Attractive Valuation for this Industry Leader
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Applied Materials (NASDAQ: AMAT) is the undisputed leader in the semiconductor equipment industry, with a market cap of $14.3 billion versus $8 billion and $4.4 billion in market cap for its closest competitors KLA-Tencor (NASDAQ: KLAC) Lam Research (NASDAQ: LRCX), respectively. In terms of revenue, Applied Materials is almost three times bigger than its competition.
This bigger size implies a strong competitive advantage in its business. Semiconductor fabrication tools is quite a fragmented industry, with most companies specializing in particular segments of the market. This means that Applied Materials is in a unique position providing a wide variety of products and serving as a one stop shop for chip manufacturers.
With a very solid balance sheet and a strong track record of cash flow generation, Applied Materials can afford to spend more than $1 billion in research and development per year, which leaves most competitors behind by a wide margin and serves as a source for superior innovation and growth. The company's trusted name and efficient scale is another source of differentiation versus the competition.
The industry is very cyclical, and chip manufacturers can reduce their capital spending sensibly if they anticipate slowing demand due to harsh economic conditions. On the other hand, semiconductors are becoming a very important part of a different kind of electronics, and their complexity is increasing as technological advancement requires better and more efficient chips. Looking beyond the economic cycle, long term demand should remain strong for Applied Materials as demand for more quantity and better quality of chips requires semiconductor manufacturers to work with the best equipment available.
Management expects to see an exponential increase in demand for its products due to the mobile computing boom over the following years. Being a market leader with a diversified portfolio of products, Applied Materials certainly is well positioned to capitalize on this new trend.
Solar energy is another area which presents long term opportunities for the company. Applied Materials has made several acquisitions in the industry and has entered the business of solar cell manufacturing tools as an important player in the last years. If the firm manages to establish a leadership position in this industry, there could be some exciting gains for investors.
Applied Materials pays a 3.3% dividend yield, and those payments have increased at an outstanding 26% compounded annual growth rate since inception. Given the company's financial strength, investors have a good reason to expect higher cash payments in the future.
Shares of Applied Materials are trading at a P/E of 11, which is not expensive at all considering its growth possibilities and is in line with the valuation of competitors like KLA-Tencor and Lam Research. These two companies have achieved higher growth rates in the past, and they may grow faster going forward due to their smaller size and more concentrated operations. But in terms of quality and competitive advantages Applied Materials is on step above them.
The business may be cyclical, but the company is strong enough to go through difficult economic conditions, both financially and competitively. At current valuations shares of Applied Materials present some considerable room for long term gains.
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