On account of lower capital spending in the cyclical industries it serves, Applied Materials' (NASDAQ:AMAT) revenue and net income have been pressured over the last two years. The Semiconductor Equipment and Display Equipment segments over this time frame experienced periods of capacity absorption and the restructuring charges produced net losses as the company re-positioned its businesses. However, Applied gained growth momentum in fiscal 2013 as customers resumed equipment purchases to satisfy strong demand for the integrated circuits (ICs) that power high demand smartphones and tablets.
Applied believes that 2013 was a transformative year for the company as it reduced its overhead expenses, stepped up investment in product development and built momentum for profitable growth. For fiscal 2013, the company booked 5% more orders compared to 2012. The company claims that orders from its leading foundry customer were the highest in its history in 2013 and it anticipates the growth momentum to continue in 2014, backed by stronger investment from its semiconductor and display customers. The company will report its Q1 2014 earnings on February 12.
Applied has a robust pipeline of new products for pending technology transitions, which it believes will help it build momentum for profitable growth in 2014 and beyond. Additionally, its merger with Tokyo Electron will help form a stronger entity, combining two of the largest players in the industry with largely complementary product offerings.
Our price estimate of $16 for Applied Materials is almost in line with the current market price. We will update our valuation after the Q1 2014 earnings release.
Semiconductor Demand To Improve In Fiscal 2014
The semiconductor market slowed down in the latter part of 2012 with capacity utilization declining to 81.2% and 79.2% in Q3 2012 and Q4 2012, respectively. Throughout that year, foundries invested heavily to produce 28 nanometer (nm) devices for Qualcomm (NASDAQ:QCOM) (smartphone ICs) as well as Altera (NASDAQ:ALTR) and Xylinx (FPGAs), among others. Utilization fell as ICs moved onto manufacturers of the smart devices to be sold through the holiday season. Displaying a seasonal uptick, industry utilization improved to an estimated 80.5% and 82.5% in Q1 2013 and Q2 2013 respectively.  We expect the pending technology transitions (22nm and 16 nm, FinFET and 3D NAND) to drive even higher levels of investment in 2014.
These transitions are reflected in Applied's guidance as well. Applied predicted wafer fab equipment (WFE) spending for 2013 to be low, between $27-$30 billion, but estimates are that investment will rise by 10% to 20% in 2014 and reach $37 billion by 2016.  Intel (NASDAQ:INTC), TSMC (NYSE:TSM) and Samsung (OTC:SSNLF), which account for roughly half of the total capital spending in the industry, have indicated strong capital investment plans for the current year with the aim of enhancing their technological capabilities. These companies have been the top three customers for Applied for many years, and we do not foresee any reason for the trend to change.
Higher memory spending and the adoption of new technologies such as 3D NAND and FinFET (3D) transistors will help fuel growth in the semiconductor equipment market. Applied derives around 58% of its valuation from the SSG segment alone and an additional 33% is attributable to the Service business, which is largely focused on the semiconductor market.
Larger TV Sizes, Growing Mobile Demand and New Technology To Drive Display Demand
With 282% annual and 31% sequential growth in Q3 2014, the display business booked its highest orders in over two years as Applied saw rising panel fab investments in China. However, display orders declined by 55.5% sequentially in Q4 2013 as TV unit growth was impacted by the elimination of subsidies in China. Applied expects to receive higher display orders in Q1 2014 as the overall TV and mobility investment cycle extends into 2014 and beyond.
Growing global TV sales and larger average TV sizes are increasing significantly faster than historical trends and are driving demand for display equipment. Shipments of 50 inch and bigger screens are up almost 70% year-on-year.  Applied estimated an average increase of two inches in TV sizes in calendar 2013, in comparison to the average annual increase of 0.5 inch in a year. For one inch of growth, one new Gen 8.5 factory is needed to fulfill the incremental area of demand.
In mobile, new display technologies are being adopted, which is a positive trend for Applied. LTPS, OLED and flexible display technologies are expected to expand the total available market for Applied's large area and precision materials engineering equipment by more than 30%. Additionally, the introduction of 4K ultra-high definition and OLED is driving demand for more complex and capital extensive manufacturing processes. Applied aims to grow its display business revenue to over $1 billion in the future.
Disclosure: No positions.