Applied Materials Forecasts An Ugly 2013

| About: Applied Materials, (AMAT)
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Applied Materials (NASDAQ:AMAT) recently decided to lay off 55 workers in its Gloucester, Massachusetts facility. Being one of the leading global suppliers for semiconductor equipment and solar panels, its substantial decrease in net income for the third quarter ending July from last year's $476 million to this year's $218 million, or $0.17 per share, down sequentially from $0.22 per share, should be seen as a harbinger of rougher times ahead for the general economy.

The semiconductor industry has been hit hard by disasters both natural and man-made, i.e. tsunami in Japan and the ongoing debt-deflationary recession happening in Europe and the U.S. In 2011, global semiconductor sales grew by just 0.4% to $299.5 billion. Computing and consumer electronics remain the primary markets for semiconductors, accounting for 60% of total sales. Unit demand for products in emerging markets, especially the BRIC nations, is rising, but weak purchasing power of the middle-class is pulling down margins. Everyone is struggling with this. Apple (NASDAQ:AAPL) reported net margins of 38.5% in their most recent earnings and guided below the 40% line going forward which shocked a number of analysts.

By the Numbers

In Applied Materials' case, 73% of sales revenues in the third quarter were from the Asia-Pacific region, which includes Japan, China, Korea, Taiwan and South East Asia. The region is not only dominant but also growing in terms of contribution to revenues.

Most of AMAT's new orders from all regions, 65%, went to its Silicon Systems Group (SSG) that exclusively deals with semiconductor chips and wafer fab equipment (WFE). The Energy and Environmental Solutions Unit (EES), which is focused on Solar, took a $44 million restructuring write-down, with a lot more to come, and contributed for just 2% of new orders. For the nine months ending July 31st for FY12, SSG and EES accounted for 66% and 3% of the net sales, respectively.

In a nutshell, rising sales in Asia-Pacific cannot offset falling sales in U.S. and Europe such that sales were down over 8% sequentially. Out of the total sales of $2.34 billion, new orders accounted for $1.80 billion, down 35% from the previous quarter. Rises in revenue from its Applied Global Service (NYSE:AGS) could also not make up for the slack in SSG either. LED Display continues to be very weak.

Future Outlook

Sales to foundries account for 58% of the SSG's orders, which is followed by Flash memory (19%), 'Logic & Others' (13%), and DRAM (10%). The demand from Foundry and Logic customers fell by 13% overall with new orders dropping 41%.

For the fourth quarter, Applied Materials is expecting the revenues to fall by 25% - 40% sequentially. The future of semiconductor is not particularly bright due to broad-based economic slowdown in U.S., Europe and China.

The Semiconductor Industry Association is forecasting sales going forward that are a microcosm of AMAT's results: slow or negative U.S. and European growth with strong Asian-Pacific growth. AMAT is pinning its future growth on 450mm wafer demands for 28nm and 20nm processes, increasing the demand for semiconductor equipment as well as rising display sales as smartphone and tablet screens increase in size, offsetting slower discrete PC and laptop sales.

According to the latest from Taiwan rumor-mill Digitimes, foundry sales could be maintained industry-wide above $9 billion in 2013, while demand for NAND flash memory is expected to remain weak. Microsoft's (NASDAQ:MSFT) Windows 8 will not help the situation. If anything, it will hurt as Windows 8 is more capable than Windows 7 on older hardware from everything I've seen, slowing PC upgrades even if the upgrade rate for Win 8 is strong. Demand for notebooks and Intel's (NASDAQ:INTC) Ultrabooks looks weak for the fall as major Taiwanese ODM Compal has cut its forecast for the 2nd half of 2012 from 47 million to less than 41 million units, a ~13% decrease. LED display prices will continue to be under pressure.

The Bottom Line

AMAT's management is banking heavily on foundries putting in heavy orders for wafer fab equipment to kick start SSG division sales beginning late next quarter, as the industry moves more heavily towards mobile devices and the need for infrastructure build out associated with it. But, management is thinking in terms of there being a recovery in China through monetary and fiscal stimulus that isn't likely coming anytime soon.

So, at this point, the stock looks like a mixed bag at best if mobile computing improves semiconductor wafer sales, while LED display and solar continue to work through their over-capacity issues. There is no compelling reason to buy AMAT today at a P/E of ~15 paying a 3% yield if the major economies are all working through recessions or slow-growth in 2013. January 2014 $15 calls are trading near $0.50 and may represent good value as the industry begins gearing up for a better 2014, while your options have 6-7 months to expire.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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.