AMAT is about to break down despite great fundamentals

July 11, 2018

AMAT is about to break down despite great fundamentals

For the last week or so, I’ve noticed that the market seems to be trying to shrug worries about trade tensions aside and focus on other matters, like continued strength in the U.S. economy as measured by things like unemployment and payroll figures, along with corporate earnings that generally seem to keep coming in with healthy growth. This morning, however, trade is once again rearing its ugly head, as overnight the Trump administration published a fresh list of proposed tariffs on an estimated $200 billion of Chinese goods. Not surprisingly, China is promising to retaliate and accusing the U.S. of using bullying tactics to try to get their way. I’ve also heard some rumbling over the last couple of weeks about the flattening yield curve and the chances it could invert, which a lot of experts would read as a leading indicator of a looming recession. I’m not so sure that a flattening curve right now is as problematic as some think. There are some interesting global factors at play right now, including negative interest rates in Germany and Japan that make short-term U.S. Treasuries more attractive worldwide than what we’ve seen happen historically. On the other hand, an extended, long-term trade conflict with China and our other biggest trade neighbors could be a catalyst that drives up costs, not only in the U.S. but across the globe to the point that recession becomes inevitable.

With respect to China, the Semiconductor industry has seen a lot of negative price pressure for the last few months, because so much of the fabrication and production of semiconductor products comes from that country. The Trump administration’s tariffs against China imports are intended to protect U.S. technology and intellectual property (or so they want the world to believe) but at the same time many of them penalize American companies that use Chinese manufacturers to produce their finished product. That puts the entire sector at risk, which includes companies like Applied Materials, Inc. (AMAT), who provide manufacturing equipment, services and software to the sector.

AMAT is down about 28% since early March, when President Trump first started rattling the tariff saber. That’s a big drop over that period that has forced the stock into an intermediate-term downward trend. The strength and momentum of that trend appears to be approaching an inflection point right now, and assuming the U.S. and China won’t stop pointing fingers and actually find a way to come an agreement anytime soon, I think there is a real chance that AMAT could break down to levels it hasn’t seen since late 2016. This is a risk that belies the company’s overall fundamental strength and strong financial position; in the long run, I think that strength will set up an interesting value proposition at some point down the road. For now, however, the downside risk from those external, geopolitical factors far outweighs any long-term opportunity.

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 $45.5 billion.

  • Earnings and Sales Growth: Over the last twelve months, earnings increased 54%, while sales increased almost 29%. Growing earnings faster than sales is difficult to do, and generally isn’t sustainable in the long-term; however it is also a good indication of a management’s ability to maximize their business operations. The company’s Net Income versus Revenue was almost 25% in the last quarter, which indicates their operating margins are very healthy.
  • Free Cash Flow: AMAT’s Free Cash Flow is strong, at more than $3.6 billion. While this number declined from about $4 billion in its most recent quarter, it has increased consistently since late 2015 when it was a little under $1 billion.
  • Debt to Equity: AMAT has a debt/equity ratio of .75, which is manageable despite its increase from .62 in the last quarter. The company has more than $5.3 billion in cash and liquid assets, which means they they have plenty of liquidity, against $5.3 billion in total long-term debt.
  • Dividend: AMAT pays an annual dividend of $.80 per share, which at its current price translates to a dividend yield of about 1.77%.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for AMAT is $6.99 per share. At the stock’s current price, that translates to a Price/Book Ratio of 6.45. The average for the Insurance industry is 5.3, while the historical average for AMAT is 4.06. That is a  pretty good indication the stock remains overvalued right now despite its decline since March. A move to par with its historical average would put the stock a little above $28 per share, which is actually below the technical bottom I’m forecasting if the stock’s current downward trend continues to assert itself.

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 two and a half years because I want to give you an idea of how far AMAT has come; the impressive rise from around $15 that started at the beginning of 2016 to a high above $60 is remarkable by any measure. The stock’s terrific run was driven in no small part by the company’s fundamental strength, and those fundamentals remain solid, so there is an argument to be made that the stock should remain higher than it where it started. Given that the stock has dropped almost 30% in just four months despite its fundamental strength, however also provides some context for how much downside risk I think there is in the stock from external forces. The stock is sitting on a strong support level around $45 right now, which I’m highlighting with the blue horizontal line. If it drops below that point, its next likely support level would be around $40 (yellow horizontal line). Another break below that level could easily see the stock drop all the way to around $30, which would mark a 33% drop from the stock’s current level, and a 50% total drop from its March highs. Bullish upside is also limited right now by the bearish strength of the intermediate trend, shown by the green moving average line. The stock would have to break above $50 with strong upward momentum and buying volume before any reversal of the intermediate trend could be confirmed.
  • Near-term Keys: Watch the $45 support level. A break below that point is a strong indication the current downward trend could resume its momentum; the best trading probabilities in that case would come from bearish trades, such as buying put options or short selling the stock. If the stock starts to reverse higher from $45, be patient and wait for the stock to break above $50 before considering any kind of bullish trade.

By Thomas Moore China Investiv Daily Semiconductors Tariffs Share: