Surging Ahead, A Semiconductor Giant's Roadmap To Amplifying Revenue Through AI And Next-Gen Technologies

Key Takeaways

• Applied Materials' focus on AI and advanced technologies like gate-all-around transistors and packaging strengthens its market position, promising enhanced revenue through innovation.
  
• Strategic investments in R&D and collaborations, along with a thriving service business, indicate potential for sustained growth and increased profitability via recurring revenue models.
  
• Geopolitical tensions, technology transitions, reliance on specific markets, demand fluctuations, and service business scaling challenges could impact revenue and margins.

Catalysts

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

• Applied Materials is capitalizing on the surge in demand for sophisticated chips, powered by the increasing integration of AI technologies, expecting this to significantly boost their revenue as AI data centers and next-generation computing require more advanced semiconductor solutions.
  
• The company is set to benefit from the gate-all-around technology transition which is expected to enhance Applied Materials' revenue prospects, particularly through the increasing complexity of new transistor technologies that expand their available market and drive higher earnings from these innovations.
  
• Applied Materials' strategic focus on advanced packaging, including its leadership in DRAM and HBM (high-bandwidth memory) technologies, positions it to capture growth opportunities as demand for these technologies escalates, expected to increase earnings by broadening its revenue streams in these critical areas.
  
• The firm's service business is eyeing double-digit growth due to the complexity of semiconductor manufacturing and development, indicating a lucrative expansion in long-term service agreements and subscriptions, which would boost net margins through recurring revenue.
  
• Investments in R&D and collaborations for emerging semiconductor technologies, alongside the push towards enabling semiconductor inflections like AI and IoT, suggest strong future growth potential, impacting revenue as Applied Materials enables key industry transitions.

Assumptions

• Analysts are assuming Applied Materials's revenue will grow by 8.1% annually over the next 3 years.
• Analysts assume that profit margins will increase from 27.6% today to 27.1% in 3 years time.
• Analysts expect earnings to reach $9.1 billion (and earnings per share of $11.56) by about July 2027, up from $7.3 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $10.9 billion in earnings, and the most bearish expecting $7.8 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 26.9x on those 2027 earnings, down from 27.8x today. This future PE is lower than the current PE for the US Semiconductor industry at 30.1x.
• Analysts expect the number of shares outstanding to decline by 1.4% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 8.52%, as per the Simply Wall St company report.

Risks

• Geopolitical tensions and trade restrictions, especially concerning China, could lead to a decrease in demand or increased costs for Applied Materials, impacting revenue and profit margins.
  
• The complexity and cost of transitioning to new semiconductor technologies such as gate-all-around transistors could lead to delays or increased R&D expenses, potentially affecting profit margins.
  
• A reliance on the growth of the advanced packaging market could pose risks if the adoption rate slows or competitors offer more innovative solutions, impacting revenue growth.
  
• Fluctuations in the demand for DRAM and NAND due to market saturation or technological shifts could affect Applied Materials' revenue streams from these technologies.
  
• Potential challenges in scaling service business growth, such as logistical hurdles or the need for significant investments in training and infrastructure, could impact expected profit margins from this segment.

Valuation

• The analysts have a consensus price target of $241.01 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 $300.0, and the most bearish reporting a price target of just $168.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $33.5 billion, earnings will come to $9.1 billion, and it would be trading on a PE ratio of 26.9x, assuming you use a discount rate of 8.5%.
  
• Given the current share price of $245.55, the analyst's price target of $241.01 is 1.9% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• 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.