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Applied Materials' shares will reach $28 in medium term

Applied Materials, the world largest manufacturer of equipment for semiconductor industry, recently reported solid results for its fiscal first quarter ended January 25, 2015. Revenues rose 4.2% q-o-q and 7.7% y-o-y to $2.36 bn and surpassed consensus estimate of $2.33 bn. The Silicon Systems Group (SSG) contributed 61% of revenues, up 0.8% q-o-q but down 2.6% y-o-y. The second-largest contributor was Applied Global Services (AGS) with a 25% revenue share. Segment revenues were down 1.5% q-o-q but up 15% y-o-y. The Display segment was up 44.7% q-o-q and 73% y-o-y, with segment contribution jumping from 8% to 12%. Around 72% of Applied Materials’ quarterly revenues came from the Asia/Pacific region. Taiwan contributed 22% of revenues, followed by Korea with 20%, China with 16% and Japan with 10%. Adjusted operating income increased 1.1% q-o-q and 17.6% y-o-y to $447 mn. As a result, operating margin of 18.9% shrank 57 basis points sequentially but was up 210 basis points from the year-ago quarter. Adjusted earnings per share came in at 27 cents, up 17% y-o-y and in line with analysts’ average forecast.

In FQ1, total new orders of $2.27 bn were up 0.8% q-o-q but down 0.5% y-o-y. On a sequential basis, Display and AGS orders were down 17.7% and 7.63%, respectively, while SSG orders improved 6.9%. However, all segments except SSG increased on a year over year basis.

At quarter end, Applied Materials had cash and short-term investments balance of $3.09 bn and long-term debt of $1.95 bn. In FQ1, the company generated $60 mn of cash from operations and spent $49 mn on capex and $122 mn on dividends. A quarterly dividend was 10 cents per share, with indicated dividend yield of around 1.5%.

My outlook for Applied Materials remains optimistic. Many of the world largest chip foundries including Taiwan Semiconductor Manufacturing and Samsung Electronics have increased their budgets for plants and equipment this year, which should translate into growing demand for new machinery. Applied Materials has a solid product line, and management has stepped up investments to prepare for the ongoing transitions to larger wafer sizes and smaller process nodes. The ramp up in FinFET, 3D NAND and new display technology will likely be the catalysts going forward. Notably, Applied Materials expects its merger with Tokyo Electron to be completed in the first half of this year as the companies await regulatory approval. The deal will create a company with about 32% wafer-fabrication equipment market share.

I believe that Applied Materials’ sharea are  attractive for medium-term investment. Target price is $28.