All the work by Nvidia, Intel, Applied Micro Devices, and Alphabet that I described in my fourth day of Christmas stock pick post means lots of orders for the companies that make the machines that make the chips for new markets in artificial intelligence, data mining, hyper-cloud computing and more. So too does the race to produce faster chips that consume less power for devices that range from smart phones to digital door bell systems. The whole Internet of Things trend requires new generations of chips–and that requires new generations of chip making machines. And let’s not forget about display where the new OLED screens in smart phones are also driving demand for new production equipment
It’s not too much of an exaggeration to say that we’re witnessing a golden age for chip-making equipment makers and especially for Applied Materials (AMAT). Or if not a golden age, at least a long, sustained up cycle in what has historically been a very cyclical sector. In fact, the cycle this time may be long enough so that its currently more accurate to think of Applied Materials as a growth stock rather than as a cyclical–with the higher PE multiple that goes along with growth stock turf. When back in November the company beat Wall Street earnings projections for the quarter and raised its earnings guidance for fiscal 2018, it set up a strong chance that the company will report a sixth straight year of earnings growth in calendar 2018. The Wall Street consensus is projecting 19.5% revenue growth for the fiscal first quarter (reported in January 2018) and a climb to 21.1% growth in the second quarter of fiscal 2018 (reported in April). This sustained growth is a huge change from 1997-2012 when Applied Materials never reported more than two consecutive years of earnings growth. The stock now shows a typical cyclical price-to-earnings ratio of just 15.8. That’s way below the PE for a growth stock and trails the PE of 25.72 for the Standard & Poor’s 500 stocks. (It also doesn’t hurt that the company has lowered share count by 17% over the last six years through stock buy backs and has announced plans to reduce share count by another 6% over the next three years.)
And that’s why I’m making Applied Materials (AMAT) my fifth day of Christmas pick. And why I’m adding the stock to my long-term 50 Stocks Portfolio today (for purchase on January 2.) Applied Materials boasts an installed base of more than 30,000 tools and customer engineers stationed in nearly every chip-manufacturing facility in the world. The relationships that come with that installed base of tool and customer engineers is a huge competitive advantage in designing and introducing new generations of chip-making equipment.
The company’s scale–it is the biggest player in this sector–also means that Applied Materials can budget more to research and development than competitors. (Over the last 12 months, the company has spent 12.2% of revenue of $14.5 billion on research and development.) Chip design is moving into one of its frantic spurts with new technologies demanding new chip-making equipment on multiple fronts. For example chip makers are pushing ahead with 3D architectures in NAND and logic chips as a way to pack more computing power into a smaller space. That will require new tools for depositing and removing layers in the manufacture of a chip. Or take a look at display technologies where OLED (organic light-emitting diodes) are grabbing a bigger share of the screen market on higher end smart phones. Increasing yields in order to drive down prices for these screens (and to prevent supply glitches) will require more spending on the kinds of machines that Applied Materials produces. The company’s position at the cutting edge of the equipment market has enabled Applied Materials to grow revenue faster than chip production itself. Credit Suisse calculates that revenues at Applied Materials per 1% bit growth in DRAM/NAND have climbed 386% and 360%, respectively, since 2013. For the equipment sector as a whole growth has been “just” 207% and 203% for those two types of chip.
Credit Suisse projects compounded annual revenue growth of 15% through 2022. Credit Suisse and Morningstar project that operating margins will climb during that period
My first 12 days of Christmas Pick for 2018 was Amazon (AMZN). My second was Nektar Therapeutics (NKTR). The third was Southern Copper (SCCO). The fourth was Nvidia (NVDA) (And just for the record the actual 12 days of Christmas started on Christmas day.)