Will AI Demand Lift Applied Materials Q3 Earnings?

Applied Materials (NASDAQ:AMAT) stock has had a solid year thus far, rising by about 31% year-to-date. In comparison, Applied’s semiconductor industry peer Texas Instruments stock (NASDAQ:TXN) has gained about 21% over the same period. Applied is set to report its Q3 FY’24 results around August 15 and we expect earnings to come in at about $2.02 per share up from $1.81 in the year-ago period, while revenues are likely to stand at about $6.68 billion, up about 4% compared to last year. So what are some of the trends that are likely to drive Applied’s earnings for the quarter?

While the last year was somewhat mixed for the company as semiconductor capital spending remained weak post the lifting of Covid-19 lockdowns, there are indicators that the semiconductor cycle is turning. Applied posted a better-than-expected set of Q2 FY’24 results, with revenue coming in roughly flat versus last year at $6.65 billion, and adjusted earnings standing at $2.09 per share.  The semiconductor downcycle appears to have bottomed out, with memory prices picking up amid slower supply growth, while PC sales are poised to improve marginally this year after declining by nearly double-digit levels in 2023. Separately, the industry is benefiting from a surge in demand from the artificial intelligence space. AI workloads are computationally intensive,  calling for more computing power and memory and typically use more complex chips that require sophisticated manufacturing processes. Applied stands to gain from this, given that it is well diversified across the semiconductor production value chain, offering tools and services ranging from materials engineering, to process control and integration.

TXN stock has shown strong gains of 35% from levels of $150 in early January 2021 to around $205 now, vs. an increase of about 45% for the S&P 500 over this roughly 3-year period. In comparison, Arista Networks (NYSE:ANET), another company that benefits from generative AI, has seen its stock surge by about 300% over the same period. Arista is a market leader in high-speed networks focused on hyper-scalers and big corporations. Turns out, Arista is part of the 30-stock Trefis High Quality (HQ) Portfolio, which has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics.

Applied Materials stock currently trades at about $212 per share. This translates into a valuation of about 25x projected FY’24 earnings. The multiple is slightly high versus historical levels. While trends such as generative AI and cloud computing could drive AMAT’s stock, the company is likely to face some pressure due to its exposure to China, given that the U.S. has been tightening restrictions on the export of the latest semiconductor technology to China. During Q2 FY’24, Applied’s sales to China came in at close to $2.83 billion, accounting for about 43% of total revenue, up 21% year-over-year.  We value Applied Materials stock at $202 per share, which is slightly below the current market price. See our analysis of Applied Materials Valuation for a closer look at what is driving our price estimate for the stock.

[1] Returns as of 8/1/2024
[2] Cumulative total returns since the end of 2016

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