AMAT: Still No Bottom for Applied Materials

By William Trent, CFA of Stock Market Beat

Even though there were conflicting signals yesterday about the state of the semi equipment market, I was on the side of those expecting a slowdown. I was warning about pending overcapacity issues for the better part of the last year. The chart of memory prices is not the sort of pattern that inspires new investment. Now that it is happening, however, I’m looking for opportunities to buy on the news.

A big piece of news came in with the earnings report from Applied Materials. Orders rose 6% year/year and 4% sequentially, sales grew 13% year/year and 11% sequentially, and earnings were significantly better than expected. All in all it was better than I thought they would be able to do. I thought of three potential explanations:

1. I am wrong about the semi equipment cycle. While possible, I refer back to the points above and say “I don’t think so.”
2. I am right about the semi equipment cycle but Applied Materials is special. It could be they are gaining share, or in market segments that will be less affected by the cyclical order slowdown. Given that Applied is the largest manufacturer, I have a hard time accepting this theory as well.
3. I am right about both semi equipment and Applied Materials, but still early. Given my skepticism of choices 1 and 2, I guess I’m still in this camp, though I am willing to entertain other possibilities (please comment!)

To test the ideas further, I turned to the tape – or at least the transcript. It’s a good thing I had stocked up on tequila, as the guidance suggests the bottom was not yet reached.

Our targets for the third quarter reflect the industry dynamics that Mike just summarized, but that is a foundation we expect orders to decline in the range of 10 to 15%, we expect revenue to be within a range of flat to plus or minus 2% and we expect EPS to be at modestly 0.30 to $0.32.

(Excerpt from full AMAT conference call transcript)

There was even a specific run-down of orders by segment:

The short-term view based on our customers’ plans in the silicon area indicates DRAM orders will trend down next quarter. DRAM manufacturers continue to invest for the future and we see significant bit growth absorbing new capacity as Vista becomes mainstream and DRAM adoption in cell phones continues to grow.

Meanwhile, flash orders will increase and partly offset the DRAM decline. Customers continue to drive capacity as new applications appear with the promise of solid state drives still on the horizon.

We expect bookings from foundries will increase but remain relatively weak. Foundry orders have not returned to levels we expected at the end of Q1, as indicated by foundries being only 12% of our Q2 orders.

Inventories have not diminished as quickly as projected, resulting in lower utilization rates at the leading edge. New 65-nanometer products continue to take out at a rapid rate, and judging from recent earnings reports, foundry business is improving. Therefore, we believe foundry utilization rates should start to improve and expect CapEx spending for foundries to recover with increased seasonal demand.

However, for the year we expect memory to comprise more than 60% of our equipment orders with foundry under 20%.

Display market weakness carried over from last quarter, with display orders being roughly flat, driven by continued delays and new investment decisions by the major players as they work through a 10% over-supply situation. We expect display CapEx spending to be down 30% to 40% for the year, more than our prior estimates.

(Excerpt from full AMAT conference call transcript)

Of course, as I noted in other articles, Applied CEO Michael Splinter is an eternal optimist. So investors have to consider his current comments in the context of those he has made in the past. Like last quarter:

At this point in the year, we are where we thought we would be, and I remain confident that our team will execute effectively throughout the year and deliver on the results we forecast for 2007.

Let me begin with some comments about the business environment. In our Fab Solutions segment, the semiconductor industry is experiencing a seasonal slowdown as anticipated. Wafer starts drop during the quarter with fab utilization in logic and foundry fabs approaching 80%, which is slightly lower than we had anticipated. The lower levels of fab utilization to a downward pressure on spares and service revenue. We expect to return to revenue growth in Q2, as fab loadings bottom out and begin to increase and ramp through the remainder of the year. Wafer start outlook is good for 2007 projected at 8% to 10% growth. And our Fab Solutions results are expected to exceed that level.

Our Silicon segment bookings were up in Q1 and we expect them to grow again in Q2. Memory orders were strong demonstrating the success of our new products that are growing share in this critical market segment. We expect our overall memory business to remain relatively strong and balanced over the year with NAND flash growing in the second half….

The foundries, however, continue to hold back on capital investment and are very much in the bottom of the trough at only 11% of our bookings in Q1. From our analysis and dialogue with our customers, we expect the foundries to come back in Q3, as 65 nanometer RAMs enter high volume production….

Now let’s turn to the Display business. It’s clear that customers are hesitating or are in between investments. During 2006, LCD TV volume grew by more than 100% and for the first time LCD TVs pass plasma TVs in the 40 to 44 inch sweet spot. We expect TV volume to continue to grow at around 60% in ‘07, and therefore we do expect orders to be up slightly in Q2 with a more full recovery in orders by Q3 and in revenues by Q4.

(Excerpt from full AMAT F1Q07 conference call transcript)

So those forecasts were too optimistic on silicon, foundries, and dislay. We’ll give them a pass on memory for now. How about the quarter before that?

While we expect a short-term order pause in Q1, we believe 2007 will see an increase in wafer fab equipment spending. With our forecast estimate forecasting an increase a roughly of approximately 6%. With our focus on creating advanced systems and solutions, as we move through each node, the buildout of 65 nanometers and the technology buys for 45 nanometers will be positive for Applied Materials. Therefore we expect to grow our Silicon business by more than 10% in 2007 despite a rather slow start.

(Excerpt from full AMAT FQ406 conference call transcript)

You get the point. Applied Materials keeps pushing out their expectations of a bottom while their customers push out their orders for more equipment. It is an old story, an utterly predictable story and one investors are clearly tiring of. The shares were down more than 5% in after-hours trading on top of a 3% decline during market hours on the back of Goldman Sachs naming the company a “conviction sell.”

As for me, I’m still looking for opportunities to buy on the news. But I’ll look somewhere other than Applied Materials, where you can never be sure which news is “the” news.

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