Semiconductors may face uncertain end-market demand, but the secular trends are strong in technology. Furthermore, increasing complexity in consumer electronic products will drive sustainable growth across the semiconductor industry.
In this article, I will run you through my DCF analysis on Applied Materials (AMAT) and then triangulate the results with an exit multiple calculation and a review of the fundamentals compared to Intel (INTC) and Lam Research (LRCX).
I recommend that investors also consider smaller firms, like ACL Semiconductors (ACLO.OB) and BE Semiconductor Industries (BESIY.PK). These are firms that are similar to ones that I have worked on in investor relations campaigns in that they have compelling growth stories. ACL recently gained 27% off of news that it was entering a joint venture agreement with Tomen Devices. The JV will be substantially accretive to EPS by forming Greater China's largest Samsung semiconductor distributor and strengthening ACL's lead in memory solutions. It is only a matter of time before Wall Street catches up on their value. My DCF model on Intel can be found here.
First, let's begin with an assumption about revenues. Applied Materials ended FY2011 with $10.5B in revenue, which represented a 10.1% increase off the preceding year. Analysts model a 109% per annum growth rate over the next five years, and I believe this sentiment is overly reserved. However, for the sake of being safe, I accept the figure.
Moving onto the cost-side of the equation, there are several items to address: operating expenses, taxes, and capital expenditures. I model that cost of goods sold will eat 60% of revenue over the next few years, compared to 9% for SG&A and 11% for R&D. These estimates are roughly around historical 3-year average levels. Capex is estimated the same way, so I assume 1.9% of revenue over the next few years. Taxes are also estimated at 33%.
We then need to subtract out net increases in working capital: we model accounts receivable as 16% of revenue; investors as 26% of COGS; accounts payable as 7% of OPEX; and accrued expenses as 50% of SG&A.
Taking a perpetual growth rate of 1.5%, and discounting backwards by a WACC of 10%, yields a fair value figure of $13.61, implying 11.3% upside.
All of this can be viewed in the context of solid recent operating performance and the Varian acquisition.
"I'm pleased to report that Applied started 2012 with a strong first quarter, posting revenue and earnings that exceeded the high-end of our ranges. Global demand for mobile electronics is driving strong capital investments by semiconductor customers, resulting in solid order momentum and higher expectations for our second quarter. The rate of technical change continues to accelerate in all of our markets and leading-edge technology investment remains a priority for our customers…
Let me now turn to the economic outlook. Since the start of the year, we have seen improvements in a number of macroeconomic indicators. While the ongoing recession and increased austerity in parts of Europe remain a concern, we believe the global economic environment will support healthy spending by consumers and businesses".
From a multiples perspective, Applied Materials is attractive. It trades at a respective 10.5x and 10.8x past and forward earnings versus 12.4x and 11.1x for Lam and 11.2x and 10.2x for Intel. Assuming a multiple of 12.5x and a conservative 2013 EPS of $1.09, the rough intrinsic value of Applied Materials is $13.63, implying 10.2% upside.
Consensus estimates for Intel's EPS forecast that it will grow by 1.3% to $2.42 in 2012, and then by 8.3% and 9.2% in the following two years. Assuming a multiple of 12.5x and a conservative 2013 EPS of $2.55, the rough intrinsic value of its EPS is $31.88, implying 18.8% upside. The company delivered impressive 2011 results, with top-line growth exceeding 20% and a particularly strong performance in the data segment. Increasing internet traffic and greater demand needs have driven up volume. The company is the leader in its field and thus is arguably the safest against the possible backdrop of a double dip.
Lam, on the other hand, has struggled - as evidenced by the 32% decline in memory shipments. Price-sensitive exposure and competitive pressures are weighing down on Lam's otherwise impressive fundamentals.
Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.