ARTICLE: Brave New World of Tech Stocks - Pt. 2By: Jim Jubak / published on MSN Money
I think Applied Materials has got the trends right, however. Consider solar panels. The solar industry began consuming more silicon than the semiconductor industry in 2001. Growth has been so fast, in fact, that it has led to a severe shortage of silicon at solar cell and panel manufacturers. That slowed growth in the solar-energy industry to 28% in 2005 and could keep growth below 10% this year. New refineries for making the raw material of solar cells and computer chips -- called polysilicon -- won't come on line to end the shortage until 2008 or so.
That problem is actually an opportunity for Applied Materials. Much of the manufacturing equipment in the solar industry has been built in-house by solar companies. That has saved money for companies growing so fast that they're often strapped for cash, but it has also led to very low yields.
Applied Materials figures that its equipment for handling and processing silicon, using technology tested in the semiconductor industry, can increase yields enough to make it an attractive investment in a time of polysilicon shortages. Plus, the new thin-film technologies acquired in the July 2006 purchase of Applied Films, added to existing thin-film technologies at the company, fit in perfectly with the solar industry's drive to reduce the cost of solar power by replacing current technology using crystalline silicon solar cells with thin-film cells.
By 2010, according to Applied Materials projections, crystalline silicon solar cells will sell for $1.25 to $1.50 a watt. Thin-film cells will sell for 90 cents to $1.30 a watt. (In 2006, the cost for crystalline silicon cells was about $2.70 a watt. That's quite an improvement from $21 a watt in 1980.) Cheaper cells, of course, mean faster growth for the solar industry and more equipment sales for Applied Materials.
The company projects $500 million annually in solar equipment sales by 2010.
That's not bad from a standing start in 2005, but it's not enough alone to power future growth at a company projected to do $9.2 billion in sales for fiscal 2006.
Flat-panel developments a key
But fortunately for Applied Materials' growth strategy, the same technologies that can be used to deposit thin films to create solar cells are key to creating flat-panel displays. On Oct. 17, for example, the company announced a new generation of manufacturing equipment to produce large-size liquid crystal displays (LCD) for TVs. The fully automated system is designed to handle larger substrates (used as the foundation for the screen) so that six 55-inch screens can be cut from a single panel and then, through improved testing, minimize manufacturing defects, all as a way to reduce manufacturing costs. That's a big deal in the cutthroat flat-panel display market where every month brings a reduction in selling price.
In the past 10 years, Applied Materials display subsidiary AKT has become the largest supplier to the flat-panel market of the equipment used to deposit thin films, and that business accounted for 15% of sales at Applied Materials in 2005. But by adding technologies from its Applied Films acquisition to those already in house, Applied Materials is going after a bigger part of what is rapidly becoming a bigger pie.
How big? In 2007, sales of LCD TV sets will pass those for traditional cathode-ray-tube TVs for the first time, according to market research company iSuppli. Sales are projected to grow to 17.8 million units in 2007, a 63% increase. By 2010 LCD TV sales are projected at 42 million units.
And, as with solar cells, Applied Materials has more going for it than just volume growth. With LCD prices falling, only the most efficient manufacturers of flat panels will survive. That makes any equipment -- such as the newest generation system from Applied Materials -- that can improve efficiency and cut costs a must-have for companies facing this relentless competitive pressure.
These aren't the only growth arrows in Applied Materials' quiver. The company has also decided to go after a bigger chunk of the market for equipment to make flash-memory chips -- the chips that store music in MP3 players and the latest iPods, for example.
Diversity is the answer
But by this time, you should get the message: From a highly cyclical company tied to the ebb and flow of the PC industry, Applied Materials has become a much more diversified silicon-equipment maker with exposure to industries such as solar and TV that should smooth out the boom and bust in the company's revenue. That "smoothing" should increase, too -- as will the price-to-earnings ratio the market is willing to pay for less volatile earnings -- as the faster growth from solar, flat panels and flash memory gradually makes revenue from those sources a bigger part of the revenue at Applied Materials.
I'd argue, then, that this is a new Applied Materials that has tapped into the trends that define the new technology sector: growth from nontraditional consumer (rather than PC) sources, less cyclical and better diversified, and ready for a new wave of growth driven by a technology sector that is even more cutthroat than it was in the 1990s.
I don't think the stock market has recognized this transformation at Applied Materials. The stock could well struggle for the rest of 2006, since chip-equipment analysts on
Wall Street are projecting a slowdown in equipment sales in the December quarter and into 2007 because of flagging growth at the sector's traditional customers. One competitor,
Novellus Systems (NVLS, news, msgs), has already warned
Wall Street that orders in the fourth quarter are likely to be down by 10% from the third quarter.
So while Applied Materials shares are cheap now at about 18 times projected fiscal 2006 earnings estimates, according to Standard & Poor's, you don't have to rush out and buy them. They could get even cheaper in the months ahead.
On the other hand, picking an absolute bottom isn't that important with these shares. You're buying them for the long haul, based on the growth that is due in the second half of 2007 and beyond and on the price appreciation that will come as Wall Street gradually wakes up to the changes at the company.