Applied Materials (AMAT) Valuation

Have you ever wondered where those price targets you see listed on Yahoo Finance or talked about on CNBC come from?  I know I have.  Which is why I am starting my journey off by doing my own financial analysis assessments on publicly traded companies.  The best part about starting here is that all the data you need is readily available if you know where to look. For my first 2 posts, I’d like to look at a couple semiconductor materials suppliers in Applied Materials and LAM Research. 

The stock prices for all companies in the semiconductor industry have been hit hard this year with the Federal Reserve sharply increasing interest rates to fight inflation.  Applied is down 33.4% YTD and LAM Research is down 38.3% YTD.  Both Applied and LAM design, manufacture, and service semiconductor processing equipment used to fabricate integrated circuits.  They supply the equipment used by semiconductor manufacturers that produce integrated chips for the likes of Apple, Nvidia, and AMD.  This week I am going to present my calculated valuation and price target for Applied Materials.  Next week, I will follow up with a valuation analysis on LAM Research and compare my results to those of Applied Materials.

Applied Materials Overview

Applied Material was founded in 1967 and is headquartered in Santa Clara, California.  However, they have sales, R&D, manufacturing, and service locations all over the globe to service their worldwide customer base.  Here’s a breakdown of their revenue by geographic region over the last 5 years.

Applied breaks up their revenue into 4 distinct business units: Semiconductor Systems, Applied Global Systems, Digital and Adjacent Markets, Corporate/Other.  The first 3 are the meat and potatoes of the business with the 4^th basically acting as a catch all for revenues and costs that do not clearly fall into any of the 3 main business segments.  The Semiconductor Systems business unit is further broken down into 3 individual segments: Foundry/Logic, Dynamic Memory (DRAM), and Flash Memory.  Here you can see the percentage contribution from each business unit as well as each segment within the Semi Systems business unit.

Relative Valuation Analysis

I like to start by performing a relative valuation analysis because it is a fairly straight forward exercise compared to a discounted cash flow (DCF) valuation. It also provides a good baseline understanding of the price a company could be trading at under a multitude of market conditions.  This analysis is especially useful when considering a company that has been publicly traded and profitable for quite some time.  First, I performed a comparable companies analysis using 5 companies that I considered closely related to Applied Materials.  The companies I chose for comparison are:

• LAM Research Corp (LCRX)
• ASML Holdings (ASML)
• KLA Corp (KLAC)
• Teradyne Inc. (TER)
• Taiwan Semiconductor Manufacturing (TSM)

As of 12/16/2022, Applied is trading at an 11,4x EV/EBITDA multiple and P/E ratio of 13.9x.  Both values fall in below the median values calculated in the comparable companies analysis. 

With the comps table complete, I proceeded with performing a historical P/E analysis.  I found macrotrends.net to be a useful resource to find past quarterly P/E data that is easy to manually input into Excel.  I decided to use the P/E ratio data going back to the beginning of 2014. In my opinion, this timeframe provided a large enough sample set without using potentially irrelevant data points. 

Finally, I was ready to put together a table calculating Applied’s share price under a multitude of EV/EBITDA and P/E scenarios pulled from the comps and historical data.  By utilizing this table, I can identify an upside, middle of road, and downside price scenario.  Putting all the data in one place as shown in the table below makes it easier to identify any data points that appear to be overly conservative or overly optimistic.  In the summary section below the table, I’ve calculated a potential upside reward of +$49.85 (+47.1%) and a downside risk of -$13.84 (-13.1%) relative to Applied Materials’ price per share of $105.80 as of 12/16/22.

DCF Model Assumptions

After performing the relative valuation analysis, I proceeded to discounted cash flow (DCF) valuation portion of my analysis.  After getting all the historical data input for the past 5 years into my excel model, I was able to analyze the historical trends and averages in the financial statements. Applied grew top line revenue greater than 10% for 4 out of the past 5 years which added up to a 5-year average of 13.2% and a compound annual growth rate (CAGR) of 12.1%.  Cost of goods sold remained in the 52.5-56.5% of revenue range each of the past 5 years.  Here’s a table that breaks down the 5-year average for most of the factors used in my DCF evaluation.

The semiconductor industry is a growth industry, and I found a few sources citing continued growth through 2030.  Therefore, I decided to use an 8-year forecast with 2030 as the terminal year.  To start my forward-looking forecast assumptions, I identifying the line items that I thought would remain consistent with the calculated 5-year averages throughout the forecast period.

• R&D/Engineeering – 10% of Total Revenue
• Marketing/Selling – 3% of Total Revenue
• G&A – 3% of Total Revenue
• Interest Rate – 4.5% of Debt
• Tax Rate – 15% of EBT
• Inventory – 150 days
• Accounts Payable – 115 days
• CapEx – 3% of Total Revenue
• Share-based Compensation – 1.5% of Total Revenue   

After reviewing the historical values and trends for the remaining line items needed for our DCF analysis, I didn’t think the same consistent approach from above would be sufficient.

• Cost of Goods Sold – I started on the high side of the 5-year range for 2023 and tapered it back down to the 5-year average by the end of the forecast period. 
• Accounts Receivable – From 2018-2020, accounts receivable days were consistent around 60 days but have spiked up to 86 days in 2022.  Therefore, I decided to forecast 85 days for 2023 then taper down each year until I got to 60 days for 2028-2030.
• Contract Liabilities – Contract liabilities days also spiked in 2022 to 44 days compared to the 2018-2021 average of around 30 days.  Therefore, I forecasted 45 days for 2023 contract liabilities but quickly tapered down to 30 days by 2026.
• Total Revenue – I estimated revenue to grow less than 2% in 2023 before ramping back up to the 5-year average of about 13% over the next 5 years before tapering back down to less than 8% in the final year of the forecast.

In determining a top line revenue growth forecast, I performed a more in-depth segmental analysis by looking at estimated growth rates for each of Applied’s business units.  In Applied’s Q4 2022 conference call, they cited weakness in a couple of target markets that will affect the next 3-4 quarters.  The cited weaknesses are in the consumer driven display markets as well as the memory segment of the Semi Systems business unit.  However, Applied also noted that the foundry and logic business segments were showing remarkable resiliency and even growth through the tough market conditions.  Fortunately for Applied, 60% of their Semiconductor Systems revenue is attributed to the foundry and logic segments vs 40% from memory.  With this information, I was able to estimate a revenue forecast for each business unit as well as Applied as a whole.  Below is a table summarizing the calculated annual revenue growth rate for each of the 8 years in my forecast. 

DCF Output

Before we can put all the pieces together in the DCF calculations, there are a few final assumptions and data points we need to put together.  First, by performing a weighted average cost of capital (WACC) analysis, I was able to determine a free cash flow discount rate of 11.6%. The tax rate assumption is consistent with Applied’s average tax rate over the past 4 years.  I decided to use a terminal EV/EBITDA multiple of 13.6x based on Applied’s median historical PE ratio since 2014 and the median EV/EBITDA calculated in the relative valuation analysis.

Now that we have all the necessary assumptions in place, it’s time to put it all together and get to the finish line.  My DCF analysis resulted in a diluted price per share of $146.79 (+38.7% potential upside compared to Applied Materials’ share price of $105.80 on 12/16/22). Here’s the full breakdown of my DCF valuation.

Although the DCF valuation appears to calculate a very straightforward and clear output, there are numerous variables and assumptions that go into developing that final number.  Which is why it is useful to choose a couple of variables and perform a sensitivity analysis to see how the DCF price per share fluctuates with the changes of the underlying variables.  In the table below, I show how the price per share changes under different discount rates (WACC) and EV/EBITDA multiples.

Applied Materials Price Target

I am a very visual person, so when it is time to determine an estimated price target for a stock, I like to see everything summarized in one place.  To do this, I put together the “football field” chart below that incorporates relative and DCF valuation ranges as well as the 52-week high/low and the analysts price target range found on Yahoo Finance.  My personal preference is to give more weight to the DCF and relative valuation components of the analysis.  Therefore, my current price target for Applied Materials as of 12/16/22 is $135 (+27.6% potential upside compared to current price of $105.80).  However, it’s important to note that my estimated price target is based on an 8-year forecast.  The model projects Applied’s earnings per share to fall 7-8% in 2023 compared to 2022.  Therefore, it’s possible Applied’s price will continue to fall over the next 6-12 months due to the potential short-term decrease in earnings.

Please join me next week as I dig into LAM Research and compare my results to this week’s results for Applied Materials.

Disclaimer: These valuations are based on my personal assumptions, calculations, and assessment.  I am not a financial advisor, nor should my assessment be considered an investment recommendation.