Applied Materials Stock Headed Lower As Semiconductor Capex Cuts To Continue

  • Applied Materials reported weak third quarter fiscal 2015 results.
  • The company's top line has taken a hit due to huge capex cuts by leading semiconductor chip manufacturers.
  • The weak capex is expected to continue through 2016 before recovering in 2017.
  • Judging by strong SSD demand, SanDisk stock appears like a good buy among semiconductor stocks while Micron remains a mixed bag due to ongoing DRAM pricing pressure.
Applied Materials Stock under pressure

Applied Materials (NASDAQ:AMAT) recently released its Q3 2015 earnings report. Applied Materials is a leading supplier of the equipment that semiconductor chip manufacturers use to manufacture their chips. The company’s revenue trends can, therefore, form an important barometer that allows us to learn more about the state of the semiconductor industry, and what to expect in the near future.

AMAT Earnings Q3 2015

Applied Materials reported revenue of $2.49 billion representing 10% Y/Y growth. EPS clocked in at $0.33. The revenue missed on consensus analysts estimates while EPS was in-line. Though the revenue growth appears quite decent when viewed on standalone basis, it’s nevertheless a large decline compared to the prior year when growth came in at 20.8% Y/Y. To compound the revenue miss, AMAT failed to issue fourth quarter guidance citing volatility in the industry.

What has taken a hit on Applied Materials is the huge capex cuts this year by large chip manufacturers such as Intel (NASDAQ:INTC) and Taiwan Semiconductor Manufacturing (NYSE: TSM). Intel announced in April that it would chop off a huge $1.3 billion in capex from $10 billion to $8.7 billion. Two days later, TSMC followed up on Intel’s announcement by saying that it would cut 2015 capex by $1 billion to a lower range of $10.5 billion-$11 billion.

The semiconductor industry, including capex, tends to be highly cyclical, with a period of strong sales and capex growth being followed by lull. 2014 proved to be a banner year for semiconductor capex which grew 14%. But Gartner predicts that capex growth this year will clock in at a measly 2.5%, and then fall to -1.3% in 2016.

The tide will eventually turn in 2017, when capex is expected to grow 13.8% and get better in 2018 when growth is projected to hit 18.5%.

Applied Materials--3.png

It’s therefore fairly safe to say that Applied Materials top line growth might take another whipping in 2016, beore finally rebounding in 2017. Long-term investors can therefore wait for the bad news to get fully baked into AMAT shares, which will probably happen by mid-next year, before starting to build positions in the shares. Though AMAT stock is down 35.9% YTD, the semiconductor industry tends to be very unforgiving when growth is not forthcoming or slows down dramatically. So right now might not be the best time for long-term shareholders to buy the beaten down shares.

Strong SSD and Mobility Demand Driving Flash Sales

There are a few more lessons we can glean from AMAT’s report. Looking at the company’s revenue segments, the company’s flash sales (39% of revenue) put forth the best performance after growing 96% Y/Y to $782.73 million. Meanwhile, the foundry segment (32% of revenue) was the worst performer after declining 29% to $642.24 million. The company’s foundry segment relates to sales of fabrication equipment to foundries such as TSMC. The drastic slowdown in the segment can be taken to mean that many fabless semiconductor companies have been holding off new orders as they try to ponder their technical roadmaps.

Applied Materials’ strong flash sales is being driven by strong demand for SSD products and mobile NAND. There are two semiconductor companies that in my view can benefit from this trend: SanDisk (NASDAQ:SNDK) and Micron (NASDAQ:MU). SanDisk finished fiscal 2014 with SSD revenue of almost $1.92 billion, or 29% of its revenue. Meanwhile Micron’s SSD revenue of $1.05 billion represented 6.4% of its top line. Intel is still the biggest SSD maker with a market share slightly bigger than SanDisks.’ Intel’s much larger revenue base, however, means that SSD products represent less than 2% of its top line, therefore creating minimal impact on the company’s top line.

SanDisk’s growth has come under pressure lately, after the company announced that it had lost a key SSD customer at the beginning of the year. Many analysts speculated that the said customer was none other than Apple (NASDAQ:AAPL), which uses up large amounts of SSD products. Indeed the speculations could very well have been spot on, seeing that SanDisk’s top line shrunk a worrying 24% during the last quarter in what was the company’s second straight quarter of negative growth. SanDisk usually insists on running its foundries at full capacity, which allows it to enjoy better gross margins than many of its rivals including Micron. But the flipside of this modus operandi is that the company is unable to respond quickly to changing customer demands. An unfavorable product mix means that the company can take several quarters before it can work through its unfavorable inventory and fully retool its fabs or new production. Indeed SanDisk pointed out that it expected to take several quarters before it could fully recover from the loss of its customer.

Micron remains a mixed bag. The company has been experiencing pricing pressure in the DRAM market (39% of revenue) and this is expected to continue into the near-future. Samsung and SK Hynix imporved their 25nm DRAM yield rates earlier this year, allowing them to produce DRAM chips at a lower cost of production than Micron. Indeed Samsung has seen strong growth in DRAM sales at a time when Micron has been badly impacted by falling DRAM prices. DRAM prices have fallen by about 24% this year, and might remain depressed for several more quarters. Manuacturers have been shoring up their DRAM capacity, and this usually leads to increased supply which further depresses prices.

Applied Materials-4

But all hope is not lost for Micron. The company’s Wireless Solutions segment (24.3% of revenue) grew 23.9% during the last quarter, the company’s best growth. This is the segment that sells NAND flash memory products to the mobile industry. With strong smartphone demand, the segment’s growth momentum is bound to continue. Healthy growth in this segment might be enough to offset DRAM pressure in maybe 4-6 quarters, though this is not a given.


Given the ongoing secular trends in the industries where the three companies exist, I would rate SanDisk Stock a good buy at the moment, while Applied Materials Stock will probably be a good buy mid-next year. Investors should probably wait and see if Micron’s DRAM issues can ease up before making an investment decision regarding Micron stock.

Brian Wu Brian Wu   on Amigobulls :

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