After Earnings, Is Applied Materials Stock a Buy, a Sell, or Fairly Valued?

Applied Materials AMAT released its second-quarter earnings report on Aug. 15. Here’s Morningstar’s take on Applied Materials’ earnings and stock.

Key Morningstar Metrics for Applied Materials

• Fair Value Estimate: $193.00
• Morningstar Rating: 3 stars
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: High

What We Thought of Applied Material’s Q3 Earnings

• We raised our fair value estimate to $193 per share from $168 after lifting our long-term growth expectations. These are supported by broad advancements in chip complexity, which we expect to be partly supported by investment in artificial intelligence.
• Results and guidance were in line with our expectations, and we saw them as positive. We like Applied’s growth in fiscal 2024 and expect an acceleration in fiscal 2025.
• We now see shares as fairly valued but think investors can wait for a better entry point at current prices.

Fair Value Estimate for Applied Materials

With its 3-star rating, we believe Applied’s stock is fairly valued compared with our long-term fair value estimate of $193 per share, which implies a fiscal 2024 adjusted price/ earnings multiple of 23 times and a fiscal 2024 enterprise value/sales multiple of 6 times. The biggest drivers to our valuation are the cyclical growth of wafer fab equipment spending and Applied’s ability to increase market share.

We forecast 8% compound annual sales growth through fiscal 2028. In fiscal 2024, we project lower growth in the low-single digits as the semiconductor market remains soft. Memory chipmakers have slashed equipment spending as they work to raise profitability and cash generation, and logic chipmakers have also seen softer demand. We expect growth for Applied’s services business to pad revenue and avoid a top-line decline in this down year. We project strong growth for Applied in a cyclical rebound across fiscal 2025 and 2026, with midcycle growth in the mid-to-high single digits thereafter.

Read more about Applied Materials’ fair value estimate.

Economic Moat Rating

We assign Applied Materials a wide moat, based on intangible assets and switching costs. Applied’s proficiency in WFE comes from top-notch design expertise, in our view, and we think the firm’s embedded services business and long-term customer roadmaps are sticky. We also believe the sheer amount of investment required to remain at the forefront of leading chip development (particularly across so many subsections of the market) creates an immense barrier to entry for all but the largest and best-capitalized chip equipment manufacturers. We expect Applied to earn returns on invested capital well above its cost of capital for the next 20 years.

We think Applied holds the most comprehensive portfolio of equipment for semiconductor manufacturing in the world. Its product lines run the gamut of chip manufacturing, can serve logic and memory chipmakers alike with cutting-edge equipment, and have offerings in nearly every category spanning the spectrum of cost and capability. While many WFE peers occupy one or two corners of the market, Applied meaningfully plays in them all. The only exception is lithography, where ASML Holding ASML has a vise grip.

Read more about Applied Materials’ economic moat.

Financial Strength

We expect Applied to focus on generating strong cash flow while prioritizing research and development investment. We also expect it to remain moderately leveraged. As of October 2023, Applied held a net cash position, with $6.9 billion in cash and liquid investments compared with $5.6 billion in total debt. We like Applied’s strong balance sheet, which is supported by long-dated debt, most of which doesn’t come due until after 2030. Applied also has a $1.5 billion revolver it could tap into if needed.

Applied’s balance sheet is strengthened by robust cash flow. Over the past five fiscal years, the firm has averaged $4.6 billion in annual free cash flow, and we expect this number to jump over our five-year forecast to more than $7 billion as its volume grows. Both are close to 100% conversion of Applied’s net income.

Read more about Applied Material’s financial strength.

Risk and Uncertainty

We assign a High Uncertainty Rating to Applied Materials. The firm is prone to the cyclicality of the semiconductor industry, with times of oversupply and lower capital expenditures followed by times of strong demand and more manufacturing buildouts. Applied’s results can fluctuate with semiconductor end demand, but we still believe it can grow over the long term.

Applied also faces risks from geopolitical uncertainty, primarily between the United States and China. The US government has levied export restrictions on advanced semiconductor manufacturing equipment, which limits Applied’s ability to ship to Chinese chipmakers. This impact has already been digested, and we believe Applied can largely compensate through demand elsewhere in the world. Still, there is a risk that restrictions ramp up further and become a headwind to sales.

Read more about Applied Materials’ risk and uncertainty.

AMAT Bulls Say

• Applied Materials is the largest WFE provider in the world, with the broadest portfolio and the largest R&D budget of its peers.
• We expect Applied to benefit from drivers of chip complexity, like gate-all-around transistors and advanced packaging.
• Applied has strong profit margins and cash flow, and it sends most of that cash flow back to shareholders.

AMAT Bears Say

• We consider Applied Materials to be a generalist in WFE. The firm competes with more specialized competitors like Lam Research LRCX and KLA KLAC, which could outcompete it in their respective markets.
• Applied faces cyclicality in the semiconductor market, which can lead to years that see lower sales and margin compression.
• Applied faces risk from geopolitical tensions between the US and China that may further inhibit its ability to ship to Chinese chipmakers.

This article was compiled by Leona Murray.