United States.
Most leading edge, 0.15 micron and 0.13 micron fabs are currently running at 80% to 90%
utilization, leaving little room for increased demand without having to add more capacity. We
believe that Applied, with the most comprehensive suite of tools at the leading edge, including
copper and low-k capability, will capture much of this capacity build-out. While leading-edge
capacity today only represents 15% of the world’s total, we anticipate that this will rise to 50% in
the next three years. Most companies, that have been forced to under-invest in the last 12-18
months, will be, in turn, forced to skip the 0.18 micron or 0.15 micron generation, just to catch
up and will therefore require production equipment capable of 0.13 micron and below. We
believe Taiwan’s foundries, Europe’s DRAM and logic producers and logic producers in the
United States will be the most aggressive leading-edge investors in the next 12 months.
Lower order cancellations; another sign the industry has bottomed.AMAT reported order cancellations of $44 million in the recent quarter, which is down
dramatically from previous quarters. Reduced cancellations, in our opinion, are a clear sign that
customers are sticking to commitments as the business climate stabilizes. We also have higher
confidence that bookings reported in the last two quarters will, in fact, ship to customers in the
next 12 months because, not only have the customers become more realistic regarding their own
production needs, but also AMAT management has carefully scrubbed its backlog to identify
orders that would likely ship beyond the 12 month window to be considered an order. We
believe that, while orders will not rebound sharply in the next six months, reported orders have
been cleaned up and are therefore more solid than before.
Rising DRAM prices could be an early indicator that other chip categories ASPs’ are likely to stabilize in the next six to nine months, leading to a quicker order rebound than is currently anticipated.
During the last two years, the DRAM industry, due to continued elusive profitability, has clearly
underinvested in technology. Now that PC sales have picked up, ahead of what could be a
renewed corporate upgrade cycle in 2003, we believe DRAM makers will once again come to the
order table to increase capacity and technology at the leading edge. While DRAM orders were
27% of the total in Q401, dropped to 10% in Q102, and have increased to 24% of the total in the
April quarter, we would expect that once the consolidation issues are a thing of the past, capital
budgets will once again be freed to invest in the future. As DRAM prices are often a leading-indicator
of pricing trends in other chip categories, we would expect not only continued spending
on logic, but also high-density flash in 2003.
The company’s balance sheet is squeaky clean, and should provide a strong foundation for working capital in an upturn.
With only 7% debt to equity, and $4.7 billion in cash and equivalents, we believe AMAT’s
balance sheet is one of the best in the industry.
Attractive Features:
Applied Materials' products cover the majority of the processes required to manufacture
semiconductor components. Over the past several years, Applied Materials has emerged as one
of the leading semiconductor capital equipment suppliers in the world, with 29% of the $33
billion 2000 front-end equipment market. Although the company lost share in 2001, we believe
current data suggests that the company is regaining the lost share at a rapid pace.
Solid balance sheet and size. With a strong cash position (about $2.78 per share as of April
2002) and relatively low debt (total debt/equity of 7% as of April 2002), and with a strong
balance sheet, we believe Applied Material has the financial resources to continue to compete
effectively in the worldwide semiconductor capital equipment marketplace – even in light of a
severe cyclical downturn in the industry in 2001 to 2002.
Strong R&D program. Over the past several years, Applied's investment in extensive research
and development (R&D) has produced the most diversified product line in the business. In 2000,
AMAT spent over $1 billion in R&D, more than double that of any other company in the
industry. We believe the products coming out of this R&D effort have a good chance at helping
the company gain market share in 2002 and 2003, thus giving the company the potential to
outpace its peers in terms of revenue growth.
New products fuel growth. Applied Materials has been very aggressive in launching new
products developed both internally and through strategic acquisitions. New key product lines,
such as CMP and Electra, represent the company’s strongest growth prospects. In addition, we
AMAT, Page 3
see high growth opportunities in copper interconnects and 300-millimeter equipment over the
next several years.
Concerns:
Dependence on capital expenditures. Although Applied Materials is well diversified across its
customer-base and geographically, the company is dependent upon the capital expenditure
programs of semiconductor companies both abroad and domestically. Unfortunately,
fluctuations in capital expenditures can arise, possibly having a negative effect on financial
results. After a period of sizzling growth, we now expect capital spending to contract by 15% in
2002.
Dynamic random access memory (DRAM) market. This market constituted about 33% of
total semiconductor sales and was largely responsible for the industry downturn in 1998.
Currently, the DRAM market is showing signs of weakness and is expected to remain depressed
through the first half of 2002. We believe that Applied Materials is unlikely to grow revenues as
previously expected given further DRAM pricing deterioration. We expect capital spending to
remain in question as DRAM manufacturers struggle with pricing issues caused by a slowdown
in end-markets (communications, consumer electronics and personal computers).
Semiconductor capital equipment orders. Recent end-market softness, excess capacity and
economic weakness across some geographic regions are further prolonging the semiconductor
order digestion period. We believe that demand for capital equipment orders will continue to
weaken as a result of a temporary spending pause by integrated device manufacturers (IDMs),
foundries and test houses. We believe that the general market is still in an overcapacity mode for
older generation equipment, but we believe the majority of new buys are coming from
companies such as Intel and TSMC, that are installing the latest in production technology.
Stock price volatility. History has shown that Applied Materials’ shares exhibit considerable
price fluctuations. Volatility arising from DRAM prices, PC demand and the general state of the
integrated circuit market is not unusual. AMAT shares are also very cyclical, with cycles
recurring each 3-5 years.
Stock Split: All numbers have been adjusted for the 2-for-1 stock split effective on April 16,
2002.
fred |
