Avoid Applied Materials -- It's Getting Cheaper for Good Reason
Shares of Applied Materials (AMAT) - Get Report have plummeted more than 33% in 2015 and are down about 26% over the past twelve months, trailing both the Dow Jones Industrial Average (DJI) and the S&P 500 (SPX) index.
To the readers who bought these shares on my buy recommendation back in February, allow me to apologize. After Applied Materials grew 2014 earnings by more than 300%, buoyed by the sustained demand for smartphones and various mobile devices, duplicating its success was a tall order. This is one call I completely got wrong. And now, despite the appeal of its shares as they sit 35% below their 52-week high, investors would do well to resist the cheap stock price and consider the factors impacting the company's growth.
Headquartered in Santa Clara, Calif., Applied Materials reports fourth-quarter fiscal 2015 earnings results after the closing bell Thursday. Applied supplies equipment, services and software to the various manufacturers that make smartphone components such as flat-panel displays, and the chips for computers and smartphones. It's been a profitable business. But for how long?
For the quarter that ended in September, analysts' average earnings estimate calls for 29 cents a share on revenue of $2.4 billion, compared to the year-ago quarter when Applied earned 27 cents a share on revenue of $2.26 billion. For the full year, earnings are projected to climb 10% to $1.18 a share, while revenue of $9.63 billion would mark an increase of 6%.
These numbers appear solid, but they are not as strong on an organic basis as they look. In its fiscal third quarter, for instance, owing to weaker-than-expected demand in its foundry business -- its chip-making segment for customers like Intel (INTC) - Get Report -- Applied missed analysts' consensus revenue estimates and reported only in-line earnings results. Not to mention, the company issued tepid fiscal-year outlook, suggesting that its order growth -- despite being on the high end -- would suffer from weak profit margins.
This resulted in several analyst downgrades, including one from Pacific Crest's Weston Twigg, who cut his price target by $4 to $23. It's true, a $23 price target is still around 38% higher than current levels around $16.67 But there was tons of implied confidence in Applied's outlook back in February based on price targets, and the stock didn't deliver.
"We are concerned that foundry demand is softening due to end-market weakness, which could last several quarters," Twigg also noted. "We also expect Intel's capex to remain low next year as it maximizes equipment reuse amid low PC demand," he added. The extent of these issues is likely to reveal itself Thursday, making AMAT stock -- despite its attractive price -- a risky play. Investors would do well to avoid these shares for now, and wait until the company has issued its outlook for 2016 and offered insight into its foundry business.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.