Applied Materials: New Normal (NASDAQ:AMAT)

Summary

Applied Materials continues to support a new normal in the WFE segment as the AI and big data era starts.
The company is more balanced now to handle shifts in particular semiconductor equipment segments.
The net payout yield reaches 13% in a signal to buy the stock similar to below $20 back in 2016.

As the stock soared to new heights, Applied Materials (NASDAQ:AMAT) always was going to eventually face the past cyclical nature of the semiconductor equipment industry. The market wasn’t going to pay extreme prices for peak earnings, if the cyclical top was around the corner. The current yields suggest the “new normal” is a legitimate possibility suggesting the dip to $42 provides an opportunity.

Image Source: Applied Materials website

New Normal

The semiconductor equipment sector has clearly reached a short-term peak. While other cycle tops were followed by massive sales dips, Applied Materials suggests otherwise with targets for this year above the 2017 peak. Wafer fab equipment industry sales are forecast to again top $50 billion and hit a record while the company further boosts EPS this year.

The industry is more diverse now with particular segments taking hits while others expand to remove the overall cyclical nature of the sector. The company suggests that the market is evolving from the mobile and social media era to one where AI and big data will further drive semiconductor sales to new heights. Investors that originally thought the PC and Internet era was the peak back around 2010 missed out on a large rally in the last few years.

Source: Applied Materials website

In respect to AMAT, anybody focused on the foundry sector would’ve seen a massive hit. AMAT saw sales into this equipment market dip by 22% while overall sales hit record levels due to a similar pickup in the DRAM segment.

Source: AMAT Q2'18 earnings release

The offsets from the services sector was the saving grace last quarter with related sales up 15% to $954 million.

FY20 Targets

One key point to FY20 targets is that AMAT doesn’t expect much in the way of growth over the next couple of years. FY20 EPS targets at $5.08 are about 14% above the FY18 target of $4.45.

The stock buybacks alone will reach, if not top, these targets. The combination of a large EPS and low stock price yields significant benefits to a stock buyback plan. The market mistakenly thinks that income growth is needed to reward shareholders.

A continuation of the buyback plan that reduced the share count by 9% over the last 12 months clearly provides a big boost to EPS. By simple math, a 10% reduction to the average share count by FY20 will boost the FY18 EPS target of $4.45 by about $0.45 to generate a $4.90 EPS target with equivalent income levels. Actual income growth in the period would provide a further EPS boost, suggesting AMAT only expect minor income growth over the next two years to reach the $5.08 target.

Combined with the solid 1.9% dividend yield, AMAT offers one of the largest net payout yields in the large-cap sector. The company returned an incredible $1.45 billion to shareholders in the last quarter alone including $1.25 billion in share buybacks. The yield that combines the net stock buyback yield and dividend yield has now reached nearly 13%.

The one big hesitation to the story is that management aggressively spent on share buybacks over a period where prices were much higher. The company bought 92 million shares in the last year at a time period where the stock was substantially higher.

The net payout yield concept only really works when management returns capital to shareholders at the appropriate times. Otherwise they signal to buy high and sell low. Considering AMAT first signaled the appeal of the stock back in early 2016 at a price below $20, one can have more confidence the management team is correctly aligned with the market. The recent purchases in the $50 range weren’t so bad considering the valuation and the new normal theory.

Takeaway

The key investor takeaway is that the "new normal" of the semiconductor equipment sector is unproven, but AMAT is placing their money into that theory. My confidence in the theory isn't high at this point, but the large share repurchases provide downside risk to investors buying the stock at these levels.

Disclaimer: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.

This article was written by

Stone Fox Capital

44.97K Followers

Stone Fox Capital (aka Mark Holder) is a CPA with degrees in Accounting and Finance. He is also Series 65 licensed and has 30 years of investing experience, including 10 years as a portfolio manager.

Mark leads the investing group Out Fox The Street where he shares stock picks and deep research to help readers uncover potential multibaggers while managing portfolio risk via diversification. Features include various model portfolios, stock picks with identifiable catalysts, daily updates, real-time alerts, and access to community chat and direct chat with Mark for questions. Learn more.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in AMAT over the next 72 hours. 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.

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