Don’t Mess with AMAT

02/15/2010 12:00 pm EST


Paul Larson

Editor, Morningstar StockInvestor

Paul Larson, editor of Morningstar StockInvestor, and analyst Andy Ng say the world’s premier chip equipment manufacturer has many competitive advantages.

Applied Materials is the behemoth of the semiconductor equipment industry, with unmatched scale and a broad product portfolio.

Applied Materials is the world’s largest supplier of semiconductor manufacturing equipment. It is the dominant player in a fragmented industry and competes in nearly every segment of the market, giving the firm a nearly ubiquitous presence in chip production.

The firm’s systems are used in the chemical vapor deposition, physical vapor deposition, and electroplating steps of the chip-fabrication process. Applied also supplies etching, chemical mechanical polishing, wafer- and reticle-inspection systems, and critical-dimension-measurement and defect-inspection scanning electron microscopes.

Applied is the closest thing to a one-stop shop for chip manufacturers. In 2008, the firm had a commanding 13% share in a $31-billion market, according to Gartner.

Applied has a wide economic moat for several reasons. Its installed base has expanded to more than 22,000 tools, and the firm has engineers in nearly every chip-manufacturing facility in the world. Applied’s scale and trusted name have allowed it to develop close relationships with customers, giving the firm insight into current and future customer technology needs.

Further, Applied’s substantial resources allow it to compete successfully in various market segments, in aspects ranging from pricing and marketing to research and development. Few firms can rival Applied’s roughly $1-billion annual research & development budget. The firm faces competitors that tend to specialize in specific segments.

A strong balance sheet gives the company flexibility in a deeply cyclical industry and allows it to enter new markets with relative ease, either through internal development or acquisitions.

[So, although Applied is] currently unprofitable because of the depth of the cyclical trough, the moat still looks to be intact.

Beyond semiconductors, Applied has been building a foundation for its emerging solar equipment business. Applied’s core technology expertise is extendable to solar cell manufacturing tools, which has allowed the company to enter this adjacent market.

Our fair value estimate is $22 per share. (The stock closed below $12.50 Friday—Editor.) Applied and its chip-equipment peers are in the midst of a severe cyclical slowdown, but business conditions have been improving. After revenue declined by 38% in fiscal 2009, we forecast that sales will rebound by more than 50% in fiscal 2010 and by 40% in fiscal 2011.

Over the long run, we expect average revenue growth to run in the low teens. Our projections are based on our expectations of chip-equipment market growth, our expectations of share gains for Applied, and emerging solar equipment opportunities. We project that operating margins will stay below par in upcoming quarters, but we expect them to rebound in the longer term as conditions normalize.

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