Applied Materials: Chipper Future

Chipmakers shop at Applied Materials. The Santa Clara, Cal., company makes tools that produce, etch, measure and inspect circuit patterns on computer chips. Its business succeeds or fails based on the demand for chips. Ben Pang, an analyst with Prudential Equity Group, expects rapid earnings growth at the company into 2007 as the worldwide appetite for cell phones, flat-panel TVs and personal computers swells. Pang on Tuesday upgraded the stock (symbol AMAT) from neutral to "overweight."

Applied Materials is a jack of all trades when it comes to chip-making gear. It is the largest equipment maker and has the broadest line of products. But last year, the company lost market share to competitors. Only recently has Applied Materials been able to stop the bleeding with better products and an expansion into new markets, Pang says. Orders in the quarter ended April 30 were $2.5 billion, up 60% from a year earlier. Net income rose to $413 million, or 26 cents per share, from $305 million, or 18 cents per share, in the year-earlier quarter. That beat the 23 cents per share analysts expected the company to earn in that period, according to Thomson First Call. Chief Executive Michael Splinter forecasts that total sales will grow 20% to 25% this year.

Side businesses should help Applied Materials generate more earnings growth, Pang says. In May, the company said it would buy Applied Films Corp., a solar-panel equipment maker, for $464 million. It also launched a joint venture with Dainippon Screen Manufacturing to make tools -- called "track" -- used in advanced chip manufacturing. Market researcher Gartner Dataquest estimates that the market for track systems will grow to $2 billion by 2008, from $1.4 billion last year.

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Last month's shopping spree has not tapped out Applied Materials. In fact, the company is flush with cash. It had $3.3 billion as of April 30, which gives the company the flexibility to pay dividends, repurchase shares or invest more in new businesses. The cash stash, says Pang, also means that when chip orders sag, as they inevitably will at some point, Applied Materials will weather the downturn better than its smaller rivals.

Pang says the stock, recently $16, looks attractively priced at 12 times his profit estimate of $1.29 per share for the 2007 calendar year. He set a 12-month target price of $21. The stock is down 71% from its 2000 high of $57.50.