Semiconductor capital equipment maker Applied Materials (AMAT) is on the list of two firms, Citigroup and Cowen, that have released their top ideas for 2022. They both conclude that AMAT will continue to ride the wave of solid semiconductor spending.
Since AMAT trades at a discount to its peers, Cowen anticipates the growth in 2022 could lead to valuation catching up to the long-term prospects. "We believe gross margin expansion, OpEx control, and stock buybacks could warrant multiple growth."
Citigroup moved AMAT to the top semiconductor name, "as best exposed equipment pick on 3D devices, heterogeneous compute, and government spending megatrends."
This past year has been marked by demand far outstripping supply of semiconductors and the equipment used for semiconductor fabrication. The push-out of revenue into 2022 portends another strong year ahead. AMAT's third-quarter earnings missed Wall Street estimates due to supply constraints in filling orders. The company's backlog was up by 77%.
There's a persistent concern that double and triple ordering of semiconductors will turn supply constraints into a supply glut. However, numerous consequential industry players believe this concern is unfounded in this cycle -- longer lead times, with demand stretch out, have led to better visibility for an extended period of time. In part, these fears have helped keep the valuation in check and the investment opportunity intact.
Chip production is coming back to the U.S. with giant wafer fabrication factories in the works. Intel (INTC) plans to spend $20 billion on two new factories in Arizona, Samsung plans a $17 billion chip-making plant in Texas, and Taiwan Semiconductor (TSM) has committed to spending $100 billion on chip production over the next three years with $12 billion on a fab in Phoenix. Overall, to meet semiconductor demand and expand into more regional production, chip companies have plans for 59 factories worth about $300 billion.
With all the new construction, demand for chip-making equipment is robust and confidence in the industry's long-term business visibility is high. The increased spending on the transition to 3nm also translates into strong visibility.
Morgan Stanley research has noted in their proprietary CIO survey that "almost four times as many believe they will need to increase tech spend as a percentage of revenue over the next three years versus pre-COVID levels."
AMAT is well-positioned to be a leader in innovation within the industry, including employing new materials, creating more energy-efficient computing, and enabling the miniaturization of chips. Citigroup believes the company also has an advantageous position in the development of the metaverse.
One caveat that could hamper Applied Materials in reaching its full potential are the restrictions on its business in China, where the company generates about a third of revenue. According to the Wall Street Journal, the Biden Administration may close regulatory loopholes that have allowed SMIC, China's largest chipmaker, to acquire vital U.S. technology.
Even with the caveat, investing in AMAT is not one to overthink for 2022. Demand is robust, with good visibility for growing revenues and earnings through 2025; valuation is reasonable, trading under a 20 P/E; buybacks are returning 80-100% of the strong cash flow to shareholders; and a diversified positioning in the industry could promote market-share gains.