Applied Materials Is Trying to Manufacture an Even Higher Stock Price

Back in July, I wrote that I thought Applied Materials (AMAT) could manufacture a higher stock price. Year to date, the stock is up 75%. Can Applied Materials stock keep going?

Last week, Applied Materials reported fourth-quarter fiscal 2016 earnings of 66 cents per share, a penny better than the consensus estimate. Revenue rose 39.2% to $3.3 billion. Backlog decreased 7% to $4.58 billion. Gross margins rose 150 basis points to 43.7% and operating margin jumped 590 basis points. Net income increased 108% to $722 million.

Management raised guidance. The company foresees first-quarter earnings of 62 cents to 70 cents, vs. the initial estimates of 58 cents. Revenue is expected to be between $3.20 billion and $3.34 billion.

The company continues to target $2.80 in earnings and $3.17 the year after, based on a $1.6 billion increase in semiconductor revenue and the wafer fab equipment market reaching $34.5 billion.

I think Applied Materials can still go higher for four reasons.

First, the long-term trends that are driving the equipment cycle are still in place. Worldwide equipment spending is estimated to grow about 3% in 2017 and is projected to keep going past $37 billion by 2019. The worldwide demand for semiconductors shows no sign of letting up, and that's driving equipment spending.

Second, new technologies like 3-D NAND memory and new etch techniques are in the early stages of their growth. Last year, Applied Materials landed over $1.5 billion of orders for 3-D NAND equipment. New etch patterning has added about $1 billion in new equipment sales.

Third, the company believes OLED display technology will be used in more than half of all smart phones by 2020. Right now, only 20% of smartphones use OLED displays. Combined with adoption of virtual reality, it could add $1.5 billion to $3 billion of incremental spending.

And fourth, Applied Materials thinks China remains a huge opportunity. The Chinese are investing heavily in new technology and could spend $20 billion to $30 billion on new wafer fab equipment over the next five years.

Historically, the semiconductor equipment group trades between 14 and 16 times forward estimates. The consensus is looking for earnings of $2.40 for fiscal 2017 and about $2.50 for the year after. Since Applied Materials is so dominant in the industry, it's not unusual for the stock to command a 16x forward multiple for a price target of $40 per share.

While the equipment market can be lumpy, I remain very optimistic regarding new types of memory, etch patterning, and higher display spending, led by OLED adoption in mobile devices and televisions. In my opinion, Applied Materials can still reach for a higher price.

This article is commentary by an independent contributor. At the time of publication, the author held no position in the stocks mentioned.

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