Apply Patience To Applied Materials

By Stephen D. Simpson, CFA | November 22, 2010 AAA

Technology investors are not always the most patient lot on Wall Street, and it is certainly true that a buy-and-hold approach towards sectors like semiconductors will produce some pretty nasty year-to-year volatility. That said, patient investors might want to think about swimming against the current on Applied Materials (Nasdaq:AMAT). Investors have certainly cooled on some parts of the chip sector and Applied's iffy guidance to start the next year will not help matters, but there could be real value here for more patient buyers.

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A Solid End To The Fiscal Year
While guidance will probably emerge as the dominant theme from Applied Material's report, the fiscal fourth quarter was actually pretty solid. Revenue rose almost 15% sequentially and jumped 89% from last year's level, easily beating both the average analyst guess and the highest published estimate. Sales were led once again by the Silicon Systems Group, but the sequential growth came from every other business unit but SSG.

Profitability was also substantially better than in the year-ago period. Adjusted gross margin rose six full points from the year-ago period and even more on a sequential basis. Operating profit (again, adjusted) was likewise strong - more than doubling on a sequential basis.

For the quarter, AMAT reported an ending backlog of $3.24 billion (up almost 4%) and orders of just over $3 billion - all good relative to the $2.89 billion in reported revenue. Nevertheless, the company did put out fiscal first quarter revenue guidance that was below the prior midpoint of analyst expectations.

The Road Ahead
Right now, the electronics sectors that AMAT serves are in a weird state of imbalance. PC sales have not been all that great - as seen in the results from Intel (Nasdaq:INTC) - and nor have TV sales. On the other hand, sales of Apple (Nasdaq:AAPL) products like the iPhone and iPad, as well as competing devices being pulled along in the wake, are offering some support to categories like memory chips. Likewise, AMAT has been navigating the vagaries of the solar market - shutting down SunFab to focus on the crystalline silicon part of the market, where panel shipments have stayed relatively strong. (For more, see Find Your Niche Market.)

In the meantime, it feels like a safe bet that AMAT's downward revenue revision will dominate the near-term outlook for these shares. With that, it would not be surprising to see other names like Lam Research (Nasdaq:LRCX), ASML (Nasdaq:ASML) or perhaps even Aixtron (Nasdaq:AIXG) get more love in the meantime.

The Bottom Line
It is not always easy to make value calls on tech stocks like AMAT, as so many tech sector investors are more interested in growth and momentum. That said, Applied Materials shares look surprisingly cheap. The company sports a LACFY above 7%, and a assigning a low forward revenue growth rate (3%) and the average trailing 10-year free cash flow margin leads to a fair value in the $18's. (For more, see Free Cash Flow: Free, But Not Always Easy.)

Value investors should not expect quick or easy validation if they decide to buy into these shares. Nevertheless, AMAT remains a leading supplier to a huge and growing market, and even the transition from growth to value should not completely strip away the chances that patient investors can see good gains here. (For more, see The Characteristics Of A Successful Company.)

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