2023-11-17 15:31:07 ET
Summary
- Applied Materials has exhibited strong financial performance in its recent FY4Q earnings report, surpassing estimates and demonstrating growth across multiple segments.
- The company is facing an ongoing US criminal investigation related to potential evasion of export restrictions, which has put pressure on its stock.
- Despite the investigation, Applied Materials maintains a positive outlook and has a history of resolving such situations with minimal financial impact.
In the recent Fiscal Q4 earnings report, Applied Materials, Inc. ( AMAT ) has exhibited a strong financial performance, surpassing estimates and demonstrating robust growth across multiple segments. Despite an ongoing U.S. criminal investigation related to potential evasion of export restrictions, the company maintains a positive outlook. While the investigation has indeed cast a shadow over AMAT's stock, we believe that historically, such situations have been resolved with minimal financial impact. This article seeks to delve into the financial details, investigate the potential implications of legal scrutiny, and provide a balanced perspective on the future of Applied Materials.
Earnings Analysis
In our view, Applied Materials has presented a robust fiscal fourth quarter earnings report with revenue of $6.72bn, marking a 5% quarter-over-quarter (qoq) increase and remaining flat year-over-year (yoy). This performance surpasses our estimates and the FactSet consensus by 3%. We attribute this growth to the strong contributions from the Semiconductor Systems ((SSG)), Applied Global Services ((AGS)), and Display & Adjacent Markets (Display) segments.
The SSG segment generated $4.88bn, a 2% increase qoq, but a 3% decrease yoy. We perceive this as a slightly mixed result. The AGS segment, on the other hand, showed more positive momentum. Its revenue of $1.47bn represents a 1% increase qoq and a 4% increase yoy. The Display segment, which we've been closely monitoring, demonstrated significant growth, with revenue of $298mn, marking a 27% increase qoq and 19% increase yoy.
From a profitability perspective, AMAT's non-GAAP gross margin stood at 47.3%, up 90bps qoq and 130bps yoy, outperforming the company's guidance by 30bps. This margin expansion reaffirms our positive stance on the firm's cost management strategy. However, it's worth noting that non-GAAP operating expenses totaled $1.19bn, indicating a 2% increase qoq and 9% yoy and exceeding the company's guidance by $20mn. Despite this uptick in expenses, the non-GAAP EPS of $2.12 exceeded Street consensus by 7%.
Looking towards the future, AMAT's guidance for FY1Q includes revenue of $6.47bn, non-GAAP gross margin of 47%, non-GAAP operating expenses of $1.23bn, and non-GAAP EPS of $1.90 at the midpoint. By segment, the company expects SSG revenue of $4.7bn, AGS revenue of $1.47bn, and Display revenue of $235mn. Importantly, this guidance takes into account a tax rate of 13%.
Elephant in the Room: China and U.S. Criminal Investigation
Applied Materials has recently been subjected to increased scrutiny due to a U.S. criminal investigation on potential evasion of export restrictions, particularly to Chinese company SMIC. The investigation, as reported by Reuters , has caused considerable pressure on AMAT shares.
On the earnings call , management did not significantly comment on the situation but has reminded investors of a previously disclosed subpoena related to the issue back in October. The leadership insists they are fully cooperating with the authorities and pointed out that they are unlikely to deliberately circumvent the sanctions.
The Reuters report suggests that AMAT may have been evading export restrictions by routing equipment worth hundreds of millions of dollars to SMIC via South Korea. The potential implications of this investigation might be significant, not only for AMAT but also for other equipment providers shipping to SMIC. The unpredictability of the situation could pose operational and future shipment challenges. Despite this, AMAT maintains that new U.S. restrictions on shipments to China do not materially impact its business.
These types of investigations, while potentially unsettling for investors, often conclude in a manageable manner. Recall that last year Seagate Technology ( STX ) agreed to pay a $300 million penalty in a settlement with U.S. authorities for shipping over $1.1 billion worth of hard disk drives to China’s Huawei in violation of US export control laws.
In terms of revenues, AMAT has reported substantial earnings from China in Q4 and anticipates this trend to continue into Q1. This is largely due to the steady shipment of DRAM products, mirroring trends seen in other equipment companies. However, there is some concern about the decline in demand for mature-edge equipment (AMAT's ICAPS business) by 2024. Although no precise guidance was provided for 2024, the company expects it to be strong, if not as impressive as 2023. This might be due to expected softness in industrial automation and automotive sectors in 2024.
Financial & Valuation
Note: All historical data in this section comes from the company’s 10-K filings , and all consensus numbers come from FactSet.
Looking at the company's financial trends over the last three fiscal years, there's been some robust growth in revenue, with a compound annual growth rate ((CAGR)) of 15.2%. Meanwhile, the sell-side consensus is expecting this growth to slow down, predicting a contraction of 0.7% this fiscal year to $26.1 billion, followed by a growth rate of 8.3% next fiscal year to reach $28.3 billion. The company's EBIT margin has also improved over the past three fiscal years, from 26.3% to 29.0%, although the consensus is forecasting a slight contraction to 28.2% this fiscal year and a subsequent expansion to 29.2% the following fiscal year.
One positive note is the company's share buyback strategy, which has resulted in a 9.2% decrease in outstanding common shares over the past three years. This strategy has helped to boost the EPS growth to a CAGR of 23.8% over the same period, outpacing its revenue growth. However, the consensus is predicting EPS to decrease by 2.0% to $7.76 this fiscal year, before rebounding by 14.0% to $8.85 the following fiscal year.
The consensus estimates on free cash flow ("FCF") are also encouraging. An expected $5,741 million in free cash flow this fiscal year represents a 22.0% FCF margin, a significant improvement from the 16.5% FCF margin four fiscal years ago. This suggests a strong ability to generate cash, which is integral for paying dividends, repurchasing shares, or reinvesting in the business.
In terms of valuation, AMAT is currently trading at a forward 12-month P/E of 19.8, which is towards the higher end of its 5-year range (9.4 to 21.6). This suggests that the stock might be overvalued relative to its historical trading range. However, when compared to its peers, LRCX and KLAC, which are trading at forward 12-month P/Es of 23.0 and 22.2, respectively, AMAT appears to be trading at a discount.
On a final note, the stock's return over the past year has been impressive, with an absolute return of 50.0%, outperforming the S&P 500 (SP500) by 34%. However, the stock's current dividend yield of 0.8% is 62 bps lower than the S&P 500, which could be a point of concern for income-focused investors. The moderate short interest of 2.6% suggests that there is a balanced view among investors on the stock's future performance.
Conclusion
Despite the formidable challenges that Applied Materials, Inc. faces, the company's robust earnings, strong growth across its segments, and effective cost management strategy attest to its resilience. The scrutiny from the ongoing U.S. criminal investigation indeed exerts pressure on the company's stock, yet history has shown that such situations often resolve without causing a significant financial impact.
One must remember the case of Seagate Technology, which managed to settle a similar issue by simply paying a penalty. Furthermore, AMAT has demonstrated a robust financial trend, with a CAGR of 15.2% over the last three fiscal years and a promising free cash flow forecast. Even with an anticipated contraction in growth, the company is expected to rebound quickly.
While the legal shadows may cast temporary doubts and drive market volatility, it is important to look at the broader picture. AMAT's long-term prospects, bolstered by its proven performance and a strong financial foundation, remain promising. Therefore, we maintain our faith in the company's ability to navigate this storm and emerge even stronger, continuing its path of growth and delivering value to its shareholders.
For further details see:
Surviving The Storm: Applied Materials' Robust Earnings Amidst Investigation