AMAT Stock: Stay Away From Applied Materials

2015 is shaping up to be an annus horribilis for Applied Materials (AMAT) and its investors.

Applied Materials 185While AMAT stock looks to open Friday off a couple percentage points following third-quarter earnings, the real chunk of Applied Materials’ 30%-plus slide this year has come thanks to the nixing of a much-awaited $9 billion buyout of Tokyo Electron, a Japanese chip equipment maker.

The Department of Justice felt that the remedies provided by the two companies were not enough to overcome federal antitrust concerns. Contrary to the common trend by investors of feeling disgruntled when a huge merger is on the line, Applied Materials investors were optimistic that the deal would grow the company’s moat in chip equipment manufacturing considerably and open up new markets.

So it hardly came as a surprise that AMAT stock sold off by as much as 12% when the proposed merger was called off.

Applied Materials Earnings

Earnings are the topic du jour, even if they’re not AMAT’s biggest issue right now.

Earnings of $329 million, or 27 cents per share, were up 9% year-over-year. On an adjusted basis, profits came to 33 cents per share to merely match Wall Street estimates. Revenues increased more than 9% to $2.49 billion, which fell short of the consensus.

Forecasts weren’t much better, with current-quarter revenues expected to be flat sequentially at best, and down 7% at worst, putting it under expectations for $2.51 billion in revenue, and an earnings range of 27 to 31 cents per share also missed a 33-cent mark.

Huge Capex Cuts

Still, the nightmare for Applied Materials came after its proposed merger failed.

Several semiconductor chip manufacturers added to its woes when they fired a warning that they would make deep cuts into their new equipment capex. Applied Materials is a leader in precision materials engineering, and manufacturers equipment that semiconductor chip manufacturers such as Intel (INTC), Taiwan Semiconductor Manufacturing (TSM), GlobalFoundries and Samsung (SSNLF), among other companies, use to manufacture their chips.

Intel and TSM are two of AMAT’s largest customers, and represent some of the largest spenders on chip manufacturing equipment. Huge capex cuts by the two companies in April sent shock waves through the chip equipment manufacturing industry. Intel was first to announce that it would lower its capex from $10 billion to $8.7 billion.

TSM followed up on Intel’s announcement two days later saying it would shave $1 billion from its 2015 capex to a lower range of $10.5 billion to $11 billion.

The semiconductor industry is highly cyclical, and a period of heavy capex spending is frequently followed by a period of weak spending. 2014 was a banner year for Applied Materials and its peers such as Lam Research (LRCX). Capex spending by semiconductor companies grew a healthy 14% across the board. Applied Materials benefited from the bounty, and saw its top line expand 20.8% while earnings grew a blistering 314%.

Poor Outlook

But with numerical navel gazers such as Gartner now predicting that semiconductor capex will grow just 2.5% during the current year, and actually recede 1.3% during the coming year, chip equipment makers such as Applied Materials are in for a rough ride.

The weak growth is already weighing heavily on Applied Materials, as shown in the company’s revenue miss and lacking guidance.

Applied Materials makes about half of its revenue from selling to foundries such as TSM that make semiconductor chips for other companies. But this segment performed very poorly during the last quarter, with sales falling sharply by 29% year-over-year. This is due to the ongoing transition from 2D planar nodes to 3D nodes. Many chip companies seem to be holding off new orders as they ponder their technical roadmaps.

The Tide Will Turn

The medium-term outlook for AMAT stock appears to be quite gloomy. But the cyclicality of the industry dictates that the tide will eventually turn at some point. According to Gartner estimates, semiconductor capex will grow a very healthy 13.4% and 18.5% in 2017 and 2018, respectively. The semiconductor industry is currently undergoing a transition from planar nodes to 3D NAND and FinFET chips. Production of 3D NAND chips is expected to ramp up in 2016 and 2017, and Applied Materials should see strong demand for specialized equipment used to manufacture these advanced chips.

The rapid transition from hard disk drives to solid state drives for data storage will also power a new wave of growth for Applied Materials. The company’s flash sales were up 96% during the last quarter to $637.7 million. This fast-growing segment now accounts for 39% of the company’s revenue, up from 22% a year ago. Strong demand for flash products should give a nice boost to Applied Materials’ top line in the near-future.

Bottom Line

A lot of pessimism seems to be already baked into AMAT stock, and the shares were down just 1.5% after it released its earnings report. The shares have lost a third of their value this year, and may not have much downside left.

Nevertheless, long-term investors should probably wait for the first signs of recovery in the industry before opening new positions in AMAT stock.

As of this writing, Brian Wu did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/08/amat-stock-capex-cuts-hurting-applied-materials/.

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