On account of lower capital spending in the cyclical industries it serves, Applied Materials' (NASDAQ:AMAT) revenue and net income have been under pressure over the last three years. The company’s revenue base declined from $10.5 billion in fiscal year 2011 (ending in October) to $7.4 billion in fiscal year 2013. Net income shrank from $1.9 billion to $256 million during the same period. The semiconductor equipment and display segments over this timeframe experienced periods of capacity absorption and restructuring charges produced net losses as Applied re-positioned its businesses.
Applied believes that 2013 was a transformative year as it reduced its overhead expenses, stepped up investment in product development and built momentum for profitable growth. Orders from its leading foundry customer were the highest in its history in 2013, and it believes the growth momentum will continue throughout 2014 as well. Applied started its fiscal 2014 on a strong note, with a 39% and 19% annual growth in Q1 2014 and Q2 2014 revenues, respectively, backed by stronger investment from its semiconductor and display customers.
The company derives around 60% of its valuation from the SSG segment alone and an additional 29% is attributable to the Service business, which is largely focused on the semiconductor market. Though the worldwide capacity expansion in the semiconductor market slowed down in 2012 and 2013, the same is expected to increase in the next two years. Foundry and NAND manufacturers are two industry segments that are expected to add the most capacity in 2014.
Accounting for approximately 15% of the market, Applied is the No. 1 semiconductor equipment supplier, and thus we expect the company to benefit from the capacity addition in the semiconductor industry this year. Applied remains focused on creating a strong pipeline of new, highly differentiated products to enable future technology inflections in logic, memory and display. In calendar 2013, it gained 1.4 points of wafer fab equipment market share, ending the year at its highest level since 2006.
Our price estimate of $19 for Applied Materials is at an approximate 10% discount to the current market price.
Semiconductor Demand To Improve In Fiscal 2014, Driven By Foundry & NAND Flash
The semiconductor industry’s capacity addition growth rate increased from 6% in 2003 to 20% in 2007, driven primarily by DRAM and NAND companies in Korea, Taiwan and China. New capacity addition declined from 7% in 2010 to 4% in 2014. However, capital expenditures on upgrading existing equipment grew sharply during the same period. The industry association SEMI expects worldwide semiconductor capacity to increase by 4% in 2014 and 6% in 2015, with foundries and NAND Flash manufacturers driving growth.
Dedicated foundries grew at a rate of 10% in 2013, and are expected increase capacity by 8%–10% in 2014. NAND, which is the second largest segment, lost 4% capacity in 2012. However, NAND capacity increased by 10% in 2013 and is expected to rise between 5%–8% in 2014. According to research firm Gartner, NAND Flash memory accounted for 42% of the global memory market in 2013 and the proportion is expected to increase to 56% by 2017. Other segments, such as DRAM, SRAM, NOR and other ROM are not expected to add any new capacity this year.
Gartner estimates capital equipment spending in the semiconductor industry to increase by 16% and 17% in 2014 and 2015, respectively. Rising mobile shipments, growing NAND demand, the pending technology transitions (22nm and 16 nm, FinFET, and 3D NAND) and a recovering DRAM market are key factors driving demand for semiconductor equipment.
Mobility Remains The Biggest Growth Driver In The Semiconductor Market
The ongoing mobility trend remains the biggest growth driver for both the foundry and NAND segments. With rapid innovation in the market, mobile devices drive demand for leading-edge foundry capacity, and thus the market leaders are aggressively accelerating ramps at advanced nodes. Management stated in its Q2 2014 earnings call:
“The advanced processors, sensors and memory needed to enable high end smartphones have driven significant growth in the silicon content of these devices. Consequently, the foundries continue to make substantial investments as they ramp 20 nanometer capacity and accelerate their pilot lines for 16 nanometer and 14 nanometer FinFET technology.”
Rising Adoption of FinFET (3D) Transistors
During the Citi Global Technology Conference last year, Applied declared that the FinFET technology adoption is the most attractive opportunity in foundry spending. It views the use of more advanced materials in FinFET production as an important growth driver. Intel has already adopted the technology and TSMC and Samsung have an aggressive roadmap to achieve the same, as devices using the FinFET technology are strong both in terms of power consumption and processing speed, important features for today’s computing devices.
Applied claims to be in a strong position to gain from the adoption of the FinFET technology, as it has a high share in EPI tools, an upgraded version of which will be extensively used for the technology. The FinFET technology can increase Applied’s addressable market by around 35%, in management’s view.
Transition To 3D NAND To Increase Capacity Expansion
3D NAND is a breakthrough in overcoming the density limit currently facing the planar (2D) NAND architecture and floating gates used in conventional flash memory, as well as yielding speed and endurance improvements. 3D NAND has a more dense chip with twice the write performance and 10 times the reliability of planar NAND.
Samsung (OTC:SSNLF), which is Applied’s second largest customer, launched its 3D V-NAND storage technology in August last year and has started mass production for the same. Samsung’s 3D V-NAND is expected to be adopted in many different applications, including SSDs, high-density memory cards, and other applications for consumer electronics. Micron (NASDAQ:MU) has also revealed its plans to transition from planar NAND flash to 3D NAND flash, with volume production targeted for fiscal 2015. Hynix (OTC:HXSCF) is expected to foray into 3D NAND and sample its products this year.
TrendForce currently projects 3D NAND will account for only 3% of the NAND Flash industry’s overall supply, since the majority of the manufacturers are still in the testing and sample delivery phase. However, it expects the 3D NAND market share to reach 20% by 2015. According to IHS research, 3D NAND technology will account for the majority of total flash shipments, equivalent to 65.7% by 2017.
Applied expects NAND spending to reach $7 billion this year. It claims to be gaining share in both planar and 3D NAND, and it has new applications growing in the segment. The company has developed a new and unique deposition technology that is focused on addressing the major issues faced by customers as they transition from planar to 3D NAND.
Disclosure: No positions.