NVDA - Applied Materials: Upgrading Back To Buy; Negatives Priced In Positives In 2024

2023-11-20 10:40:56 ET

Summary

• We are upgrading Applied Materials back to a buy.
• October quarter results and its January quarter outlook are consistent with the elevated and unsustainable spending by its Chinese customers.
• We are, however, less concerned about the high exposure to the Chinese domestic customers now as we expect leading edge WFE spend to rebound in 2024.
• Additionally, we are not concerned about the US government investigation onto its shipment to its Chinese customers and do not see any potential impact to its future financial performance.
• We now expect the stock to outperform through 2024 as leading-edge WFE spending for foundry/logic and DRAM recovers.

We’re upgrading Applied Materials ( AMAT ) to a buy post-earnings and news of the U.S. investigation. We now think the macro weakness and headwinds from the Biden administration ban have been priced into the stock and outlook. While we continue to be cautious on the semi-cap in the near-term, including Lam Research ( LRCX ) and ASML ( ASML ), we see a more favorable risk-reward profile for AMAT in 2024 driven by a rebound in WFE spending, which pulled back substantially this year. We don’t think it’s too early for longer-term investors to begin to explore entry points on the pullback.

This quarter , management reported flat Y/Y revenue growth to $6.72B, largely driven by better sales to Chinese customers panic buying ahead of the Biden administration ban expansion; DRAM shipments grew 66% this quarter to $1.32B, and the company’s core segment of Semiconductor Systems expanded 4% QoQ to $4.88B. Consistent with management’s expectations, we continue to believe higher Chinese sales will support financial performance into the next quarter. Management now guides for net sales of approximately $6.47B, plus or minus $400M, representing a 4% QoQ decline from $6.72B this quarter and $6.74B in a year ago quarter. We think FY24 will surpass FY23, driven by organic growth from foundry/logic and DRAM companies driving WFE spending as they transition to higher complexity chips and advanced nodes after somewhat of a dry 2023. We don’t expect WFE spending to rebound over the next 1-2 quarters; instead, our bullish outlook on AMAT is based on our belief that the company will experience a material reacceleration in top-line growth in 2HFY24.

Geopolitics intensify with AMAT in the middle

Reuters reported that AMAT is under U.S. criminal investigation from the Justice Department for the possibility that the company evaded semi export restrictions on China’s chipmaker, SMIC; the stock’s aftermarket slide of over 8% is primarily due to this news. The sources told Reuters that the investigation is into AMAT potentially having sent equipment to SMIC through South Korea without export licenses; the amount is worth hundreds of millions, according to those involved. The report states, “The company produced semiconductor equipment in Massachusetts, then repeatedly shipped the equipment from its plant in Gloucester to a subsidiary in South Korea, the people said. From there, the equipment went to China's Semiconductor Manufacturing International Corporation (SMIC)."

We’re not too worried as it remains unclear if there will be charges associated with the investigation if AMAT is found guilty and the news is priced into the stock. Additionally, the pullback creates an attractive entry point into the semi-cap player ahead of the 2024 WFE spend rebound, in our opinion.

Valuation

The stock is trading below the peer group at an extremely attractive valuation. On a P/E basis, the stock is trading at 19.7x C2023 EPS $7.89 compared to the peer group average of 40.4x. The stock is trading at 4.9x EV/C2023 Sales versus the peer group average of 5.9x. LRCX is trading at a similar valuation but higher, while ASML is trading well above the peer group average on an EV/Sales metric. We see attractive entry points at current levels to ride the upward trend in 2024.

The following chart outlines AMAT’s valuation against the peer group.

Word on Wall Street

Wall Street remains bullish on the stock. Of the 34 analysts covering the stock, 24 are buy-rated, nine are hold-rated, and the remaining are sell-rated. We attribute Wall Street's positive outlook on the stock to two factors: the first is the company’s position in the etch and deposition industry of the semi-cap, without which the chip-making process, as we know, wouldn't be possible. The second is expectations of an uptick in WFE spending. We share Wall Street’s longer-term outlook on the stock.

The stock is currently priced at $155 per share. The median sell-side price target is $160, while the mean is $159, with a potential 2-3% upside.

The following charts outline AMAT’s sell-side ratings and price targets,

What to do with the stock

We’re upgrading AMAT to a buy. We think the 4Q23 results and outlook for next quarter confirm the current export ban will continue to be a near-term headwind driving elevated Chinese sales. We expect WFE spend to rebound in 2024 and 2025, reaccelerating top-line growth driven by advanced node spending on both foundry/logic and DRAM fronts. We don’t think the WFE spend rebound will happen overnight, but we’re already seeing signs of recovery in DRAM bit shipment and pricing and expect to have more visibility on smartphone and data center/server TAM growth in 2024 to confirm our positive thesis playing out. We see a more balanced risk-reward profile now for the stock to outperform in 2024. We recommend investors explore entry points at current levels.

For further details see: