Applied Materials (NASDAQ:AMAT) provides manufacturing equipment, services and software to semiconductor manufacturers, and is the world’s largest semiconductor fabrication equipment supplier, based on revenue. With macro headwinds leading to soft demand for consumer products, most semiconductor manufacturers reduced their capital spending in 2012, which in turn led to a drastic decline in Applied’s equipment sales. Though its revenue further declined in Q1 2013, the rate of decline slowed considerably compared to the previous quarter. Additionally, a growing mix of silicon system revenue, lower inventory reserves as well as the strong execution and efficient management of discretionary spending helped Applied return to profitability in Q1 2013.
Witnessing a 44% sequential increase in its Q1 2013 orders, Applied believes its orders bottomed out at the end of fiscal 2012. We remain optimistic on the company’s long term prospects, as we think that the accelerated changes in device technology and the adoption of new materials in the industry will fuel its top line growth. Additionally, we believe that the increasing complexity in manufacturing processes provide an added opportunity for growth.
In this article, we discuss key factors that drive our $13.50 price estimate for Applied Materials, which is almost in line with the current market price.
1. Increasing Capital Equipment Spending By Semiconductor Manufactures
Applied’s semiconductor manufacturing systems are used by integrated device manufacturers and foundries to build and package memory, logic and other types of chips. Weak market conditions in 2012, caused pullbacks in expansion plans throughout the industry as manufacturers adjusted their production levels to match the end-user demand. However, witnessing more than 80% increase in semiconductor orders, Applied scored significant application wins in Q1 2013, which make us believe that the situation could improve this year.
While the wafer fab equipment (WFE) market saw spending increase by 13.3% in 2011, Gartner estimated the same to decline by 13.3%, totaling $31.4 billion in 2012. It expects capacity utilization to decline into the low 80% range, before slowly increasing to about 87%. Though the situation is expected to improve in 2013, Gartner does not estimate the market to return to positive growth in the year. 
Some of the factors that can revive demand for semiconductor equipment are:
- Growing capacity for the 28-nanometer node and ramp-up of 20 nanometer technology by semiconductor companies.
- Rising global demand for mobile products – These devices drive demand for leading-edge foundry capacity, the market leaders are aggressively accelerating ramps at advanced nodes. Applied believes that mobile customers will account for approximately 45% of wafer fab spending in 2013. 
- Higher NAND demand: Applied believes that the NAND demand will grow by close to 50% in 2013, which it thinks is sufficient to drive investment in new capacity addition.
2. Sustained Market Share in the Semiconductor Equipment Market
Historically, Applied Materials has enjoyed the highest market share in global semiconductor equipment sales, based on its broad product portfolio and global reach. Its share in the semiconductor market increased from 12% in 2011 to 13.3% in 2012. Semiconductor equipment manufacturing is a complex and highly capital intensive industry, and the threat from smaller and niche players remains unsubstantial.
Last quarter, Applied witnessed strong demand for its transistor products and converted a number of existing positions into volume orders. The company strongly feels that it has the requisite capacity to build momentum for a higher market share in wafer fab equipment (WFE) in 2013. With a leading product portfolio and sustained investment in R&D, we believe that Applied can retain its market share over our review period.
3. Apart From Mobility Trend, Larger TV Sizes & 4-K Resolution Technology To Fuel Display Demand
Applied display segment orders grew by 66% in Q1 2013, on account of the ongoing mobility investments and the resurgence in TV equipment orders. Though its customers still remain cautious about the end-demand, Applied believes that with larger models in the TV industry reaching attractive prices and the introduction of new 4-K resolution technology, there could be a marginal increase in investment in display factories this year.
Additionally, with a higher number of touch-enabled hybrid (notebook-tablet) models hitting the market, orders for equipment to manufacturer touch panels and high performance mobile screens remain strong, as production moves to larger substrate sizes.
4. Solar Division Remains A Long Term Growth Driver
Revenue from Applied’s Energy and Environmental Solutions (EES) division declined drastically in 2012, as the solar industry struggled with excess manufacturing capacity and soft end-demand. Though Applied claims that the growth in demand is starting to consume the excess manufacturing capacity in the solar industry, it maintains a cautious approach as the investment in new capacity remains low.
Applied claims that the solar end market continues to grow between 10% and 20% annually. However, the supply conditions remain challenging until the industry further consolidates and rationalizes its manufacturing capacity. Given the growth potential of the solar industry, we believe that the solar business could be an important long term growth driver for the company. While the slower-than-anticipated revival led to a significant decline in the market in 2012, we estimate the situation to stabilize in the future.
Applied announced a restructuring plan for its EES business in Q3 2012, to lower its cost structure and operating breakeven level to approximately $500 million. As the demand in the solar industry remains sluggish, it plans to take additional steps to reduce its cost base and minimize associated losses. By the end of fiscal 2013, the company aims to reduce EES operating expenses to $25 million per quarter.
- Gartner Says Worldwide Semiconductor Manufacturing Equipment Spending to Decline 11.6 Percent in 2012, Gartner Press Release, March 21, 2012
- Applied Materials’ CEO Discusses F1Q13 Results – Earnings Call Transcript, Seeking Alpha, February 13, 2013
Disclosure: No positions