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Morningstar | Wide-Moat Applied Materials Appears Undervalued in Spite of Softer Near-Term Equipment Spending

Applied Materials reported fiscal fourth-quarter results that reflected a slowdown across the wafer fab equipment, or WFE, market. Forward guidance exhibited persisting softness, particularly in equipment demand from memory suppliers. We continue to expect modestly lower WFE spending in 2019, primarily due to weaker 3D NAND-related investments. Despite the near-term challenges, our positive thesis on the rise in capital intensity for semiconductor manufacturing is intact. Shares fell 7% during after-hours trading, as we believe the market expects a cyclical downturn. We are maintaining our wide moat rating and $49 fair value estimate for Applied and we find current levels attractive.

Fiscal fourth-quarter sales were $4 billion, up 1% year over year and down 10% sequentially. Semiconductor system sales fell 5% over the same period last year, with higher DRAM and logic sales offsetting a decline in NAND and foundry spending. Services revenue grew 18% year over year to $977 million, as the firm’s large installed base drives sales of upgrades, refurbishments, and service contracts to troubleshoot issues faced by customers. We think this part of the business (24% of total revenue during the quarter) is very sticky and should help mitigate the cyclical tendencies of equipment sales, particularly in the near-term. Display sales rose 4% year over year to a record $702 million, driven by OLED display investments. Gross margins were 44.3%, down 110 basis points sequentially due to lower equipment volume and a less favorable mix skewed to growth products versus leadership products.

For fiscal 2018, revenue grew 19% to $17.25 billion, led by growth across each of the major segments. Within the semiconductor systems group, all sub-segments grew with the exception of foundry. Management expects first-quarter sales to be at a midpoint of $3.7 billion. This would represent a 12% year-over-year and 8% sequential decline. In particular, semiconductor system revenue is expected to be down 21% year over year, partially offset by an increase in services and display sales (7% and 10%, respectively). We note memory customers are better equipped to navigate “downturns” with greater cash cushions and profitability levels from the recent memory upswing, thanks to more rational behavior from a supply/demand standpoint. Consequently, we don’t think short-term delays in equipment spending by Samsung and Micron will last nearly as long as past downturns. Meanwhile, key secular trends (artificial intelligence, shift to the cloud, rise in automotive content) remain very much intact and will continue to require more advanced equipment from the likes of Applied.