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Applied Materials offers stability within the volatile tech sector
Posted by: Chandan Dubey (IP Logged)
Date: July 15, 2012 09:28AM
Applied materials (AMAT) is one of the companies I have been adding in the last few months. It is a company which I covered a long time back (see Companies with buybacks: AMAT edition). I started buying the company around $11 and have kept adding whenever it dips below $10.
Yesterday, I bought 2 call options at strike $5 expiring in Jan 2014 for $5.55 each and sold 1 put option with strike $10 expiring in Jan 2014 for $1.68. If you do not understand options, have a look at my previous article on writing puts. What you need to know is that both these strategies are going to be profitable for me if the stock goes up.
Given that I have decided to concentrate my portfolio, I am only adding high quality companies. Specifically, the company should satisfy all of the following requirements
All and let me repeat, all of these conditions must be met before I will invest in the business. This is imperative because I like to add to my holdings when after buying they keep dropping and offering me better and better value. I have been scared out of adding to my positions after a big drop because one of these conditions were not met. So, I have decided to be on the safe side. Given that the stock market is huge and at any given point there are numerous options to invest in, there is no reason to settle for something less for your money. If you do not feel comfortable, do not invest !
I will look at Applied Materials (AMAT) in this light and see if it makes good on everything I promised above.
One of the most important criteria is the business the company is in. For example, investing in Groupon is inherently risky from this perspective. The company has no barrier to entry (anyone can copy the website and procure deals from local businesses if they undercut Groupon on the margins) and the underlying business model is very fragile. There is no customer loyalty to speak of and hence it leads to cutthroat competition and eventually low margins for everyone.
Another important criteria is the capital expenditure of the business. Groupon has a very low cap-ex. To expand its business to a new country, it only needs to copy its website and hire a small marketing team which will approach local businesses for the deals. On the other hand, France Telecom (FTE) is a business with high cap-ex. It not only needs to modernize the old infrastructure (wires and equipment) to keep pace with the ever changing landscape of mobile and wired technologies, it also needs to spend large sums of money to expand into new markets.
Let us look at the business of AMAT along these two criterions.
AMAT operates in the following segments.
Simply speaking AMAT is in the business of making machines that build semiconductors.
Semiconductors are the backbone of the modern civilization. They are found in computers, phones, iPads, televisions, and numerous other electronic equipments. As we know, there is an intense competition between Hewlett-Packard, Apple, Nokia, Research in Motion and also Intel, AMD, Nvidia in segments of the technological pie. The competition is sometimes brutal and has driven some companies on the brink of obsoletion (example Nokia, Research in Motion). Other companies have suffered a large threat to their business by upstarts (Cisco) or due to management missteps (Hewlett-Packard). In short, the tech sector offers a very volatile and ever-changing landscape. Applied Materials on the other hand stands in the back of all this fight. It does not make a product which directly goes to the consumer but it makes products for the companies who make products for their customers. It does not care who wins the smartphone fight between Apple, Nokia and Research in Motion. As long as smartphones are made, the company which makes them will need equipments to put together the chips that enable the smartphone to work. All these chips will need AMATs machines to put them together. AMAT is the largest supplier of the equipments to this industry, a position which it has held since 1992.
The manufacturing process for the thin film transistor (TFT) liquid crystal display (LCD) used in notebook computers, televisions, and desktop monitors is also quite similar to the integrated circuits for semiconductors. AMAT is the number one equipment supplier to this industry and has been a leader since 1993. Nearly every display in the world today was made by using AMATs’ equipment.
Solar energy is the dark horse in AMATs portfolio of products. They are also #1 provider of solar equipment i.e., wafer and cell producers manufacturing systems.
AMAT competes with Novellous Systems (NVLS), KLA-Tencor (KLAC) and Lam Research (LRCX) in different segments of the market.
I hope that with a bit of understanding of the business which I talked about just now, I have convinced you that AMAT has a relatively stable business compared to the likes of Nokia, Cisco, Hewlett-Packard and Research in Motion. The landscape in the equipment industry is relatively less crowded and AMAT has managed to keep its leadership position since 1992 (almost 20 years now).
Let us come to the second criteria for the business, which was Capital Expenditure. This is not one of the businesses for which we can easily say what the cap-ex will be. So, we pull up the figures from the last 10 years from Vuru.co.
We see that the income has increased quite dramatically and the capital expenditure has also come down quite a bit as a percent of net income. This is a good sign. So even though the business does not seem to be one with very low cap-ex (like See’s candy), it is not very capital intensive either.
The balance sheet
|Item in $m||Period ended 29.04.2012|
|Cash and short term investments||1,761|
|Total current assets||6,330|
|Total current liability||2,666|
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