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Scale and a one-stop-shop approach give this firm an advantage over its competitors.
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A Positive Outlook for Applied Materials
Erik Kobayashi-Solomon: Hi, I'm Erik Kobayashi-Solomon, co-editor of Morningstar's OptionInvestor.
Today, it's my great pleasure to welcome Andy Ng, stock analyst here at Morningstar covering chip and chip equipment companies. Andy thanks for coming.
Andy Ng: Sure.
Erik Kobayashi-Solomon: So, a couple of weeks ago, I wrote a bullish option strategy on Applied Materials, it’s a company that you cover and you really like.
First thing that I wanted to ask you is Applied Materials is a chip equipment company. Exactly, what does that mean, a "chip equipment company"? How is that different from a chip company?
Andy Ng: Applied Materials, they sell chip equipment which is the manufacturing tools that are used to manufacture semiconductors. So their customers include chipmakers like Intel, Samsung and other firms in the semiconductor industry.
Erik Kobayashi-Solomon: Okay. So they're not making the actual chips that go into a computer or a cell phone or something like that. They're making the equipment to make those chips.
Andy Ng: Right.
Erik Kobayashi-Solomon: Okay, got you. One of the things in talking to you about this and reading your report, AMAT, Applied Materials really has this one-stop shopping for chip equipment. How do you think this is advantageous compared to some of their other competitors who are more "niche-y?"
Andy Ng: They're the closest thing to a one-stop shop for selling chip equipment. But really the thing that is Applied's comparative advantage is they are really the 800-pound gorilla of the industry. They are the largest chip equipment maker in the world.
And so that allows them to have a massive R&D budget, marketing, service and support which is really important to chipmakers. So that is really to their advantage and what gives them a leg up over their competitors which tend to be smaller.
Erik Kobayashi-Solomon: I see. Looking at an AMAT stock chart, obviously, they have come a long way off their lows from last year. But if you compare them to some of the chip companies, their customers, right? The chip companies tend to be bouncing back even getting back towards kind of pre-crisis levels. And AMAT is still not up to that level yet. What do you think the market is worried about with AMAT? Is it a valid concern?
Andy Ng: Yeah. Even when you look at Intel's recent report, the semiconductor industry has really recovered from the depths of the downturn. But really when you look at the chip equipment market, things are still pretty depressed.
This year, equipment spending will probably improve by over 50%. When you look at it in terms of absolute numbers, things are still somewhat weak, so that's what the market is worried about.
But we think that because the customers are doing so well, we think that capital spending by chipmakers will increase later this year or next year.
Erik Kobayashi-Solomon: So basically the chipmakers are good as their profits increase, they say "Oh, we need to buy some more equipment. Let's call AMAT."
Andy Ng: Yes. So there's a bit of a lag-time that's going on and that's what we think is happening.
Erik Kobayashi-Solomon: Now, I know that Intel just reported. Intel's report was very good looked-like. What does this tell you about Applied Materials and other chip equipment makers for the next few quarters for these guys?
Andy Ng: Well, Intel is one of Applied's biggest customers, so definitely it's a good thing for Applied. But the thing is that when you look at the broader semiconductor industry, it seems like things are really improving.
When you look at buyers of chip equipment, nowadays the biggest buyers are memory makers. So when you have Intel doing well, it means computers are doing well, it means that the computer memory guys are doing well.
Erik Kobayashi-Solomon: These are companies like Micron, SanDisk or something like that?
Andy Ng: Yes and Samsung. And so hopefully there's more optimism that eventually when things continue to improve that the semiconductor industry as a whole will buy more equipment and that will spur companies like Applied into it the next upturn. And since the stocks in that space fluctuate with industry cycles, we think that Applied stock will go up when that happens.
Erik Kobayashi-Solomon: So really, Intel's good results are a leading indicator for AMAT.
Andy Ng: Yes.
Erik Kobayashi-Solomon: Well, that's great. Andy thanks a lot for coming. I sure appreciate it.
Andy Ng: Sure.
Erik Kobayashi-Solomon: And thank you for joining us. Please stop by the Morningstar OptionInvestor website where you'll find many more great option ideas based on Morningstar's fundamental research.