Idea of the Week: Is Information Technology About to Face a New Reality?

Recently we published a report, “Will Experts Be Watching Applied Materials for Insight on Apple?”, which can be found here, noting that one of the more important technology earnings events of the quarter would be Applied Materials Inc.’s (AMAT.OQ) fiscal third quarter earnings report on Aug. 18. We felt the results would indicate if the momentum seen in the semiconductor capital equipment sub-industry would continue and also provide insight on what to expect downstream from smart phone producers such as Apple Inc. (AAPL.OQ) and Samsung Electronics Co. Ltd. (005930.KS). AMAT’s conference call made it clear that some substantial shifts are taking place in the space; therefore, it is relevant to follow up.

Exhibit 1. Applied Materials (AMAT.OQ) and Benchmark Indices % Gains Since Aug. 17, 2016 Close

Source: Thomson Reuters I/B/E/S

Momentum continued

AMAT is the largest non-lithography semiconductor capital equipment company, with a market cap of $32.6 billion and a presence in nearly every major process of computer chip manufacturing. Therefore, poor performance by AMAT would likely put a damper on the industry’s momentum. Analysts and investors alike had high expectations for Applied Materials heading into its earnings call. As this earnings season’s anchor, they brought home the gold.

Earnings improved 51.5% from the prior year to an EPS of $0.50 per share, which topped expectations by 5.1%. Revenue of $2.82 billion was up 13.3% from the prior year, but fell short of analysts’ estimates of $2.84 billion. However, the real winner was the EPS guidance for AMAT’s fiscal fourth quarter of $0.61 to $0.69 per share, with a mean 35% above the $0.48 per share analyst consensus estimate, which includes a backlog of $4.9 billion.

The market reacted favorably to this earnings report with AMAT shares at a 15 year high, closing at $29.95 (with a high of $30.15) per share on Aug. 23rd, up 9.75% from the Aug. 17 close. Momentum related to Applied’s outlook carried through the benchmark indices and even into some of AMAT’s competitors, such as LAM Research Corp. (LRCX.OQ), which saw shares increase 4.1% to $93.88 per share over the same period.

Exhibit 2. Peer Comparison of Thomson Reuters StarMine CAM Component Scores 

Source: Thomson Reuters Eikon

Top scoring company

The Thomson Reuters StarMine Combined Alpha Model (CAM) ranks companies on a scale from 1 to 100, with 100 being the highest, utilizing a combination of value, momentum, ownership and quality model component analytics. AMAT’s score of 92 places it in the top decile of North American companies.

Applied’s score of a 99 on Thomson Reuters StarMine Price Momentum (Price-Mo) model signals that this darling of the industry’s stock price has momentum on its side and may continue on its upward trajectory. This is a good sign for the industry.

Crowd favorite

If this were an Olympic event, Applied would be favored. Thomson Reuters StarMine Analyst Revisions Model (ARM) measures analyst sentiment and ranks companies by a score of 1 to 100, with 100 being the highest. AMAT’s ARM score of 98 (up from 91 on Aug. 18) places them in the top decile of North American companies.

Exhibit 3. AMAT – Thomson Reuters StarMine Analyst Revisions Model (ARM) Scores vs. Price

Source: Thomson Reuters Eikon

The bullish sentiment is reflected by several upward revisions to analyst estimates due to strong guidance and expected sustainability throughout the next few quarters.

What’s next

AMAT’s earnings report confirmed that management is living up to the hype and has executed strategic initiatives to improve operating performance. Managers are also taking advantage of major technology shifts within the industry to increase AMAT’s market share.

CEO Gary Dickerson outlined major technology inflections: “In both semiconductor and display, we see dramatic advances in technology taking place. We are in the early stages of large multi-year industry inflections that are driving growth in our business today, and creating new opportunities for the future.” He went on to outline four key inflections:

• “First, foundry and logic customers are making significant innovations in transistor and interconnect for 10 and 7 nanometer devices.”
• “The second key inflection is 3D NAND. This is a materials-enabled technology that significantly expands our addressable market.”
• “The third big wave of investment is China, which represents an important long-term growth opportunity for the industry.”
• “The fourth big driver for Applied is organic LED displays. OLED is also enabled by materials innovation, and that makes our available market opportunity more than three times larger than for traditional LCD.”

The inflections will be pivotal to the winners in consumer electronics. One area to look out for next is how these technologies facilitate virtual reality (VR) and augmented reality (AR). Dickerson suggested tuning into their September analyst meeting for more on this. “Looking further ahead, we’re increasingly excited about DR and AR, as it has broad implications not only for display, but also for semiconductor. Leading companies in Silicon Valley and around the world are making big investments in this area, and our technologists are engaged with them as they develop their road maps. We will spend more time covering this topic at our analyst meeting in September.”