- Applied Materials will report its Q3 Fiscal Year 2022 earnings on Thursday, August 18.
- While quarterly earnings may continue to be robust, its order backlog and outlook are key for its share price reaction.
- Applied’s share price may react negatively, as the company is likely to revise downwards its near term growth expectations.
Applied Materials ( AMAT ) is scheduled to announce earnings related to Q3 FY 2022 next Thursday, and its order backlog and guidance will be key for its share price reaction, which most likely will be negative as the company adjusts medium-term expectations for a more challenging macroeconomic and operating environment than expected in the recent past.
Background
As I’ve covered in a previous article , Applied Materials has a leading position in the semiconductor equipment industry, but the company’s significant exposure to China makes me cautious on its medium to long term growth prospects.
Applied Materials is a global company operating in the semiconductor industry, supplying manufacturing equipment, services and software to other semi and display manufacturing companies. Its largest business segment is Semiconductor System, which comprises the sale of manufacturing equipment and generates more than 60% of total revenues, Services is responsible for some 25%, while 10% of its revenue is driven by Display.
Even though Applied operates in several steps of the chip manufacturing process ((CMP)), it has a leading position in the segments of polishing, Ion Doping and Thermal, where it holds significant market shares as shown in the next graph.
Semiconductor industry (Bloomberg)
Like other semi equipment companies, Applied has a relatively concentrated customer base, with some of its largest customers including Taiwan Semiconductor Manufacturing Company ( TSM ), Samsung Electronics ( OTCPK:SSNLF ) or Intel ( INTC ). Geographically, Applied generates the vast majority of its revenues in Asia, in countries such as China, Korea and Taiwan.
Even though the semiconductor industry has very good growth prospects over the long term, Applied is one of the semi equipment companies with higher exposure to China, representing some 30% of its annual revenues, which can potentially be a headwind in the next few years. China’s strategy in the semiconductor industry is to gradually increase the local content in chip manufacturing, to reduce its exposure to foreign companies, thus Chinese competitors may gain market share, being a potential negative factor for Applied’s revenue and earnings growth.
More recently, the U.S. also showed intentions of limiting chipmaking equipment sales to Chinese companies in order to protect domestic chip companies, with Lam Research ( LRCX ) and Applied Materials being the two U.S. companies potentially more affected by this restriction. This adds to my concerns about Applied’s exposure to China, which clouds to some extent its medium term business prospects.
However, this Chinese theme is a structural issue that is not likely to affect Applied’s share price performance in the short term, while its upcoming earnings announcement on Thursday is much more important for Applied’s share price direction in the near future.
Applied Materials Q3 FY 2022 Earnings Preview
Applied Materials is scheduled to report its Q3 FY 2022 earnings on August 18, 2022, after the market close. The street is expecting Applied to report revenues of $6.27 billion and GAAP EPS of $1.76, which is in-line with the company’s guidance provided last quarter.
Q3 Guidance (Applied Materials)
This represents revenue growth of about 12% YoY, but practically flat QoQ, the second consecutive quarter of flat revenues, which may be justified by supply constraints of key parts of its equipment. On the other hand, the service and maintenance segment may have achieved solid sales in the last quarter due to high utilization at customers’ factories. Note that revenue estimates have been unchanged during the past three months, after a strong downward revision when the company announced earnings, and new guidance, back in May (the red line in the next graph).
Revenue revisions (Bloomberg)
Regarding its gross margin, it is expected to drop to 46%, or 100 bps lower than in the previous quarter, while net income is estimated at $1.54 billion, a decline of 10% YoY. These results are still solid as the Wafer Fab Equipment (WFE) market is still somewhat supply constrained and demand for Applied’s systems is robust, but more recently there have been some signs of slowdown in the semiconductor industry and the company is not expected to be immune to this trend.
While the chip shortage led to strong investments from foundry clients, with TSMC, Intel or Samsung announcing during 2021 significant investments in new capacity (factories) over the coming years, with a sizable part of those investments being directed to manufacturing equipment, more recently there has been some signs that investments may be paused and demand for chip manufacturing equipment may be peaking. Given that the vast majority of Applied’s revenues are generated in its System unit, decreasing capital expenditures (capex) from its largest customers should be a headwind for near term growth.
While the logic market continues to be supported by strong demand for chips from data center customers, weaker PC and consumer electronics demand is hurting growth prospects in the industry. Indeed, very recently both Micron Technologies ( MU ) and Nvidia ( NVDA ) warned about slowing demand, increasing worries about a slowdown in the semiconductor industry. Moreover, both Micron and SK Hynix have recently lowered their capex plans for the near future, which doesn’t bode well for equipment manufacturers such as Applied.
As the semiconductor industry is known for being cyclical, widespread shortages of chips in the past couple of years led to heavy investments in new capacity, that will take some time to enter the market, thus announcements of additional investments in capacity seem to be low at this point. Therefore, a key metric for investors to watch related to Applied’s earnings release will be its order book, to see if customers are still placing orders for new equipment or if a slowdown is already visible.
Forward Guidance is the Key for AMAT's Stock
I think the market is expecting weakness in these numbers, as weak demand for smartphones is likely to hamper orders for chip-making tools, which may create a headwind for Applied. The issue here is to know if demand from other types of customers, especially in the data center segment, will be enough to offset lower demand elsewhere.
Therefore, in my opinion, more important for Applied’s share price reaction to its earnings release will be its outlook for the next few quarters, rather than if it beats estimates for the current quarter. We may be at a point of turnaround in the chip cycle, and investors are likely to react quite badly to downward expectations for the next couple of years, something that the company has not made so far, despite the increasing prospects of economic recession in the near term and softer growth prospects highlighted by other companies operating in the semiconductor industry.
Investors should also note that, despite a positive operating momentum in the semiconductor industry over the past few years, Applied’s share price reaction has been negative in the past five quarters on its earnings day, not boding well for the upcoming earnings release that is likely to lead to lower growth expectations in the coming quarters.
Earnings Surprise (Bloomberg)
Conclusion
Applied Materials is likely to report a rather positive quarter as the semiconductor equipment market is still supported by strong demand, but there have been clear signs that weaker demand from the PC and consumer electronics markets is having a negative impact on the industry’s growth prospects, of which Applied is certainly not immune.
Therefore, management is quite likely to revise its growth expectations regarding the next few quarters, thus investors should pay attention to any sign of demand deceleration in the earnings call, which, if it happens, is very likely to lead to a negative share price reaction next Friday and beyond.
For further details see:
What To Expect From Applied Materials' Upcoming Earnings?