When the economy gets wobbly, semiconductor stocks tend to struggle. After all, semis have historically been cyclical, with booming sales when times are good, as they were in the pandemic, and busting when demand dries up.
We are currently in a dry spell for a lot of chip stocks, especially those in PCs and smartphones. Consumer electronics chips are facing the dual headwinds of a post-pandemic air pocket after many loaded up with a new phone or PC two years ago, as well as economic headwinds as the Federal Reserve has rapidly raised interest rates.
Still, that's not deterring the world's largest semiconductor equipment stock by revenue from continuing to hike its payout -- and quite generously, I might add!
Chip investors are cautious, Applied Materials feels generous
Last Monday, Applied Materials (AMAT -0.46%) announced a 23.1% increase to its dividend, to be paid on June 15 to shareholders of record May 25, making the ex-dividend date May 24. The new $0.32 dividend only amounts to about a 1% yield at these price levels. Still, the dividend increase was the largest Applied has made in five years.
In addition, Applied Materials usually returns much more to shareholders in the form of share repurchases. For instance, in Applied's recent fiscal year ending last October, the company repurchased $6.1 billion worth of stock, while paying out $873 million in dividends. On that note, however, Applied also increased its share repurchase authorization by $10 billion, in addition to the $4.7 billion remaining on its current one.
Management also struck a highly-confident tone in the press release. CEO Gary Dickerson noted the dividend and repurchase increases, "reflect our positive long-term view of the semiconductor market and our confidence in Applied’s outsized growth opportunities driven by our technology leadership, broad portfolio of differentiated products and strong customer engagements." Meanwhile, CFO Brice Hill added, "As the market for semiconductors has grown and diversified -- and our services business has become larger and more subscription-based -- Applied’s revenue and profitability have become more predictable and resilient."
Hill also added the company intends to double the previous dividend per share over the next "several" years. One would assume that refers to the prior $1.04 annual dividend. If Applied Materials makes similarly-sized dividend hikes of 24% each of next two years, that would double the dividend to $2.08, or $1.7%.
What has Applied feeling so generous?
It may seem strange that Applied is feeling so frisky with regards to shareholder returns. After all, isn't the PC market in its worst-ever downturn, with smartphone sales not far behind, and the server market also slowing?
That's all true, but the downturn in consumer-based semiconductors doesn't mean things are as bad for the entire industry, or chip equipment companies in particular.
First, while things are down in consumer electronics, auto and industrial chips are still in short supply, and capacity expansion is booming. One of the elements Hill pointed to above was Applied's diversification. Applied put that on display in its last earnings release, noting its significant exposure to trailing-edge node equipment, specifically ion implant equipment, which helps produce chips for auto and industrial customers.
Those machine sales are actually accelerating right now, even as memory and leading-edge customers are pulling back, which is helping to mitigate the severity of the downcycle for Applied. That's something less-diversified chipmakers and equipment suppliers can't all say right now. It's also why Applied predicted relatively flat sales next quarter, outside of a temporary supplier issue, despite the memory and leading edge markets being in a severe correction.
Hill also noted Applied's Global Services (AGS) segment, which includes spares, maintenance, and subscription services that help chipmakers increase their production yields. This is an underrated part of Applied's business, at 21.5% of total sales with about 30% operating margins. That services revenue tends to be tied to the installed base and usage of machines already sold, so that business should grow just about every year, and won't be subject to the volatility of overall annual machine sales.
There may be an exception in the next couple quarters, since the U.S. new restrictions on Chinese chip sales is causing Applied to lose some (but not all) Chinese services revenue. But outside of that, this services segment should put a floor under profits in a downturn. And even better, the profits from the AGS segment alone more than covers the current dividend, even with the recent increase.
Equipment companies better than chipmakers themselves?
Applied's diversification and services business perhaps makes it more resilient than, say, a chipmaker without services revenue, or one only focused on one or two parts of the industry.
Moreover, the passing of the CHIPS Act last summer and countries looking to increase local production is only a further tailwind for chipmaking equipment companies relative to chip sales themselves.
And yet, equipment makers tend to trade at the same valuations, or perhaps even at a discount, to many chipmakers. There are of course exceptions, such as ASML (ASML -1.57%) which has a monopoly on extreme ultraviolet technology (EUV), and trades at a 43 PE ratio. And yet, compare that with the most expensive semiconductor stock Nvidia (NVDA -1.97%), which has a PE ratio of 110.
Meanwhile, Applied Materials, which has grown free cash flow at a 30% annualized rate over the past 10 years, trades at less than 16 times earnings.
This isn't to say that chipmakers like Nvidia or others won't do well over time; it just seems that the equipment makers are underrated. If you own lots of chip stocks but no equipment stocks, now may be a good time to diversify with Applied or its peers.
