Overcoming Trade Restrictions And Evolving ICAPS Will Create Opportunities

Key Takeaways

• Trade restrictions and slowed DRAM and ICAPS sales may significantly limit revenue growth, especially from the China market.
  
• Advanced technologies offer growth potential, but may not achieve the high revenue increases expected, affecting earnings projections.
  
• Export controls and evolving competition in China, coupled with ICAPS investments decline, threaten Applied Materials' revenue growth and market presence.

Catalysts

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

• The company faces trade restrictions impacting its ability to serve the China market, potentially hurting future revenue and service growth, as approximately $400 million of revenue is expected to be impacted in fiscal 2025.
  
• A more measured level of investment is expected in the ICAPS nodes following strong spending in prior years. This slowdown could dampen revenue growth prospects in comparison with previous high growth rates.
  
• The deceleration in DRAM sales, particularly due to reduced purchases from Chinese customers, suggests that future revenue growth in this segment may be limited and come in below expectations.
  
• The slowdown in the growth rate of the advanced packaging segment, despite its recent expansion, may lead to a more conservative outlook on revenue contributions from this high-growth area over the next few years.
  
• While the company is positioned to benefit from the ramp-up of advanced technologies like gate-all-around transistors and backside power delivery, the substantial future growth required to realize meaningful revenue increases may not match consensus expectations, contributing to potentially muted earnings growth projections.

Applied Materials Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Applied Materials compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Applied Materials's revenue will grow by 3.9% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 24.1% today to 25.8% in 3 years time.
• The bearish analysts expect earnings to reach $8.1 billion (and earnings per share of $10.0) by about August 2028, up from $6.8 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 19.6x on those 2028 earnings, down from 22.0x today. This future PE is lower than the current PE for the US Semiconductor industry at 29.1x.
• Analysts expect the number of shares outstanding to decline by 2.66% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 10.3%, as per the Simply Wall St company report.

Applied Materials Future Earnings Per Share Growth

Risks

• The impact of updated trade rules and export controls will significantly reduce Applied Materials' ability to access the China market, potentially resulting in a revenue loss of approximately $400 million for fiscal 2025, directly affecting both service and product revenue.
  
• A decline in ICAPS node investment following strong spending in 2023 and 2024 may negatively impact revenue growth, given that ICAPS is the largest market segment for Applied Materials.
  
• Evolving competitive dynamics within China's equipment manufacturing sector could put pressure on Applied Materials' market share over time, particularly in deposition and etching technologies, potentially affecting revenue and margins.
  
• Increasing R&D investments to support technology growth areas may pressure short-term margins, despite their potential to deliver long-term benefits, and impact near-term profitability.
  
• Uncertainty in market conditions and demand fluctuations, especially in the ICAPS segment and amidst broader economic shifts, might impact revenue consistency and challenge Applied Materials' growth forecasts.

Valuation

• The assumed bearish price target for Applied Materials is $160.41, which represents two standard deviations below the consensus price target of $204.29. This valuation is based on what can be assumed as the expectations of Applied Materials's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $250.0, and the most bearish reporting a price target of just $152.0.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $31.5 billion, earnings will come to $8.1 billion, and it would be trading on a PE ratio of 19.6x, assuming you use a discount rate of 10.3%.
• Given the current share price of $184.87, the bearish analyst price target of $160.41 is 15.3% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
• 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.