Year 2 of the Chip Shortage Is Starting, and Applied Materials Stock Is Still a Buy

The world continues to grapple with a big question: "When will the chip shortage end?" The answer is almost certainly not 2022. Perhaps it will end in 2023, but it's too early to know for sure. In the meantime, semiconductor designers, manufacturers, and fabrication equipment companies continue to report stellar growth and profitability.

Applied Materials (NASDAQ: AMAT), one of the leaders in developing fab equipment (the machines that make chips), just reported yet another fantastic quarter of sales and profit growth -- with plenty more on the way. Here's why this is still a great stock to buy for the long term.

Someone in a lab suit holding a semiconductor.

Image source: Getty Images.

The chip shortage comes full circle

Two major worries for Applied Materials (AMAT) headed into its first-quarter 2022 report (the three months ended Jan. 30, 2022) were the chip shortage and supply chain constraints. A piece of chip fab equipment has chips in it too, and some components are in short supply. Add in ongoing shipping issues, and companies like AMAT are having problems getting orders filled in a timely manner.

But demand is strong right now, lifting the price on equipment sold and keeping AMAT's financials moving up and to the right. Q1 2022 revenue was $6.27 billion, a 21% year-over-year increase, and operating profit margin was a very healthy 31.5%. As a result, free cash flow was $2.51 billion, nearly doubling from the same quarter last year.

Strength came from nearly all AMAT segments, including the particularly unpredictable DRAM and flash memory chip markets, and services revenue (ongoing maintenance and support from the existing installed base of fab machines) was also up a steady 14% year over year. The lone pain point in the report came from the small display segment, where AMAT provides machines for the manufacture of LCD and OLED screens. Sales fell 11% year over year, but only accounted for 6% of total revenue in Q1.

The short story is that, in spite of the chip shortage and supply chain constraints coming full circle and affecting AMAT, the company was able to handily overcome these problems and deliver strong growth.

Another great year is here

One of the chief concerns with companies like AMAT that are tied to cyclical manufacturing trends is that eventually the chip shortage will end, supply and demand will balance out, and revenue and profits for the company could peter out or even decline for a time. This is the historical norm, and it will happen again at some point.

AMAT Revenue (TTM) Chart

AMAT Revenue (TTM) data by YCharts

However, supply was constrained in the last year, which means there's pent-up demand for fab equipment in 2022. In fact, AMAT management has some view into 2023 trends that indicate its growth trajectory could continue long into next year as well. Chips are proliferating throughout the global economy, and AMAT's manufacturing partners can't keep up. Company CEO Gary Dickerson said this on the earnings call: "Overall, our outlook for the next decade is very positive. We expect semiconductor and wafer fab equipment to grow significantly faster than the economy with outsized opportunities for Applied Materials."

While ups and downs will remain present, AMAT is on track to be a much larger company 10 years from now than it is today. And given that AMAT supplies all sorts of chipmakers that serve all sorts of chip designers, investing in this stock means an investor doesn't need to pick an industry winner. AMAT will act as a sort of proxy for global semiconductor demand overall.

But for now, let's focus on the immediate term outlook. Guidance for second-quarter fiscal 2022 implies 14% year-over-year revenue growth at the midpoint of guidance, building on the 41% sales growth reported a year ago. Adjusted earnings per share are expected to rise 16.5% at the midpoint of guidance.

Applied Materials shares currently trade for 27 times trailing-12-month free cash flow. That's a great long-term bet on the overall rise of the chip industry that's expected over the course of the next decade. I remain optimistic on this company's prospects after the last earnings update.

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Nicholas Rossolillo and his clients own Applied Materials. The Motley Fool recommends Applied Materials. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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