Applied Materials, Inc. (AMAT) has been a standout performer in the current year, with AMAT stock currently trading just below the all-time high of $24.65 attained on June 2.
AMAT stock has clearly outperformed the industry’s most popular benchmark, iShares PHLX Semiconductor ETF (SOXX), with year-to-date gains of 28% vs. 6%. AMAT is one of the top-10 SOXX weightings, and larger holdings Intel Corporation (INTC) and Micron Technology, Inc. (MU), with the two failing to match its performance with YTD returns of -6% and -11%, respectively.
Applied Materials stock got badly hammered in 2015 following a precipitous decline that was triggered after the Department of Justice nixed the proposed mega-merger with Tokyo Electron, culminating in AMAT hitting a three-year low of $14 in August.
Investors also grew wary of the stock after the industry’s heaviest R&D spenders — who also happen to be Applied Material’s biggest customers, Intel, Samsung (SSNLF), Taiwan Semiconductor Manufacturing (TSM) and GlobalFoundries — fired off warnings about huge impending capex cuts.
This year has, however, been a lot kinder to Applied Materials. The stock has been on a tear ever since the company beat top- and bottom-line expectations during second-fiscal-quarter 2016 earnings where the company recorded a small but highly significant 0.4% year-over-year growth after years of double-digit declines.
But, even more importantly, Applied Materials provided upbeat FQ3 guidance of 14% to 18% revenue growth and EPS of 46 cents to 50 cents, well above a Wall Street consensus of 2% quarter-over-quarter revenue growth and EPS of 36 cents.
With such a backdrop, can Applied Materials stock go on to set new all-time highs?
Cyclical Semiconductor Industry
Applied Materials derives about half of its revenue from selling equipment to foundries such as Intel and TSM that manufacture their own semiconductor chips and those for other fabless chip players.
After enjoying a breakout two-year period of double-digit growth, the semiconductor industry came to a screeching halt in 2015, with industry-wide sales finishing the year 2% lower to $333.7 billion.
The semiconductor industry is known to be highly cyclical, with a period of strong growth usually followed by another of stagnation or even serious declines. This is a natural cycle that most of the time is triggered by the ebb and flow of the world economy.
But this time ’round, there is a method to the madness. The current slowdown has mainly been orchestrated by the industry transition from 2D planar nodes to more energy-efficient 3D chips. Consequently, many chip players have been holding off new orders as they take time to ponder their new technical roadmaps.
But, things are finally looking up, with production of FinFET and 3D NAND chips by leading players such as Micron expected to ramp up significantly in 2016 and hit double-digit growth in 2017. That could help explain why AMAT reported a healthy 52% Q/Q and 37% Y/Y jump in new equipment orders to $3.45 billion during the last quarter, the highest in 15 years.
So the worst may now be behind Applied Materials and the company could start seeing brisk business as foundries rush to place orders for the highly specialized equipment required to manufacture these advanced chips.
Dumping HDDs for SSDs Helps AMAT Stock
But that’s only part of what’s driving new growth at AMAT. The rapid transition from hard disk drives to solid state drives is also contributing in a big way. Close to half of Applied Materials’ new Silicon Systems orders were flash orders, a huge jump from 21% of new orders a year ago. Strong demand for flash products is giving a nice boost to AMAT’s top line.
Gartner predicts the semiconductor chip industry’s three-year slowdown will hit a nadir in the current year before beginning a strong recovery with semiconductor capex predicted to grow a healthy 7.2% in 2017 and 8.7% in 2018. So AMAT stock could be at an inflection point and could return to strong top-line growth in the coming years.
Being one of the largest components of SOXX, AMAT stock tends to closely track the sector, so this year’s outperformance suggests that the upward trend might be close to running out of steam. But AMAT stock badly underperformed SOXX in 2015 and could simply be taking up the slack.
Given the positive outlook for the entire sector, AMAT stock looks like a good holding over the next two to three years.
As of this writing, Brian Wu did not hold a position in any of the aforementioned securities.
