Tickers in this Article: AMAT, KLAC, NVLS, ASML, MU, AUO, STP, LPL
Right up there with "it's different this time" in the lexicon of dangerous Wall Street sayings, is "how much worse can it get?" When it comes to Applied Materials (Nasdaq:AMAT) and its solar and flat panel businesses, apparently the answer is "a whole lot worse." Although recovery in semiconductors is arguably in sight, it seems likely that analysts and institutional investors are going to be more interested in names like KLA-Tencor (Nasdaq:KLAC), Novellus Systems (Nasdaq:NVLS) and ASML (Nasdaq:ASML), until Applied Materials proves convincingly that it can pull out of this nose-dive.

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A Sour End to a Tough Year
Not so long ago, I publicly wondered as to whether Applied Material's forward guidance was one of those kitchen sink situations, where management just wanted to get all of the negativity out of the way. Apparently, the answer is "no," as the fourth quarter was not very strong, and the company's forward guidance was not encouraging.

Sales fell about 24% from last year and 22% from the prior quarter, as the display and solar businesses were quite weak. That said, it wasn't as though the core semiconductor equipment business was stellar either, as sales, there, fell 24% from last year.

With most tech stocks, however sales go, so goes profits. By generally accepted accounting principles (GAAP), Applied Materials saw notable erosion in gross profits, operating profits and the corresponding margins. (To know about the differences between IFRS and GAAP, read: What Are Some Of The Key Differences between IFRS and U.S. GAAP?)

Orders Look Grim
This was a pretty lousy quarter for orders as well. New orders fell about one-third from the third quarter level, and were close to half the level reported in the year-ago fourth quarter. Semiconductor orders were soft, down about a quarter, as memory makes like Samsung and Micron Technology (Nasdaq:MU) hold back on expenditures during this tough time in their business.

It doesn't seem like an exaggeration to say that Applied's orders, in display and solar, were just gutted; display orders were down 91% and solar were down 73%. This isn't quite shocking when you look at how weak the stocks of companies like AU Optronics (NYSE:AUO), LG Display (NYSE:LPL) or Suntech Power (NYSE:STP), but the fact that it's not stunning doesn't make it any better.

What Will the New World Order Look Like?
Maybe it isn't fair, and maybe my memory isn't completely accurate, but it feels like Applied Materials has a knack for entering markets right before they get sliced up, badly. I seem to recall that Applied Materials made a big push into flat panel equipment just as that market was getting "commodified," and now the company has bought Varian just as the solar industry is being slowly drawn and quartered.

Now, to be fair, it is not as though flat panels went away - they are everywhere these days, and there is still a need for equipment to make those panels (even if Applied's orders here wouldn't seem to suggest so ...). Likewise, solar is here to stay and the market will recover eventually. What is less clear, though, is what the company's margin structure is going to look like going forward.

So, in addition to serving a host of volatile, cyclical markets, now the operating profitability of the business is in question. Small wonder, then, that so many analysts seem to approach Applied Materials with the attitude of "we know it's too cheap, but we don't want to recommend it." (For additional reading, check out: Tips For Investors In Volatile Markets.)

The Bottom Line
Odds are that foundries will lead the recovery in semiconductor equipment, and that would seem to point in favor of KLA-Tencor, Novellus and ASML over Applied Materials and Lam Research (Nasdaq:LRCX). Then, of course, there are the smaller players like Cymer (Nasdaq:CYMI), Advanced Energy (Nasdaq:AEIS) and Ultratech (Nasdaq:UTEK) for investors who want even more beta with their alpha.

Is Applied Materials too cheap today? Almost certainly. The trouble, though, is that a buyer here around $12 has to be comfortable with the risk that it might see 10, 9 or $8 before 18 or $20, and those latter two could take two or three years to reach. For investors who don't mind, and happen to believe that a solar recovery will add a nice kicker to this story down the line, this is a stock to consider. Just don't expect the Street to love the name until it is obvious that a recovery is underway, and the stock is already up 30 or 50% from the bottom.

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

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