Why Applied Materials' Appeal Goes Beyond Its Mega-Merge

| About: Applied Materials, (AMAT)

Summary

Applied Materials reported sales of $2.3 billion, up 15% from the previous year’s comparable quarter. Its bottom-line grew even more impressively—EPS of $0.28, up 56%.

Applied Materials and Tokyo Electron are some of largest chip equipment makers, with fiscal 2013 revenues of $5.46 billion and $3.06 billion, and market shares of 16.2% and 9.1%, respectively.

Applied Materials has booked over $600 million in display orders, beating its own expectations by $100 million.

Applied Materials (NASDAQ:AMAT) is one of the leading companies in the red-hot semiconductor industry, which has gained about 26% year-to-date compared to 8% for the S&P 500. Applied Materials shares have tucked in 31% gains year-to-date. The company has had a stellar year so far. In the third-quarter of the current fiscal year, Applied Materials reported sales of $2.3 billion, up 15% from the previous year's comparable quarter. Its bottom-line grew even more impressively-EPS of $0.28, up 56%. Meanwhile, the company's gross margin of 45.5% is at a 6-year high, while operating margin and cash flow are both at 3-year highs.

One of the reasons why investors have been bidding up Applied Materials shares is because the company is close to finalizing its $9 billion buyout of Tokyo Electron, a Japanese chip equipment maker, in an all-stock deal. The deal is expected to entrench Applied's leading position as a wide moat player in chip equipment. The merged company will gain a wide presence in many key markets and bolster its competitive position.

Applied Materials and Tokyo Electron are some of largest chip equipment makers, with fiscal 2013 revenues of $5.46 billion and $3.06 billion, and market shares of 16.2% and 9.1%, respectively. The merger is highly strategic given that the two companies will complement each other since each company happens to excel where the other is weak. The two companies can pool their extensive technical expertise to develop next-generation chipmaker tools that will help scale down Moore's Law. Both companies have broad front-end wafer fab portfolios. The front-end wafer fab segment of the market is much larger than the back-end, with total market value of $32 billion vs. $6 billion, according to Research firm Gartner. Applied Materials owns 12% of the front-end fab market compared to 11% for Tokyo Electron. The combined entity will be the runaway leader in the market with more than 25% share. What truly separates Applied Materials from other chip equipment makers is that both have diversified across many segments and sub-segments, unlike their rivals most of whom specialize in specific segmentsinvestment, especially for long-term investors.

Improving semi-conductor demand

Positive mobility and current connectivity trends are continuing to drive growth in the semiconductor and display market. Additionally, new material innovations are improving device performance, yield, and costs. Applied Materials believes that significant ramp ups in 3D NAND, FinFET, and display technologies will fuel the next big wave of capital inflows into the semiconductor sector.

The company estimates that Wafer Fab Equipment spending will grow 10% to 20% in the current fiscal year. In 2015, Applied Materials expects customers to invest more in 3D NAND and DRAM, improving growth even further. For instance, the build out of 28 nanometer and 20 nanometer nodes is fueling strong performance in Applied Material's transistor business. The company claims that wider adoption of FinFET technology will provide a catalyst in foundry spending. Intel is one of the companies that have already adopted FinFET technology, along with Samsung and TSMC. FinFET technology provides better circuit performance, and also increases power efficiency and processing speeds, all of which are critical features in today's computing devices.

Applied Materials expects NAND bit to grow around 40% in the current year, saying that customers are already busy charting out their 3D NAND road maps to achieve cost parity with planar NAND. The transition from planar NAND to 3D NAND has the potential to expand Applied Materials' current market by about 35% to 50%. Further, the company expects DRAM shipments to grow 60% in the current year, mainly driven by an enterprise-driven PC refresh cycle that is already underway. Overall memory spending could grow as much as 30% this year, and Applied Materials is optimistic it can grow its memory market share by at least 2 percentage points.

Increase in Display Capacity & New Technology

Applied Materials' display business is coming along nicely, driven by the company's investments in capacity addition. Applied Materials has booked over $600 million in display orders, beating its own expectations by $100 million. Growing demand for big screen TVs is one of the key trends driving the display technology market. TV screens are growing at an average of 0.5 inches each year, higher than the historical average. Applied Materials expects its display technology segment to grow at 15% over the next three years, and plans to build 3 Gen 8.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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