Applied's Growth Accelerates With A Strong Q2 2013

| About: Applied Materials, (AMAT)

After a continuous sequential decline in its top line last year, leading semiconductor equipment manufacturer Applied Materials (NASDAQ:AMAT) reported a strong Q2 2013, with a 25% q-o-q increase in its sales ($1.97 billion). While the company continued to face challenges in its solar equipment business, its silicon systems group (SSG) and display segment saw increased strength. The higher revenue base combined with lower inventory charges and prudent management of its expenses helped Applied grow its gross margins by almost 4% in the quarter.

Booking a 7% rise in orders, Applied claims to be witnessing healthy demand for semiconductor equipment with a steady increase in utilization at its customers’ factories. After a significant decline in its display business last year, it is seeing rising strength and investment in the market. The company is confident on building momentum towards profitable growth in the subsequent quarters.

We remain optimistic on Applied’s long term prospects, as we think that the accelerated changes in device technology and the adoption of new complex materials in the industry will accelerate demand for semiconductor equipment in the future.

Improving Wafer Fab Equipment Market; Applied to Gain Additional Share

Weak market conditions in 2012 caused pullbacks in expansion plans throughout the semiconductor industry as manufacturers adjusted their production levels to match the end-user demand. However, the 80% increase in Applied’s Q1 2013 semiconductor orders instills hope of the situation improving this year. Applied reported a 33% sequential increase in its SSG revenues and a 14% increase in orders in Q2 2013. While higher foundry investment accounts for the majority of its revenues, the increase in orders was primarily driven by rising NAND demand and improving DRAM spending.

The ongoing mobility trend remains the biggest growth driver for the semiconductor industry. According to Applied, 200 million smartphones and 35 million tablets were shipped in the first three months of the calendar year 2013. It believes that the market is in line to achieve the expected annual growth of 35% and 55% for phones and tablets respectively, in 2013.

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. Applied announced in its recent earnings call transcript that the value of silicon being consumed by smartphones and tablets has surpassed that being used in PCs. It believes that mobile customers will account for approximately 45% of wafer fab spending in 2013.

Foundries continue to add capacity at 28 nm, prepare to begin 20 nm pilot production at the end of this year and accelerate the development of 3D transistors. Applied claims that its strongest position is in foundries and as the foundries focus on developing new transistor technologies, it places the company in a strong position to increase its share with its leadership in the transistor module.

Gartner estimates the wafer fab equipment (WFE) market to have declined by 17.4%, totaling $29.9 billion in 2012. It expects capacity utilization to decline into the low 80% range, before slowly increasing to 85% towards the end of 2013. Though Gartner forecast the market size to decline to $27 billion this year, it believes the market will return to growth 2014 onward.

Building Momentum in Display

Applied has seen growing strength in its display business on account of the ongoing mobility investments and the beginning of resurgence and TV equipment orders. It registered a 46% sequential rise in display equipment sales in Q2 2013 and reported a 41% increase in orders. The company has managed to remain profitable in its display business despite the worst downturn in the history of this market, and managed to more than double its display segment operating margins in the quarter.

Applied has invested in a new TV fab in China and has secured 100% of the CVD and PVD business for the new factory. It already has a strong foothold in the CVD market and claims to be increasing its share in the display PVD market as well. It saw its share increasing in multiple product lines in Q2 2013 as the improving market conditions enabled its customers to add on to their capacity.

Rising demand from emerging economies, new 4-K resolution technology and increasing proportion of 50 inch and larger models at affordable prices are key factors driving growth in the global TV market. Applied believes that it has the potential to double its orders this year to over $800 million.

Improving Margins

Applied’s gross margins remained under pressure last year owing to a lower revenue base and increasing expenses. However, it has reported higher margins since the last two quarter due to a significant reduction in its solar spending, re-prioritization of R&D projects to key growth areas and a reduction in its workforce.

Applied targets to reduce its solar spending to $25 million per quarter by the end of 2013, and intends to reinvest the savings in product development for other markets. It plans to divert a majority of its R&D investments to increase its share in the wafer fab equipment and display markets. It claims to be gaining traction in some high value businesses that support higher margins.

Applied believes that it has scope to further reduce its operating expenses by improving its organizational complexity. Materials costs account for a majority of its products’ overall expenses. The company is working towards implementing lower cost designs as well as saving money on existing products. Declining costs combined with a higher revenue base can improve Applied’s operating margins in the future.

Q3 2013 Outlook

  • Net sales to increase marginally.
  • Non-GAAP EPS in the range of $0.16 to $0.20.
  • Non-GAAP operating expenses to be around $550 million, +/- $10 million.

We are in the process of updating our price estimate of $13.50 for Applied Materials.

Disclosure: No positions.

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Tagged: , Semiconductor Equipment & Materials, Earnings
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