From the fall of 2012 until very recently, my bullish call on Applied Materials (Nasdaq:AMAT) finally started to pay. Shares rose nearly 50% in six months as investors finally started to believe that NAND capex spending was going to improve and that the flat panel business had likely bottomed, not to mention some confidence that the company would see better results with different leadership. Although these shares are not overpriced on a free cash flow basis, investors who want to stay exposed to semiconductor equipment may want to think about switching over to the stocks of companies with better individual growth stories.

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Fiscal Second Quarter Results Show Some Improvement
Applied Materials still has a lot further to improve, but at least this quarter saw the company moving in the right direction. Revenue fell more than 20% from the year-ago period, but did rise 25% from the prior quarter and beat the average Wall Street estimate (and matched the Street-high number). On a sequential basis, the sales growth was fueled by strong growth in both the core Silicon business (up 33%) and the flat panel business (up 46%).

Perhaps more impressive was the company's performance on the margins. A strong sequential improvement in gross margin (up 340bp) isn't so surprising, but the 110bp improvement over last year was a solid result. Although the improvement didn't exactly carry through the income statement (operating income fell 42% from last year), the company's 14.4% operating margin was nevertheless better than most analysts expected.

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Orders And Market Share Better, But Will It Last?
For the quarter, Applied Materials reported that new orders fell 18% from last year, but grew 7% sequentially. This growth appears to be driven by improved spending from memory customers and flat panel display manufacturers.

Applied Materials also appeared to gain some share this quarter. In both inspection and the PDC group, it sounds as though AMAT gained share from KLA-Tencor (Nasdaq:KLAC). That's promising, but I wouldn't make too much of it yet. Applied Materials is more dependent on NAND spending and these gains could have been a byproduct of order timing and customer mix. Along those lines, Tokyo Electron has also been seeing solid demand recently from memory and foundry customers. Still, it's better than the alternative.

Can Applied Materials Stand Out From The Crowd?
Applied Materials is the largest name in semiconductor equipment, and there aren't many areas where the company doesn't compete. That gives the company broad exposure to the semiconductor capex cycle and the spending tied to the migration from 28nm to 20nm.

Unfortunately, it also means that as semiconductor capex goes, so goes Applied Materials. Relative to companies like ASML (Nasdaq:ASML) or Ultratech (Nasdaq:UTEK), then, there aren't the same product- or market-specific stories to really push the stock. True, a recovery in flat panel equipment demand would be a big help, but I do have concerns that the company has grown to a point where it is hard-pressed to distinguish itself from the industry apart from driving better internal cost savings and efficiencies.

The Bottom Line
I don't want to underestimate the potential significance of margin improvements at Applied Materials – even in a revenue growth-obsessed sector like technology, margin improvements can drive stocks. Even so, the stock's strong performance has driven its price/tangible book value ratio above the top end of its typical range, while there are still ample reasons to be cautious about customer commitments to higher semiconductor capex spending.

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To the extent that modeling cash flow for a deeply cyclical company like Applied Materials makes any sense, the stock does appear to be undervalued on a long-term, full-cycle basis (fair value appears to be near $17). I don't want to sell the company short on its ability to improve margins and/or reap the benefits of a flat panel recovery, but with an almost 50% gain from the bottom in hand, I'd be tempted to think about switching to other names in the space like Ultratech.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.