Applied Materials Stock: Liquidation May Not Be Complete (NASDAQ:AMAT)

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Investment thesis

Applied materials (NASDAQ: AMAT) will release its FQ2 results card on May 19. Despite its strong free cash flow (FCF) yields, its stock has also been hurt by the recent decline in semi-equities. Like As a result, AMAT stock was also sent into a bear market, 30% below its January highs.

However, it has outperformed many of its more expensive semi-expensive counterparts as the market has digested the industry’s massive gains from 2020. The market remains concerned about the industry’s ability to sustain growth, considering given growing macroeconomic weakness, supply chain disruptions affecting manufacturing equipment suppliers, and soaring raw material prices.

Our price action analysis also suggests that AMAT stock is at a near-term low, following May’s strong sell-off.

We like the FCF returns in AMAT stock, and believe they provided a strong defense for its valuation during the sell-off. However, we’ve grown more cautious about its less robust technical image.

Our analysis of the price action suggests broad resistance at the $120 level, which was its previous critical support zone. But, given January’s huge upside trap, there could be potential for a deeper sell before AMAT stock hits a medium-term low.

Accordingly, we are revising our Buy to Hold rating, in the direction of its FQ2 chart, with a price target of $120 (implied up 2.7%). We urge investors to watch the retest of its critical short-term low of $105 before considering adding exposure.

AMAT shares’ high FCF returns helped it avoid a deeper sell-off

Stock AMAT NTM FCF returns % Vs. peers

Stock AMAT NTM FCF returns % Vs. peers (TIKR)

AMAT share Performance YTD % Vs. peers

AMAT share Performance YTD % Vs. peers (koyfin)

The semi-finished industry has been battered since the start of 2022. Of the names we tracked in our charts above, only Broadcom (AVGO) stock is down less than 20% year-to-date . As a result, there was nowhere for semi-investors to hide as market makers turned to digest their massive 2020 gains.

Nonetheless, we believe AMAT stock’s robust FCF returns have helped it weather the recent maelstrom that engulfed semi-equities. AMAT stock last traded at an NTM FCF yield of 5.85% (vs. 5-year average of 7.42%). This could help explain in part why the hit was less severe than the -38.2% hammering in NVIDIA (NVDA) stock or even the -28.8% in AMD (AMD) stock. Notably, AMAT stock outperformed its manufacturing equipment counterpart ASML (ASML). ASML stock has fallen 29% year-to-date, with its FCF yield of 2.11% lagging AMAT’s robust returns.

Investors should watch for slowing growth

GAAP EPS Consensus Estimates of Applied Materials

Applied Materials GAAP EPS Consensus Estimates (S&P Capital IQ)

Applied Materials Sales & EBIT Margins % Consensus Estimates

Applied Materials revenue and EBIT margins % consensus estimates (S&P Capital IQ)

Applied Materials led revenue of $6.35 billion (midpoint), up 13.7% year-over-year for the second quarter. Updated consensus estimates suggest the company should be able to meet its guidance. The company also expects EPS of $1.90, up 32.6% year-on-year. In addition, we believe ASML’s recent outstanding Q1 earnings performance has also bolstered street optimism that Applied Materials will at least meet its guidance.

However, the semi-stock market reaction demonstrated that investors may have looked beyond its FQ2 report. We believe the market remains hesitant on the pace of industry growth from H2’22 as growth could potentially slow given the challenging 2021 compositions. Additionally, we need to observe if Applied Materials could be impacted by more significant supply chain disruptions affecting its near-term revenue forecast. We noted in our previous article that management was quite concerned about supply chain issues. Therefore, we urge investors to pay close attention to management’s comments on its supply chain management.

Price Action Analysis Suggests Short-Term Caution

AMAT share price

AMAT Stock Price Chart (TradingView)

Our price action analysis suggests the market has digested its quick gains from 2020. The consolidation zone in 2021 proved to be a shrewd distribution phase, as market makers unloaded their holdings and lured buyers into the decline.

Additionally, January’s huge bullish trap, as seen above, supported our “end flow” view, attracting the last bearish buyers. However, we thought the robust FCF returns in AMAT stock could help defend against the market selloff. But, in price action, you often learn never to fight market currents, as AMAT stock has proven.

Nonetheless, AMAT stock appears to have hit a short-term low at the $105 level during the May selloff. However, a series of critical resistance areas have formed which may hamper the short-term momentum of AMAT stock.

Therefore, we believe that the $120 resistance level could be an important area to test the market’s will to regain its bullish momentum. But, we urge investors to wait for a retest of the $105 level before adding exposure. Otherwise, there could be another downside, as seen above, which could hurt investors further.

Is the AMAT action a buy, a sell or a hold?

With an implied upside of less than 3% from its resistance level of $120, we believe the risk/reward profile has weakened significantly for AMAT stock in the near term.

So, we are revising our rating on the AMAT share from Buy to Holdheading towards his FQ2 earnings.

About William G.

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