Applied Materials

Moat: 3/5

Understandability: 4/5

Balance Sheet Health: 4/5

Applied Materials is a global leader in providing manufacturing equipment, services, and software to the semiconductor, display, and related industries.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Applied Materials (AMAT) operates in the technology industry and offers a vast array of products and services within the semiconductor, display, and adjacent markets. The company’s core business revolves around providing equipment used in the manufacturing of semiconductor chips, flat-panel displays, and other high-tech materials. This involves not only manufacturing and delivering the equipment, but also providing services, software, and other support to its customers. AMAT’s main divisions are:

Semiconductor Systems: This is their largest segment and accounts for approximately 73% of their total revenue. They sell manufacturing equipment that is used to produce virtually all types of chips from high performance computing chips to sensors in everyday electronics.
Applied Global Services (AGS): This segment helps its customers improve the performance of their manufacturing equipment and also provides additional services, tools and training.
Display and Adjacent Markets: This segment provides production equipment for displays for everything from TVs, smartphones, to auto displays. This sector accounts for a smaller, but growing part of the overall revenue.

Revenue Distribution

The company’s revenue is derived mainly from the sale of equipment to customers, and by region:

China accounts for roughly 30% of their sales.
Taiwan provides roughly 25% of the revenue.
United States provides roughly 15% of the sales.
Other countries make up for the remaining 30%.

Industry Trends & Competitive Landscape

The semiconductor industry is characterized by rapid technological change, high capital expenditure requirements, and cyclical demand. It’s also characterized by constant need to innovate and optimize performance and production. It is increasingly vital that chips have greater performance, while using significantly less power, and having a small manufacturing footprint. In this industry, competition is incredibly intense, and companies that do not innovate constantly risk obsolescence or loss of significant revenue streams. Applied Materials compete with multiple big companies, but its most significant competitors are Lam Research and ASML, both of which compete in lithography equipment, a sector that Applied Material’s does not compete directly.

Recent News and Issues

In their latest earnings call, management highlighted the growing impact of AI and machine learning on their business, with new technologies like 3D chip designs requiring new equipment that they are well positioned to provide. They also cited an increase in demand for chip making equipment in Asia, due to new regulations designed to increase local chip manufacturing output.
They expect 2024 growth to be relatively moderate, due to a slowdown in demand.
They have acknowledged concerns about China’s technology ambitions, and any potential restrictions by the US government on selling certain products to Chinese companies, but they do not believe these headwinds will have a major impact on the company’s long term prospects.
Management has been emphasizing growing demand for their AI tools, especially in advanced packaging, for many years to come.
The company has emphasized its importance in new energy industries and materials and are developing new capabilities there, especially for solar panels and EV batteries.
Management has noted the rising interest in silicon carbide and other newer materials, but that adoption will be gradual as they are currently not as good at performing at high level for microchips as the current Silicon-based process.

Financials in-depth Looking at AMAT’s financials, we can derive the following insights:

Revenue growth is very cyclical. The company’s revenue has seen large spikes and falls depending on customer demand and economic environment. However, their long-term revenues have been very solid in the past two decades.
Profitability fluctuates. Although AMAT is very profitable, its profit margin can fluctuate greatly from period to period, and is highly dependent on their R&D spending and overall cost control.
Debt is not a worry. The debt levels are generally very low compared to their cash holdings. The company has historically not required debt to grow significantly.
They have a history of buying back shares and issuing dividends. They have not been afraid to return profits to shareholders, while also investing heavily into their R&D and the business.

Here is a further in-depth analysis based on latest form 10-Q of July 29th, 2023:

Revenue for the three months ended July 2023 was $6.43 Billion, which is 12.1% higher than same quarter last year. However, they lowered the revenue forecast for Q4.
Semiconductor systems segment grew in revenues by 14% from last year, while display and adjacent markets declined 2%.
Net income for the three months ended July 2023 was $1.48 Billion, which is 24% higher than same quarter last year. This was driven by their revenue growth and decreased operating costs.
R&D spending was $882 Million in the quarter, which is slightly higher than the previous quarter. They have been consistently investing more into R&D. This is expected to continue.
They have repurchased $1.5 Billion of stock during this quarter and have almost $5 Billion in remaining buyback authorization.
Their cash holdings were at 4.99 Billion, and they have a debt of $5 Billion, therefore, their net cash is still positive.
Their effective tax rate was 13.6% for the quarter.
Operating expenses for the company was up to 2278 Million.
Their working capital decreased to 5414 Million
They report the value of their property and equipment at $6767 Million, up from 6686 Million last year.
Total Equity is around $14.3 Billion

Moat Analysis Applied Materials has a moderate economic moat (3/5) based primarily on switching costs, size, and their long time relations with many large customers:

Switching Costs: The intricate and specific nature of equipment used in chip manufacturing creates high switching costs for AMAT’s customers. Many customers would have to spend hundreds of millions of dollars to replace AMAT’s machinery, not to mention the downtime involved. This leads to sticky relationships for long periods of time.
Scale: AMAT’s scale is considerable, in terms of its revenue, employees, R&D expenditure and production capacity. This advantage lets the company generate higher sales and lower cost structure, that can deter new entrants into the market.
Reputation: The company has a well-regarded name and brand recognition among its customers and has long-lasting working relationships that give customers high confidence in purchasing from them. The quality and reputation that AMAT has built in the market will take years for a competitor to reach.

However, these advantages can and have been eroded. Companies operating in the technology industry are faced with rapid technological change, and have to keep up with changing demand. In addition, any new entrant in this field is likely to be well-funded and highly motivated.

Also, many of the new entrants that have sprung up in the chip manufacturing world, like some foundries that produce chips for smaller companies, have less need for very expensive high-end equipment and may seek to provide a strong niche in the industry, which may erode AMAT’s share.

Risks to the Moat There are several risks to AMAT’s moat and overall business. They include:

Technological Obsolescence: Rapid technological change could quickly make their existing equipment obsolete if a new technology arises that renders their machinery less useful.
Competition: The semiconductor equipment sector is highly competitive, with other large players also capable of innovation. This can put pressure on the cost and effectiveness of their operations.
Cyclical Industry: The chip industry goes through cycles of boom and bust, which causes volatility in orders and thereby, revenue and profitability of AMAT.
Political and Trade Uncertainty: Increased global trade tensions, such as those between US and China, can negatively affect supply chains and their ability to reach different markets, thereby decreasing demand for their equipment. In addition, government regulations for different countries can limit AMAT’s ability to sell to certain companies.
Dependence on a Few Key Customers: A few of the largest chip producers contribute to a large part of AMAT’s revenue, putting them at the mercy of their sales. Should some of these customers perform poorly or choose a different supplier, AMAT’s revenue could suffer significantly.

Understandability Rating Justification

Applied Materials’ business model is relatively straightforward, with the company primarily selling manufacturing equipment to other companies that produce tech parts. So, for a person with a little technical know-how and finance basics, understanding what AMAT does is quite simple. Their technology, however, is very complex, which is why some people may not understand their business fully. The rating is 4/5, since I believe most people can understand the business even if they don’t fully understand the product.

Balance Sheet Health Rating Justification The company shows relatively sound fundamentals. The current ratio is above 2, giving them the ability to pay off any debts in the short-term. They also have a strong history of paying down debts and also returning money to shareholders. This makes it seem they are a very good cash flow generator, but they are susceptible to market sentiment, trade disputes and other problems specific to the tech manufacturing industry. The rating given is 4/5 since they are still at some risk due to the industry and their debt.