Wednesday, May 13, 2009

Applied Materials Segment Performance Varies

Applied Materials (AMAT) is on the ropes. Fortunately it has large cash reserves. It is still paying a dividend (about 2% at this stock price). And it should bounce back when (or if) the global economy starts to recover.

The main take away for me from the AMAT analyst conference on May 12, 2009 was that there is a great deal of variance between the four major segments that make up the company. Let's take a look.

Traditionally Applied Materials makes the machines that make semiconductor chips. Broadly, the chips can be further divided into memory chips and logic IC's, although of course many systems now integrate both on a single chip. AMAT calls this it Silicon Segment. It had $260 million in revenue in the quarter. A year ago, the Silicon Segment had $1.27 billion in orders.

There is the cyclical problem with being a capital equipment manufacturer for you in a nutshell. Demand for end products like cell phones and computers is down. So demand for the chips that make them work is down. The chip manufacturing companies have plenty of capacity right now. Even as demand ramps up (if it does), they can go a bit before adding new capacity.

What silicon semiconductor equipment that was sold did not really go to increase unit capacity. A few companies are continuing to forge ahead on their technology roadmaps during the downturn. This means, in this industry, smaller process technologies. Applied Materials is selling the next generation of machines that can produce chips with smaller gates.

New orders in the Silicon Segment were $259 million. You can't tell exactly what the next quarter's revenues will be from new orders. The lag for this type of equipment is typically more than a quarter. Applied Materials had a backlog of $3.16 billion in orders at the end of the quarter (including all segments), so it could run for some time just filling older orders.

The global services segment is more steady. It had $319 million in revenue and $236 million in new orders, compared to $599 million in revenues year-earlier. That is still quite a drop off. Equipment needs to be maintained, but with utilization low the need for services drops off too.

The best news was in the environmental technology segment, which I prefer to refer to as Solar. Again, AMAT does not make solar cells, it makes the equipment to make solar cells. These are of two major types, crystalline silicon and thin-film. A year ago this quarter, revenues in solar were only $85 million. This quarter the revenue came in at $357 million, though new orders were only $141 million. Demand was very high a year ago - you remember the energy price bubble? - and now while there is plenty of long-term demand, new factories of any kind are considered a risky business.

The fourth segment is Display, which you can think of as equipment to make flat LCD screens for TVs. Results here were dismal: $84 million in sales and $13 million in new orders. Year-earlier revenues were $198 million. Again, a lot of capacity was built in 2007 and 2008, then demand slumped in the fall of 2008. Applied Materials management believes that flat-screen tvs continue to win market share, so some time in late 2009 manufacturers will have to start increasing capacity again for the presumed sunnier days of 2010.

The silicon segment is expected to recover gradually as demand re-ramps and older process technologies are scrapped for newer ones. Solar will ramp again as soon as energy prices go back up and financing becomes more generally available. Services will ramp as utilization of current equipment increases.

Of course, all of these trends assume that the economy will improve in the second half of 2009 and show something like sustained growth in 2010. In the meantime, if you own some AMAT stock (I do), sit back and enjoy your dividends. Applied Materials has $3.1 billion in cash and equivalents in the bank, and even in this dismal quarter was better than break even on cash flow (but non-GAAP net loss was $136 million, and GAAP net loss was $255 million). Some day demand for semiconductor equipment will return, and with its new solar business on top of that, Applied Materials will be even more impressive than it was back in 2007.

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