Maker of machinery employed in semiconductor manufacturing, Applied Materials (NASDAQ:AMAT) reported Q3 FY2022 results that beat analyst expectations, with revenue up 5.22% year on year to $6.52 billion. Guidance for next quarter's revenue was $6.65 billion at the midpoint, which is 1.6% above the analyst consensus. Applied Materials made a GAAP profit of $1.6 billion, down on its profit of $1.71 billion, in the same quarter last year.
Applied Materials (AMAT) Q3 FY2022 Highlights:
- Revenue: $6.52 billion vs analyst estimates of $6.26 billion (4.01% beat)
- EPS (non-GAAP): $1.94 vs analyst estimates of $1.79 (8.65% beat)
- Revenue guidance for Q4 2022 is $6.65 billion at the midpoint, above analyst estimates of $6.54 billion
- Free cash flow of $1.25 billion, up from $205 million in previous quarter
- Inventory Days Outstanding: 143, up from 137 previous quarter
- Gross Margin (GAAP): 46.1%, down from 47.8% same quarter last year
Founded in 1967 as the first company that built the tools for other companies to use to make semiconductors, Applied Materials (NASDAQ:AMAT) is the largest provider of semiconductor wafer fabrication equipment.
Applied Materials is the only semiconductor manufacturing (capital) equipment maker who provides tools used in each of the processes used to create semiconductors. Roughly half its systems’ revenues come from deposition technologies, with another 30% from cleaning or removal systems.
Applied Materials counts among its customers the biggest chip makers in the world: TSMC, Intel, Samsung, and Micron, although it tilts more towards foundry and logic chip makers than memory producers.
The semiconductor capital (manufacturing) equipment group has become highly concentrated over the past decade. Suppliers have consolidated, and the increasing cost of innovation have made it unaffordable to almost everybody, except the largest companies, to produce leading edge chips. The result of the increased industry concentration has been higher operating margins and free cash generation through the cycle. Despite this structural improvement, the businesses can still be quite volatile, as demand fluctuations for the semiconductor equipment are magnified by the already cyclical nature of underlying semiconductor demand.
Applied Materials's revenue growth over the last three years has been strong, averaging 20.5% annually. But as you can see below, last year has not been especially strong, with quarterly revenue growing from $6.19 billion to $6.52 billion. Semiconductors are a cyclical industry and long-term investors should be prepared for periods of high growth, followed by periods of revenue contractions (which can sometimes offer opportune times to buy).
While Applied Materials beat analysts' revenue estimates, this was a very slow quarter with just 5.22% revenue growth. This was the third straight quarter of decelerating growth for Applied Materials, potentially indicating a coming cycle downturn.
Product Demand & Outstanding Inventory
Days Inventory Outstanding (DIO) are an important metric for chipmakers, as it reflects the capital intensity of the business and the cyclical nature of semiconductor supply and demand. In a tight supply environment, inventories tend to be stable, allowing chipmakers to exert pricing power. Steadily increasing DIO can be a warning sign that demand is weak, and if inventories continue to rise the company may have to downsize production.
This quarter, Applied Materials’s inventory days came in at 143, 3 days above the five year average, suggesting that inventory has grown to a level slightly above the long term average.
Applied Materials's gross profit margin, how much the company gets to keep after paying the costs of manufacturing its products, came in at 46.1% in Q3, down 1.8 percentage points year on year.
Applied Materials's gross margins have been stable over the past year, averaging 47%, and remain roughly inline with other semiconductor companies, pointing to a stable pricing environment. It’s great to see a solid gross margin which indicates the company remains competitive.
Applied Materials reported an operating margin of 29.9% in Q3, down 2.8 percentage points year on year. Operating margins are one of the best measures of profitability, telling us how much the company gets to keep after paying the costs of manufacturing the product, selling and marketing it and most importantly, keeping products relevant through research and development spending.
Operating margins have been trending up over the last year, averaging 31.3%. Applied Materials's margins remain one of the highest in the semiconductor industry, driven by its highly efficient operating model's economies of scale.
Earnings, Cash & Competitive Moat
Analysts covering the company are expecting earnings per share to grow 8.31% over the next twelve months, although estimates are likely to change post earnings.
Earnings are important, but we believe cash is king as you cannot pay bills with accounting profits. Applied Materials's free cash flow came in at $1.25 billion in Q3, down 18.7% year on year.
Applied Materials has generated $4.92 billion in free cash flow over the last twelve months. This is a solid result, which translates to 19.5% of revenue. That's above average for semiconductor companies, and should put Applied Materials in a relatively strong position to invest in future growth.
Applied Materials’s average return on invested capital (ROIC) over the last 5 years of 41.4% implies it has a strong competitive position and is able to invest in profitable growth over the long term.
Key Takeaways from Applied Materials's Q3 Results
With a market capitalization of $92.2 billion, more than $3.54 billion in cash and with free cash flow over the last twelve months being positive, the company is in a very strong position to invest in growth.
We were impressed by how strongly Applied Materials outperformed analysts’ earnings expectations this quarter. On the other hand, it was less good to see that the revenue growth was quite weak and gross margin deteriorated a little. Zooming out, we think this was still a decent, albeit mixed, quarter, showing the company is staying on target. The company is up 2.77% on the results and currently trades at $111.35 per share.
Is Now The Time?
When considering Applied Materials, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. Although we have other favorites, we understand the arguments that Applied Materials is not a bad business. We would expect growth rates to moderate from here, but its revenue growth has been solid, over the last three years. And on top of that, its impressive operating margins are indicative of an highly efficient business model.
Applied Materials's price to earnings ratio based on the next twelve months is 13.1x. We don't really see a big opportunity in the stock at the moment, but in the end beauty is in the eye of the beholder. And if you like the company, it seems that Applied Materials doesn't trade at a completely unreasonable price point.
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