How AI And Semiconductor Innovations Propel Revenue Growth

Key Takeaways

• Accelerating demand for AI and data center computing is set to boost Applied Materials' DRAM and HBM system shipments, enhancing future revenue.
  
• The transition to new semiconductor architectures and strategic R&D investments position Applied Materials for increased market share and significant long-term financial improvement.
  
• Applied Materials faces risks from market volatility, geopolitical tensions, intense competition, and technology execution, potentially impacting revenue stability and profit margins.

Catalysts

Engages in the provision of manufacturing equipment, services, and software to the semiconductor, display, and related industries.

• Applied Materials is witnessing an acceleration in demand for AI and data center computing, which directly benefits its DRAM and high-bandwidth memory (HBM) system shipments, influencing future revenue growth.
  
• The company is set to benefit from the transition to new semiconductor architectures like gate-all-around transistors, which expands its addressable market and is expected to impact revenue positively due to higher process equipment spending.
  
• Advances in materials engineering position Applied Materials as a key player in enabling the next generation of semiconductor technology, enhancing its market share and impacting future earnings positively.
  
• The focus on integrated solutions and services, especially for advanced packaging and the roll-out of new solutions, is expected to double the revenue from its advanced packaging product portfolio, significantly affecting future revenue contributions.
  
• Strategic investments in R&D and operational capabilities, particularly in areas like EPIC (equipment process innovation and commercialization), aim to align with mega-trends such as data center AI, indicating potential for significant long-term revenue and net margin improvement.

Assumptions

• Analysts are assuming Applied Materials's revenue will grow by 8.7% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 27.7% today to 27.1% in 3 years time.
• Analysts expect earnings to reach $9.3 billion (and earnings per share of $11.9) by about October 2027, up from $7.4 billion today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as $7.7 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 24.4x on those 2027 earnings, up from 21.1x today. This future PE is lower than the current PE for the US Semiconductor industry at 28.5x.
• Analysts expect the number of shares outstanding to decline by 1.62% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 8.04%, as per the Simply Wall St company report.

Risks

• Overreliance on the semiconductor sector for AI leadership and energy-efficient computing advancements could make Applied Materials vulnerable to market volatility affecting this industry, potentially impacting revenue stability.
  
• Potential geopolitical tensions or trade restrictions, especially concerning China, where a significant portion of revenue is generated, could disrupt operations and sales, adversely affecting revenue and profit margins.
  
• The intense competition in DRAM, foundry-logic, and advanced packaging could pressure Applied Materials to invest heavily in R&D to maintain its market position, possibly affecting net margins if revenue does not increase proportionately.
  
• The strategic focus on integrated fab-in-a-fab solutions and advanced packaging as growth drivers entails execution risk. Failure to deliver these complex technologies efficiently could impede revenue growth and profitability.
  
• Any delays or setbacks in the deployment of new semiconductor technology (e.g., gate-all-around transistors and advanced 3D architectures) could slow down revenue growth and impact the company's ability to gain and maintain market share, affecting earnings.

Valuation

• The analysts have a consensus price target of $230.94 for Applied Materials based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $280.0, and the most bearish reporting a price target of just $185.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $34.5 billion, earnings will come to $9.3 billion, and it would be trading on a PE ratio of 24.4x, assuming you use a discount rate of 8.0%.
• Given the current share price of $191.02, the analyst's price target of $230.94 is 17.3% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.