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Summary

  • Solid quarter was accompanied by a solid outlook.
  • Merger with Tokyo Electron remains on its trajectory.
  • Still I believe long-term targets might be aggressive, and a lot of good news is already priced in.

Investors in Applied Materials (NASDAQ:AMAT) were pleased with the solid second-quarter earnings report issued last week, as the company hopes to receive regulatory approval for the merger with Tokyo Electron later this year.

Despite the solid progress, I believe that the company's 2017 targets might be a bit aggressive and that the run-up in the company's shares over the past year have already reflected a great deal of good news.

Second Quarter Highlights

Applied Materials reported second-quarter revenues of $2.35 billion, up 19.3% compared to last year.

The company reported earnings of $262 million compared to a $129 million loss last year which was entirely the result of a $278 million goodwill impairment charge.

A Look At The Operations

Applied Materials reported solid year-on-year topline growth while sequential revenue growth of 7.4% was impressive as well. Orders came in at $2.63 billion for a book-to-bill ratio of 1.12, implying that the backlog is on the increase again.

Gross margins rose by 159 basis points to 42.5% of sales on the back of solid operating leverage. The company kept very tight cost control, with marketing and selling costs even falling compared to last year, while other costs were well contained. The absence of a huge impairment charge was of course helpful to earnings as well.

The largest silicon systems group performed well with revenues increasing by 7% to $1.58 billion, as the order intake rose to $1.67 billion. The Applied global service unit managed to report a 5% jump in revenues to $534 million as the order intake fell by 10%, resulting in a book-to-bill ratio of 1.

A spectacular order intake was recorded at the display unit with orders coming in at $340 million while sales actually fell by 8% to $147 million, creating a huge backlog improvement. The problematic energy and environmental solutions business was stable with both orders and revenues coming in at $88 million.

Outlook For The Third Quarter

For the third quarter, Applied expects sales to be flat to down by 5% compared to the second quarter. Despite the expected fall on a sequential basis, revenues are still seen up by 13-19% on the year before.

Non-GAAP earnings are seen between $0.25 and $0.29 per share which compares to second quarter earnings of $0.28 per share. GAAP earnings are seen at least $0.03 per share lower on acquisition and integration costs.

Valuation

Applied Materials ended the quarter with $3.4 billion in cash, equivalents, short and long term investments. Long term debt stands at $1.9 billion, resulting in a net cash position of $1.5 billion.

At his pace annual revenues of $9 billion and earnings of $1 billion appear to be attainable. At $20 per share, Applied has a market value of around $24.5 billion. This values operating assets at $23 billion, the equivalent of 2.5 times annual revenues and 23 times earnings.

The company's quarterly dividend of $0.10 per share provides investors with a 2.0% dividend yield.

Takeaway

Investors were quite happy with the results driven by strong demand for machines to produce flat-panel displays as many competitors have cut back their exposure in that area. The solid performance and guidance underlies the 10-20% growth forecast for the year as issued by CEO Gary Dickerson.

Growth is driven by strong demand for storage in mobile phones as well as market share gains. Despite this strong operational performance, all eyes remain on the $9.4 billion acquisition of Tokyo Electron which is expected to close in the second half of this year.

At the time of the announcement, Tokyo reported $5.4 billion in annual revenues and flat earnings. Combined with Applied's performance so far this year, annual revenues of $15 billion and earnings of $1-$1.5 billion for the combination should be attainable. On top of that come $250 million in annual synergies in year one, expected to increase toward $500 million per year three.

As Tokyo Electron's shareholders will hold a 32% stake in the new combination, a valuation comes down to roughly $36 billion, or $33 billion after $3 billion in planned repurchases. This still values the company at 2.2 times annual revenues, 26 times annual earnings before synergies, and 19 times earnings reflecting full synergies.

That being said, shares trade at just 11 times the 2017 profit target of $3 billion as set by Gary Dickerson which seems quite aggressive and a bit stretched to me. If Dickerson manages to deliver, shares arguably offer appeal although they would still trade at 11 times earnings three years ahead in time. I fear that his ambitions might be a bit stretched and for that reason remain cautious.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Applied Materials: Share Price Already Reflects A Great Deal Of Good News

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