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Commentary: Applied Materials argues bullish case for chips

4 min read

Memo to those analysts worried about a semiconductor slowdown and potential supply glut: Applied Materials (Nasdaq: AMAT) thinks you're way too early with the pessimism.

When Applied Materials, the leading supplier of semiconductor equipment, speaks, Wall Street listens. And the company is as bullish as it has ever been.

Applied Materials topped estimates in its third quarter Wednesday with earnings of $604 million, or 70 cents per share. First Call's survey of 28 analysts predicted a profit of 68 cents per share for the quarter ended July 30. Sales jumped to $2.73 billion, 25 percent higher than a year ago. The company had a backlog of $3.69 billion at the end of July, compared to $3.18 billion at the end of April.

Although those results were enough to cheer investors, Applied Materials' outlook was the focus. CFO Joseph Bronson said the company's new orders in the fourth quarter will top $3.5 billion with sales in the $2.85 billion to $2.9 billion range. Fourth quarter earnings will be in line with current consensus estimates of 75 cents a share.

"There has never been a period of time when this industry has had such growth rates," said Bronson, who added that he expects that "the current industry up cycle will continue."

David Wang, Applied Materials' resident industry guru, said the industry is showing strong balance and there's nothing that would derail the chip sector in the next year. Applied Materials' customers, who happen to be the biggest players in the chip world, are optimistic.

Top six reasons to be chipper

Officials cited six main reasons for their bullishness:

  • Chip makers still need more production capacity at 0.18-micron levels, especially with strong demand from the communications market.
  • Companies are investing in new technology, particularly related to 300mm wafers. The company will recognize the bulk of 300mm revenue in 2001, Bronson said.
  • The memory chip industry will see a capacity shortage by the end of 2000. That means more equipment spending.
  • Japanese chip companies' expansion appears to be set for 2000 and 2001. Applied sees 10 new expansions in Japan, with more than 150,000 wafer starts per month.
  • The economic outlook remains at positive major semiconductor centers.
  • Newly introduced devices continue to expand the demand for chips. New servers, workstations, consumer applications and communications equipment are driving a 30 percent increase in silicon consumption this year, Bronson said. PCs will consume about 28 percent in silicon, he added. In addition, wireless devices will be outdated in two years, further fueling demand.

    The big debate

    Although Applied Materials' outlook is nice, bearish analysts will remain unconvinced because each of the six reasons above can be shot down. Applied Materials projected a year's worth of demand. The big question: How much of this upside is already priced in?

    In a report earlier this week, USB Piper Jaffray analyst Ashok Kumar became the latest analyst to say the chip cycle has peaked. Salomon Brothers analyst Jonathan Joseph was the first to raise red flags.

    Based on fundamental and technical evidence, Kumar said PC growth rates are slowing, cellular handset shipments have peaked and oversupply is on the way. Peaks and valleys are nothing new, but the real trick is calling booms and busts ahead of time.

    On PC growth rates, Kumar expects shipments to peak in the September quarter. Flash memory, which is used in wireless devices, is expected to overshoot supply in the summer of 2001.

    How does this affect Applied Materials? When Advanced Micro Devices, Intel and wireless chip customers get squeezed, they'll stop buying manufacturing equipment.

    Now there are plenty of analysts to dispute Kumar and company, but the legions of worrywarts are growing. Wit SoundView analyst Michael O'Brien said the chip boom still has some legs and added that Applied Materials will benefit.

    Kumar's view: No one knows for sure when chip stocks will unravel, but a little profit taking never hurts. "Wealth accumulation is not only about making money, it is also about keeping it," he wrote. "We believe there are an abundance of reasons for keeping your powder dry and sitting on the sidelines."

    Those pesky unknowns

    Applied Materials Chairman James Morgan acknowledged that the company's forecasts include only "the things we know about."

    In its recent earnings report, Nokia (NYSE: NOK) signaled that earnings will be off target. That outlook sparked a host of worries about the wireless sector, which is driving chip sales and capital spending.

    Applied Materials' customers are bullish now, but three quarters from now things could change. Big plant spending has been derailed before.

    • Applied Materials tops 3Q estimates, sees growth ahead
    • Capacity debate rages in chip sector
    • AMD hurdles estimates, sets split
    • Intel sees strong second half
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