No matter what kind of broad-based damage is seen in the stock market when economic conditions become difficult, or even recessionary, there are always pockets of strength – in certain defensive-oriented industries, and also in smaller segments of sectors and industries that may not traditionally be considered defensive, but still generally benefit from other shifts in corporate and consumer trends.
Over the last month, the broad market has rebounded off of bear market lows to rally about 10% higher, primarily on hopes that the impact of COVID-19, as dramatic as it has been, will be temporary, and that the U.S. economy will be restarted sooner than later. It still isn’t clear whether that kind of optimism is well-founded; the Trump administration, and even some state governors are starting to push to reopen certain aspects of national and regional economies against the recommendations of health experts. And while yet another wave of financial stimulus is expected to be finalized this week from the federal government, it also remains unclear whether it will be sufficient to help stem the tsunami of unemployment claims that has hit economic reports in the last few weeks.
One of the interesting trends in the market is a reflection of the stay-at-home, shelter-in-place measures that have been adopted around the world. Many companies have transitioned all or at least the majority of their business operations – at least, in “white-collar” areas where employees don’t have to be on-site – to remote, telecommuting functions. While unemployment is rising, shifting major portions of the workforce to a telecommuting model has also saved millions of jobs and helped to keep a lot of other businesses running. That is part of the reason that companies that provide remote technology products and solutions have seen big increases in price over the last month. It has also spurred a sizable boost for businesses tied to cloud-based, and streaming services. As you drill down, that doesn’t just mean the Netflixes or Amazons of the tech world, but it also means that companies on the production and supply side of those solutions – including semiconductors, which are generally very sensitive to economic downturns – could stand to benefit.
In the semiconductor space, I like to pay attention not just to the producers – Intel, Advanced Micro Devices, Samsung Electronics, and so on – but also the companies that provide solutions and services to aid their production. That means equipment makers, like Applied Materials Inc. (AMAT) are always of interest. AMAT is a stock that was among the star performers in the market in 2019, more than doubling in price from the beginning of that year until it hit an all-time high at around $68 in February. The stock followed the rest of the market lower from that point, and as it led the market in 2019, it also led the plunge, giving back most of 2019’s increase amid a -47% drop in price. From that low point, AMAT has rebounded back strongly to a current price at around $52. That means that while it has rallied a little over 42% from its low, AMAT remains -25% below its February high. The company’s fundamental profile is healthy as of the last earnings report, and while the full impact of the pandemic isn’t really going to be known until their next report, which is due next month, is released, there is an argument to be made that stocks like AMAT could be a good place to focus your attention. Let’s dive in to the numbers so you can decide for yourself.
Fundamental and Value Profile
Applied Materials, Inc. provides manufacturing equipment, services and software to the global semiconductor, display and related industries. The Company’s segments are Semiconductor Systems, which includes semiconductor capital equipment for etch, rapid thermal processing, deposition, chemical mechanical planarization, metrology and inspection, wafer packaging, and ion implantation; Applied Global Services, which provides integrated solutions to optimize equipment and fab performance and productivity; Display and Adjacent Markets, which includes products for manufacturing liquid crystal displays, organic light-emitting diodes, upgrades and roll-to-roll Web coating systems and other display technologies for televisions, personal computers, smart phones and other consumer-oriented devices, and Corporate and Other segment, which includes revenues from products, as well as costs of products sold for fabricating solar photovoltaic cells and modules, and certain operating expenses. AMAT has a current market cap of $47.9 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased by almost 21%, while sales improved by 10.9%. That strong pattern was also seen in the last quarter; earnings increased 22.5% and sale rose 10.87%. That earnings patterns reflected, at least in part, generally improving conditions in the memory market, where oversupply had previously been a big concern. The company’s margin profile is impressive, and appears to be strengthening; Net Income versus Revenue was 21.43% in the last quarter, and marked an improvement from 17.49% over the last twelve months. Whether than pattern will hold in the next quarter’s report remains to be seen; but it does indicate a company with very healthy operating margins before the pandemic took full effect.
Free Cash Flow: AMAT’s Free Cash Flow is strong, at almost $3 billion. While this number declined from about $7 billion at the beginning of 2018, it is also up from around $2.5 billion at the end of 2018. It also translates to a Free Cash Flow Yield of 6.25%.
Debt to Equity: AMAT has a debt/equity ratio of .54, which is conservative, and implies debt management shouldn’t be a problem. The company has nearly $4 billion in cash and liquid assets, which means they they have plenty of liquidity, against $4.71 billion in total long-term debt. Over the last six months, cash has been increasing while long-term debt has been declining, which is a very useful pattern to consider in anticipation of the company’s next earnings report. It’s very reasonable expect to see a sizable impact on operations in the last quarter resulting from COVID-19, but the company’s financial discipline before then is something that will make it easier to blunt its long-term effects.
Dividend: AMAT pays an annual dividend of $.8 per share, which at its current price translates to a dividend yield of about 1.69%. It should be noted that the company increased its dividend in the last year by 10% annually, from $.80 per share.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $50 per share. That means that BAX is slightly overvalued, with about -4% downside from its current price. It also puts a bargain price for the stock at around $40.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The chart above covers the last year of price activity. The red line traces the stock’s bearish slide from February to March, and informs the Fibonacci retracement lines on the right side of the chart. The stock’s rally off of its low at around $36.50 pushed the price up to the 50% Fibonacci retracement line about a week ago, where it hit strong resistance around $53 per share. It dropped back to about $49, which also lines up with the 38.2% Fib line before rallying in the last couple of days to its current price. A break above $53 could give the stock room to rally to next resistance at around $57, where the 61.8% retracement line can be seen. On the other hand, if the stock drops below $49, its next most likely support level is probably around $44, with additional downside to about $41 if bearish momentum accelerates.
Near-term Keys: If you prefer working with short-term, momentum-based trades, the stock’s current price action could provide some useful opportunities. Use a break above $53 as a signal to buy the stock or work with call options, with a nice exit point for a quick-hit gain at around $57. If the stock drops below $49, you can think about shorting the stock or buying put options, with an eye on the $44 to $41 range providing a useful bearish target. What about the value proposition? AMAT’s fundamentals look pretty solid; but it is probably smart to wait to see what kind of effect the current pandemic has had on those fundamentals before making a decision about the stock’s usefulness as a long-term investment. I think that argument is support by the fact the stock’s value price is more than -20% below the stock’s current price, which to me means that caution is warranted for the time being.