Will Applied Materials Surprise This Time?

| About: Applied Materials, (AMAT)

Summary

Applied Materials is scheduled to report its first-quarter fiscal 2016 financial results on Thursday, February 18, after market close.

According to 19 analysts' average estimate, Applied is expected to post a profit of $0.25 a share, a 7.4% decline from its actual earnings for the same quarter a year ago.

I see robust growth prospects for the company. New smartphones will use higher performance chips, like the next-generation Apple processor, which are more complex and cost more to manufacture.

Considering its compelling valuation, AMAT's stock is undervalued. The forward P/E is very low at 10.29, and the PEG ratio is also very low at 0.62.

The average target price of the top analysts is at $20.50, up 27.6% from its February 12 close price, which appears reasonable in my opinion.

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Applied Materials (NASDAQ:AMAT), the worldwide leader in the manufacturing of semiconductor equipment, is scheduled to report its first-quarter fiscal 2016 financial results on Thursday, February 18, after market close. According to 19 analysts' average estimate, Applied Materials is expected to post a profit of $0.25 a share, a 7.4% decline from its actual earnings for the same quarter a year ago. The highest estimate is for a profit of $0.27 a share while the lowest is for a profit of $0.24 a share. Revenue for the first quarter is expected to decrease 4.9% year over year to $2.24 billion, according to 17 analysts' average estimate. Since Applied met estimates in its last quarters, as shown in the table below, there is a good chance that the company met estimates also in the first quarter.

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Data: Yahoo Finance

Since the beginning of the year, AMAT's stock is down 14% while the S&P 500 Index has decreased 8.8%, and the Nasdaq Composite Index has lost 13.4%. However, since the beginning of 2012, AMAT's stock has gained 50%. In this period, the S&P 500 Index has increased 48.3%, and the Nasdaq Composite Index has risen 66.5%. Considering its compelling valuation and its leading position in the industry, the drop in its price creates an excellent opportunity to buy the stock at an attractive price. According to TipRanks, the average target price of the top analysts is at $20.50, up 27.6% from its February 12 close price, which appears reasonable in my opinion.

AMAT Daily Chart

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AMAT Weekly Chart

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Charts: TradeStation Group, Inc.

I see robust growth prospects for the company, despite the slowing demand for smartphones. New smartphones will use higher performance chips, like the next-generation Apple (NASDAQ:AAPL) processor, which are more complex and cost more to manufacture. That will benefit chip equipment manufacturers like Applied Materials. Moreover, according to the company, while its product set has been strongest in the foundry market, the company has introduced new products to strengthen its position in memory and continue to get stronger in this market. In the past two years, Applied has increased its DRAM market share by 5%. The company believes it can increase its NAND market share by 5% amid the transition from planar NAND to 3D NAND. Looking forward, Applied Materials expects DRAM bit growth in the 25%-30% growth range, but DRAM investments to decline substantially after several years of recovery. NAND bit growth is forecast at 35%-40%, with investment spending forecast to rise. About 80% of 2016 spending in NAND will be focused on 3D NAND.

Applied has shown orders and sales growth in its last four quarters as shown in the chart below.

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Source: Applied's Quarterly Reports

Applied's book-to-bill was 1.02 in the last quarter, and in ten of its twelve last quarters, it was higher than one; this indicates growing demand for Applied's products. The chart below shows Applied's book-to-bill ratio for each quarter since 2011.

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Valuation

Considering its compelling valuation, AMAT's stock, in my opinion, is undervalued. The trailing P/E is low at 14.34, and the forward P/E is very low at 10.29. The Enterprise Value/EBITDA ratio is also low at 8.67, and the PEG ratio is very low at 0.62, the fifth lowest among all S&P 500 tech stocks. The PEG ratio - price/earnings-to-growth ratio - is a widely used indicator of a stock's potential value. It is favored by many investors over the P/E ratio because it also accounts for growth. A lower PEG means that the stock is more undervalued.

The 10 S&P 500 tech stocks with the lowest PEG ratio

Source: Portfolio123

Applied has been paying uninterrupted dividends since 2007. The forward annual dividend yield is at 2.49% and the payout ratio is only 35.4%. The annual rate of dividend growth over the past three years was at 4.9% and over the past five years was high at 8.2%.

The company generated $1.16 billion in cash from operations in fiscal 2015, paid dividends of $487 million and used $1.33 billion to repurchase 76 million shares of common stock.

AMAT Dividend Chart

AMAT Dividend data by YCharts

Ranking

According to Portfolio123's "Technamental" ranking system, AMAT's stock is ranked fourth among all 67 S&P 500 tech stocks.

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The "Technamental" ranking system is quite complex, and it is taking into account many factors like valuation ratios, growth rates, profitability ratios, financial strength, efficiency ratios, technical factors and industry strength, as shown in the Portfolio123's chart below.

Back-testing over sixteen years has proved that this ranking system is very useful.

Summary

Applied Materials is scheduled to report its first-quarter fiscal 2016 financial results on Thursday, February 18, after market close. According to 19 analysts' average estimate, Applied is expected to post a profit of $0.25 a share, a 7.4% decline from its actual earnings for the same quarter a year ago. Since Applied met estimates in its last quarters, there is a good chance that the company met estimates also in the first quarter. I see robust growth prospects for the company, despite the slowing demand for smartphones. New smartphones will use higher performance chips, like the next-generation Apple processor, which are more complex and cost more to manufacture. That will benefit chip equipment manufacturers like Applied Materials. Considering its compelling valuation, AMAT's stock is undervalued. The forward P/E is very low at 10.29, and the PEG ratio is also very low at 0.62, the fifth lowest among all S&P 500 tech stocks. Moreover, the company generates strong cash flow, and returns substantial capital to its shareholders by stock buybacks and increasing dividend payments. The average target price of the top analysts is at $20.50, up 27.6% from its February 12 close price, which appears reasonable in my opinion.

Disclosure: I am/we are long AMAT.

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.