Applied Materials May Be Ready for a Break

 | May 16, 2017 | 1:00 PM EDT
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Applied Materials (AMAT) is scheduled to report its second-quarter fiscal 2017 results after the close on Thursday. Can Applied deliver another blowout quarter?

I have been bullish on Applied Materials for a long time. Everybody else has been, too. The stock is up 124% over the last 12 months -- and it's up 35% year to date. It's not exactly a secret that Applied is doing well.

In fact, just yesterday, two investment banks raised their price targets on the stock. Needham and Stifel reiterated their buy rating on Applied and increased their price targets to $50.

It's not hard to see why everyone is bullish on Applied. Analysts think this will be the third straight quarter of triple-digit earnings growth. In the fourth quarter of 2016, earnings were up 128%. First-quarter earnings rose 160%. Now, investors are looking for second-quarter earnings to increase 124% -- to $0.76 per share. Revenue is expected to be up 45% -- to $3.45 billion. Wow, that's exciting!

I think the stock can go higher over the longer term, but it may take a well-deserved break, since the company is about to hit a second-half slowdown. In fact, the party could be coming to an abrupt end.

Investors are already looking through the second quarter towards the third. But the consensus estimate for the third quarter is just $0.66 per share. That's up only 43% year-over-year ($0.46). Even if management raises third-quarter guidance on Thursday, the triple-digit streak will come to an end with the second-quarter report.

Looking forward to the fourth quarter, last year the company reported $0.66 per share, but analysts are forecasting earnings of just $0.53 per share. That means earnings growth peaked in the first quarter (i.e. the period ending January 29, 2017). That's a long time ago!

The analyst consensus is forecasting fiscal 2017 revenue of $13.26 billion, up 22.5%. But next year, revenue is expected to be just $13.79 billion, up only 4%.

When you look at the run the stock has been on, it looks like it's on a precarious perch. Kind of feels like this stock run is about to run out of gas or someone is about to steal the punch bowl!

Even if these next two quarters are "beat and raise" quarters, the company still won't be able to produce triple digits earnings. Revenue growth is slowing too. To get more revenue growth, you have to go out to fiscal 2019, which I'm not willing to do right now.

Over the longer term, I think Applied Materials can go higher, but the stock clearly needs a rest.

The wafer fab market is notoriously difficult to forecast. Worldwide equipment spending is estimated to grow about 3% in 2017 and is projected to keep going past $37 billion by 2019.

New technologies, like 3D NAND and new etch technologies are in the early stages of growth. Last year, Applied Materials landed over $1.5 billion of orders for 3D NAND equipment. New etch patterning has added about $1 billion in new equipment sales.

Third, the company believes OLED display technology will be used in more than half of all smart phones by 2020. Right now, only 20% of smartphones use OLED displays.

And finally, Applied Materials thinks China remains a huge opportunity. The Chinese are investing heavily in new technology and could spend $20 billion to $30 billion on new wafer fab equipment over the next five years.

Clearly investors are excited by AMAT's past performance, but that past is the past. I think the excitement is about to come to an abrupt end. Eventually the stock will get to $50 per share, but not this week.

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