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Applied Materials (NASDAQ:AMAT) Misses Q4 Sales Targets, Stock Drops


Full Report / November 18, 2021
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Maker of machinery employed in semiconductor manufacturing, Applied Materials (NASDAQ:AMAT) missed analyst expectations in Q4 FY2021 quarter, with revenue up 30.6% year on year to $6.12 billion. Guidance for the next quarter also missed analyst expectations with revenues guided to $6.16 billion at the midpoint, or 4.54% below analyst estimates. Applied Materials made a GAAP profit of $1.71 billion, improving on its profit of $1.13 billion, in the same quarter last year.

Applied Materials (AMAT) Q4 FY2021 Highlights:

  • Revenue: $6.12 billion vs analyst estimates of $6.34 billion (3.47% miss)
  • EPS (non-GAAP): $1.94 vs analyst expectations of $1.96 (small miss)
  • Revenue guidance for Q1 2022 is $6.16 billion at the midpoint, below analyst estimates of $6.45 billion
  • Free cash flow of $942 million, down 39.1% from previous quarter
  • Inventory Days Outstanding: 123, up from 116 previous quarter
  • Gross Margin (GAAP): 48%, up from 45.4% 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.

Its primary peers and competitors are ASML (NASDAQ:ASML), Lam Research (NASDAQ:LCRX), KLA Corp (NASDAQ: KLAC), and Tokyo Electron (TSE:8035).

Semiconductor Manufacturing

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. Read More Chip manufacturing is done in "batches" on a single round silicon disk, known as a "wafer". Multiple chips can be fabricated on a single wafer, which itself can cost over $10,000 today for the more advanced nodes. The actual chip fabrication process requires hundreds to thousands of steps that are executed at an atomic scale. From start to finish, including fabrication, testing and packaging, it can take 3 months to make a chip. The process to create a silicon wafer starts with sand, which is melted to extract silicon, then purified and formed into a cylinder, which is then sliced down into discs about 1mm thick that are then polished into wafers. Next, the wafers go to a semiconductor foundry and go through a process where successive layers of insulating, conducting, and semiconducting materials are stacked on top of one another to form many small complex interconnected 3D structures (wires, insulators, etc), with each layer consisting of 15-20 processes such as deposition, lithography, etching, stripping, testing, and cleaning.

Sales Growth

Applied Materials's revenue growth over the last three years has been measured, averaging 13.3% annually. But as you can see below, last year has been stronger for the company, growing from quarterly revenue of $4.68 billion to $6.12 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).

Applied Materials Total Revenue

Despite missing analyst estimates this quarter, 30.6% revenue growth for Applied Materials's was still solid. This marks 8 straight quarters of revenue growth, which means the current upcycle has had a good run, as a typical upcycle tends to be 8-10 quarters.

However, Applied Materials believes the growth is set to even accelerate, and is guiding for revenue to grow 31.3% YoY next quarter, and Wall St analysts are estimating growth 14.5% over the next twelve months.

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.

Applied Materials Inventory Days Outstanding

This quarter, Applied Materials’s inventory days came in at 123, 14 days below the five year average, showing that despite the recent increase there is no indication of an excessive inventory buildup at the moment.

Pricing Power

Applied Materials's gross profit margin, how much the company gets to keep after paying the costs of manufacturing its products, came in at 48% in Q4, up 2.7 percentage points year on year.

Applied Materials Gross Margin (GAAP)

Applied Materials' gross margins have been trending up over the last year, averaging 47.3%. This is around the average of what we typically see in semiconductor businesses, but the rising margin may be indicative of improving cost controls.

Profitability

Applied Materials reported an operating margin of 33.1% in Q4, up 4.9 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.

Applied Materials Adjusted Operating Margin

Operating margins have been trending up over the last year, averaging 31.6%. 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 19.7% 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 $942 million in Q4, down 18.3% year on year.

Applied Materials Free Cash Flow

Applied Materials has generated $4.77 billion in free cash flow over the last twelve months, translating to 20.7% of revenues. This is a strong result; Applied Materials's free cash flow conversion was higher than most semiconductor companies, in the last year. If it maintains this level of cash generation, it will be able to invest plenty in new products, and ride out any cyclical downturn more easily.

Applied Materials’s average return on invested capital (ROIC) over the last 5 years of 43.5% 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 Q4 Results

Sporting a market capitalization of $140 billion, more than $5.45 billion in cash and with positive free cash flow over the last twelve months, we're confident that Applied Materials has the resources it needs to pursue a high growth business strategy.

We were very impressed by the strong improvements in Applied Materials’s operating margin this quarter. And we were also glad to see the improvement in gross margin. On the other hand, it was unfortunate to see that the revenue guidance for the next quarter missed analysts' expectations and it missed analysts' revenue expectations this quarter. Overall, it seems to us that this was a complicated quarter for Applied Materials. The company is down 6.76% on the results and currently trades at $148 per share.

Is Now The Time?

Applied Materials may have had a bad quarter, but investors should also consider its valuation and business qualities, when assessing the investment opportunity. We think Applied Materials is a solid business. However, its revenue growth has been weak, and analysts expect growth rates to deteriorate from there. But on a positive note, its impressive operating margins are indicative of an highly efficient business model, and its high return on invested capital suggests it is well run and in a strong position for profit growth.

Applied Materials's price to earnings ratio based on the next twelve months is 19.6x. There are definitely things to like about Applied Materials and looking at the semiconductors landscape right now, it seems that the company trades at a pretty interesting price point.

The Wall St analysts covering the company had a one year price target of $162.1 per share right before these results, implying that they saw upside in buying Applied Materials even in the short term.

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