Why Applied Materials Is A Buy

Aug.25.11 | About: Applied Materials, (AMAT)

Everyone who has been looking for Applied Materials (AMAT) turning the corner yesterday afternoon must have been disappointed. Though the company reported a profit of $476 million, or 36 cents per share, 3 cents ahead of estimates on revenue of $2.8 billion, beating analyst estimates by $10 million, its guidance was well below expectation, so the stock took a big hit in after hours trading.

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Does it mean that the stock is a sell? We dont think so. We still believe that the stock is a good buy for five reasons:

1. The company will eventually recover from a temporary setback in its Japanese operations in the aftermath of the March 11 earthquake.

2. Applied Materials is well positioned to take advantage of the improving industry fundamentals. Applied Materials operates in four segments:

  • The Silicon Systems group develops equipment for the chip fabrication process and accounted for 55% of FY 2010 sales.
  • Global Services provides services to improve the efficiency of semiconductor factories and accounted for 20% of FY 2010 sales.
  • The Display segment develops equipment used to produce flat panel displays and accounted for 9% of FY 2010 sales.
  • Finally, Energy and Environmental services produces equipment used in the production of solar cells and energy efficient glass and accounted for 16% of FY 2010 sales.

3. Solid fundamentals, hefty profit margins, high quarterly growth, and plenty of barriers to entry to its market. Applied Materials has a solid balance sheet with nearly $2.6 billion in cash and only $200 million in long-term debt. On a valuation basis, the stock is relatively cheap, with a low P/E ratio. Based on its projected ROE and retention rate, the long-term sustainable rate of growth in earnings (retention rate times ROE) should be in the range of 12 to 15%. This implies a PEG ratio (based on the current forward P/E ratio) of less than one, indicating a favorable investment opportunity.

Company

Forward PE*

Operating profit margins

Quarterly profit growth (yoy)

Applied Materials

8.60

24.31%

85.20%

KLA-Tencor Corp (KLAC)

8.29

36.63

116.70

Lam Research(LRCX)

9.72

25.20

-10

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*Oct. 2012

4. A demonstrated record of innovationsthe company has been producing materials for fast growing industries like smart phones and solar panels.

5. A 2.8% dividendunusually high for technology companies not that bad for a high-technology company in a low interest environment.

The bottom line: Applied Materials is a long-term buy.

Disclosure: I am long AMAT.