I peviously cautioned against an investment in Applied Materials (AMAT) - arguing that the company was growing anemically and faces considerable uncertainty in end-market demand. Since the article was first published, shareholder value has declined by 3% while competitor Novellus Systems (NVLS) has appreciated by a very impressive 16.4%. While I am bullish on the market overall, I believe that both companies are overvalued.
From a multiples perspective, both companies nevertheless appear cheap. Applied Materials trades at a respective 7.8x and 9.9x past and forward earnings, while Novellus trades at a respective 10.8x and 14x past and forward earnings. Both companies are fairly liquid with the former having a net cash position of 29.1% of market value and the latter having a net cash position of 14.4% of market value. I find that the low multiples, however, are justified given unclear fundamentals, macro headwinds, and possibly low utilization rates.
On the positive side, at the fourth-quarter earnings call, Applied Materials' CEO, Mike Splinter, noted sound operating performance:
"I'm pleased to report that Applied Materials ended our fiscal year with solid fourth quarter results despite a challenging environment for all of our businesses. 2011 has been the most successful year in Applied Materials' history, and we set records for revenue, earnings per share and operating cash flow. Our semiconductor business delivered a strong performance despite a significant drop-off in wafer fab equipment spending in the second half of the year. Our services group exceeded their previous peak revenue, driven by growth in our spares and services business, combined with robust demand for 200-millimeter equipment. EES generated $2 billion of revenue and operating profit of over 20%, while in display, we established leadership positions in the emerging touch panel and high-resolution mobile display markets".
Additionally, I am optimistic about the integration of Varian Semiconductor, which will make Applied Materials the leader in transistor technologies in its industry. I am further anticipating that the semiconductor market will improve in early 2012, as customers increasingly shift to more advanced technology. Both Applied Materials and Novellus will benefit from 28 nm, greater capital intensity and the rising demand for mobile with tablets and smartphones.
All of this, however, is not enough to inspire appreciation in shareholder value as a result of the uncertainty. In particular, the extent of a bookings recovery is not clear, the EES segment is likely to decline, and demand for solar may shrink. Management also previously noted that growth in Asia is slowing, customers are reassessing investment plans, and the near-term outlook looks weak.
Consensus estimates for Applied Materials' EPS are that it will decline by 43.1% to $0.74 in 2012, grow by 54.1% in 2013, and then decline by 11.4% in 2014. Assuming a multiple of 10x and a conservative 2013 EPS estimate of $1.10, the rough intrinsic value of the stock is $11. This is currently less than what the market values the business at and, hence, I recommend holding out from an investment. The Street shares this sentiment with the consensus "hold" rating.
Consensus estimates for Novellus' EPS are that it will grow by 1% to $3.06 in 2011, decline by 12.1% in 2012, and then grow by 11.9% in 2013. Assuming a multiple of 12x and a conservative 2012 EPS estimate of $2.56, the rough intrinsic value of the stock is $30.72. This too is less than what the market values the business at, although the difference is notably greater. The Street currently rates shares a "hold."