Capital equipment manufacturer Applied Materials (AMAT) reported an in-line Q2 and weaker-than-expected guidance. Shares rallied, however, when management indicated that orders had “bottomed.” This wasn’t good enough for Credit Suisse, which slashed its estimates:
“Bottom”-line. We wouldn’t chase the stock at these levels despite “the bottom”. Trimming estimates from $8.89bb/$1.05 to $8.74bb/$0.80 in CY08, $1.06 EPS in CY10 goes to $1.09 (~11c solar in CY09). AMAT’s execution in silicon leaves much to be desired; solar has made progress but well within our thesis of “three fundamental constraints” for AMAT’s solar. Despite the “peak” in FPD orders, we’d argue AMAT deserves credit for execution in FPD, but not enough to carry the stock at current levels. Ultimately, if you are a believer in solar as we are, there are dozens of other pure-play solar companies…
Laying out its bear case for AMAT, CS cited the firm’s consistent underperformance in its silicon business, a coming glut in the solar market, and cost issues implicit to solar technology:
AMAT silicon orders are down 60% vs SCE peers down ~45% from peak to trough – we think this is structural as AMAT’s segments will not grow as quickly as say litho, process control or etch. Regardless of the bottom argument, AMAT’s silicon business is worth less than perceived before, at least to account for this relative underperformance. (ii) Solar – thesis of three fundamental constraints – (a) solar will be significantly oversupplied starting in 1H09 (AMAT may not be able to lower costs in time), (b) AMAT’s Gen 8.5 choice is an unproven risk – this size was chosen to lower BOS costs initially but has instead increased overall costs (c) The cost challenge – For silicon solar cells, High efficiency = high capital intensity (this is a known, multi-decade problem) and unfortunately Low Efficiency = High BOS cost (i.e., we are sceptical AMAT can hit LCOE targets for solar).
Shares remain Neutral rated and target stays at $20.50.
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