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Published: April 7, 2010
When investors shift funds into a certain
sector, they often go with the biggest, most
liquid names in the
group. These bigger firms offer direct exposure to the
anticipated favorable trends without the volatility often found
with smaller industry players. So it's curious to find that
investors have moved headlong into semiconductor stocks during
the past year -- the Philadelphia Semiconductor
index has risen
+57% -- while Applied Materials (Nasdaq: AMAT), a favorite name
in past cycles, has risen a more moderate +29%.
This atypical underperformance is the result of pair of factors
-- and each of them look set to reverse course.
Tracking Applied Materials'
market share can be quite tricky.
The company sells a range of equipment that is used in various
stages of the chip development and production process. Investors
need to become familiar with industry jargon to be able to track
industry sales trends at a granular level. For starters, Applied
Materials lost market share in the last few years to rivals such
as Tokyo Electron. As a result, sales fell even more sharply in
2009 than at key rivals. Nevertheless, a combination of new
products and improved sales execution has halted the market
share erosion in recent quarters, and management recently spoke
of market share gains at a recent meeting with analysts. Even if
market share remains flat and doesn't erode any further, the
company is poised for fairly robust sales growth as chip makers
start to re-invest in the equipment needed to design and make
state-of-the-art semiconductors.
We are now entering the boom phase in a notoriously boom-or-bust
industry. Applied Material's sales fell from $8.1 billion in
fiscal 2008 to just $5.0 billion in 2009. Management has noted a
strong rebound underway, and after a recent boost in guidance,
it thinks sales in fiscal 2010 will exceed $8 billion, perhaps
reaching $8.5 billion. Industry analysts think annual sales
could reach $10 billion by fiscal 2011. Equally important,
Applied Materials has embarked on aggressive cost-cutting, so
the company should squeeze out more profit in this next cycle.
Management expects the benefits of recent cuts to steadily boost
margins during each of the next five quarters. In another
shareholder-friendly move, management announced a $2 billion
stock buyback plan, which could remove nearly 10% from the
existing share count.
The company has another perception problem with investors: a
decision to move into the solar power industry, which has not
generated any meaningful profits yet. The solar segment is a bit
Jekyll-and Hyde for the company. Applied Materials is seeing
solid demand and impressive profit margins for its equipment
focusing on the production of traditional crystalline solar
panels. The Sunfab division, however; which focuses on
less-efficient thin-film solar panels, has been a drain on the
coffers. Although the shift into solar may prove to be prescient
over the long haul, management is throttling back its investment
in the near-term, which should create far less drag on the
bottom line.
The exposure to the more dynamic end of the solar power industry
could help boost sales and profits in coming years, as should a
push into equipment that helps produce flat panel displays. But
the important question for investors is whether the current
spending rebound in the core semiconductor business will last
several years or prove to be short-lived. Historically speaking,
these cycles tend to last three to four years, and we're only
several quarters into the up leg of the cycle.
If the bears are correct, and spending is likely to be muted,
then shares probably have only a small amount of upside. But if
the cycle lasts several years, Applied Material's leaner cost
structure and lower share count could power a steady bottom-line
expansion into 2011 and 2012 with per share profits coming in
around $1.35 by fiscal 2012. If you apply a multiple of 15 times
earnings, shares could approach $20 -- some +50% higher from
recent levels.
-- David Sterman
Contributor
StreetAuthority |
