U.S.-China tensions could force AMAT much lower

May 31, 2018

U.S.-China tensions could force AMAT much lower

Over the last several weeks, the threat of a trade war between the United States and China has put a lot of pressure on the broad market. Virtually every sector of the economy could be affected by U.S. tariffs on steel and aluminum as well as on auto imports. One of the most affected industries right now by trade tensions is the semiconductor industry. For the year, that uncertainty has propelled the entire industry to wide swings from high to low of 10% or more; remarkably, for the year the industry is actually up about 3% for the year despite that high volatility. The question is far from settled, however, as both China and the U.S. continue to rattle their political sabers and dig in their heels.

Names like Intel (INTC), Advanced Micro Devices (AMD), Micron Technology (MU) and Texas Instruments (TXN) may be among the best-known names in the semiconductor industry, but there is another stock in the industry with particular exposure to risk from a U.S.-China trade war, and that is Applied Materials (AMAT). This is a company that you may not have heard about, but the fact is that AMAT is one of the biggest players in the semiconductor equipment and manufacturing industry. Some of their most impressive growth over the last year has come from their China operations, which include customers like Taiwan Semiconductor and Samsung Electronics. A full-fledged trade war threatens to seriously damage an important part of this company’s business in a way that could erode an otherwise solid fundamental profile. By most value-oriented and technical measurements, the stock is also quite overvalued and appears more likely to break down over the next few months than it is to rally to new highs.

Fundamental and Value Profile

Applied Materials, Inc. (AMAT) 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.

  • Earnings and Sales Growth: Over the last twelve months, earnings grew by more than 50%, while sales grew by about 25%. This is an indication of management’s ability to maximize profits while also growing revenues aggressively. As previously observed, a big portion of the company’s growth in both areas has come from China, where they reported revenue for the first quarter of 2018 of more than $1 billion.
  • Free Cash Flow: Over the last twelve months, Free Cash Flow has grew by about 20%, but declined about 10% in the most recent quarter.
  • Debt to Equity: the company’s Debt/Equity ratio increased over the last twelve months, attributable primarily to stock buybacks that reduced shareholder equity while total long-term debt stayed mostly level over the period.
  • Dividend: CVS pays an annual dividend of $.80 per share, which translates to an annual yield of 1.55% at the stock’s current price. It is also worth noting that AMAT doubled their annual dividend payout in February of this year, from $.40 per share.
  • Share repurchases: Along with doubling their dividend in February, AMAT also announced the would spend an additional $6 billion to its existing $2.8 billion repurchase program. Stock buybacks serve to decrease the number of available shares in a stock, which usually helps to provide support to the stock’s price over the long term.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods 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 7.38. The stock’s historical Price/Book Ratio is 3.7, which implies the stock is trading twice as high as it would normally be expected to do. This puts the stock at risk of a long-term drop to as low as $25.63 per share.

Technical Profile

AMAT has been following a strong upward trend since September of 2015, rising from a low at that time at around $14 per share to a March 2018 high at around $62 per share. The stock has dropped more than 16% from that point, marking a short-term downtrend that is in danger of extending even further. Here’s a look at the stock’s latest technical chart.

Source: TradersPro.

  • Current Price Action: The stock has shown considerable volatility over the last couple of weeks, as concerns about semiconductors in general, along with U.S.-China trade tensions have weighed on the entire industry. That was emphasized by an overnight gap to the downside from $54 to around $49 per share on May 18th. The has rallied somewhat over the last week off of support at around $49 per share.
  • Trends: The diagonal red line traces the stock’s downward trend  that began in March. As the stock approaches that line at around $54, it should act as resistance to any further increases in the stock; conversely, a break above this resistance level would act as a bullish catalyst that could propel the stock near to its 52-week high around $62. The dotted, horizontal green lines on the chart at $49 and $42, respectively mark the stock’s most likely support levels if the downward trend remains in force. A break below $49 at any point in the near future should open the door to even steeper declines that aren’t likely to be arrested until the stock reaches $42 per share.