Applied Materials

Applied Materials' solid fiscal third-quarter results were driven by surging AI infrastructure demand. Revenue grew 25% year on year to $9.1 billion, beating FactSet consensus estimates. Fourth-quarter guidance is for $10.25 billion in sales and $4.02 in EPS at the midpoint, ahead of our estimates.

Why it matters: The artificial intelligence-driven growth cycle for chip equipment continues to strengthen. We are impressed by the demand for leading-edge logic, DRAM, and advanced packaging, which is outpacing chip supply. We expect this to drive the majority of growth in wafer fabrication equipment for 2026-27. DRAM looks especially strong, with sales growing 52% year on year and management expecting an even higher step-up for the second half of the year. Applied benefits from industry efforts to increase existing capacity and new fab builds. Applied raised its 2026 systems growth outlook above its earlier target of 30%, expecting another solid year in 2027. As this demand visibility improves, Applied is expected to bring roughly double its quarterly system output online by 2028.

The bottom line: Results and guidance reaffirmed the upside we baked into our model ahead of earnings. We maintain our $520 fair value estimate for wide-moat Applied Materials. After the shares slipped against high expectations ahead of the earnings release, we now view them as fairly valued. Positive guidance from peers as well as Applied indicates that industry demand remains healthy. We model close to 20% annual revenue growth through 2030, with faster growth in the next three years, driven by robust equipment demand, clean room expansions, and tight chip supply. We like that profitability is improving alongside growth. Non-GAAP gross margin reached 50.4%, marking its 13th consecutive quarter of year-over-year expansion. We estimate margins to rise steadily as richer mix, value-based pricing, and operating leverage kick in.

Our fair value estimate is $520 per share. Our valuation implies a fiscal 2026 adjusted price/earnings multiple of 42 times and a fiscal 2026 enterprise value/sales multiple of 11 times. Against fiscal 2027 and 2028 non-GAAP earnings, our valuation implies multiples of 30 times and 23 times, respectively. The biggest drivers to our valuation are the growth of wafer fab equipment spending and Applied Materials' ability to increase market share.

We forecast 19% compound annual sales growth for Applied Materials through fiscal 2030. We project superb growth through 2028, driven by robust capacity expansions at both logic and memory chipmakers to supply AI demand. Thereafter, we project growth tapering towards our longer-term midcycle expectations in the high single digits, in line with the historical trend of the WFE market, along with some long-term AI upside. We expect midcycle growth to be driven by more advanced chip designs at chipmakers that rely on Applied Materials' equipment to manufacture gate-all-around transistors, chiplet designs, and high-bandwidth memory, among other technologies. Applied Materials' system sales are the most cyclical, and its services business is quite stable, which helps offset some cyclicality on the top line. We expect this services revenue stream to rise in the mid-teens annually over our forecast.

We project Applied Materials to maintain its non-GAAP gross margin close to 50%, with modest shorter-term fluctuations due to product mix and volumes. This margin level is higher than historically, which we attribute to a higher mix of systems sales for AI buildouts. We project operating margin to rise meaningfully in the next three years, with rapidly expanding volumes supporting AI chip supply builds. We estimate 38% non-GAAP operating margin in fiscal 2030, up from 30% in fiscal 2025.

We assign Applied Materials a wide economic moat rating on the basis of intangible assets and switching costs. Applied Materials' proficiency in wafer fabrication equipment is the result of topnotch design expertise, in our view, and we think its embedded services business and long-term customer roadmaps are sticky. We also believe the amount of investment required to remain at the forefront of leading chip development, particularly across so many subsections of the market, creates an immense barrier to entry to all but the largest and best-capitalized chip equipment manufacturers. We expect Applied Materials to earn returns on invested capital well above its cost of capital, more likely than not, for the next 20 years.

We see Applied Materials holding the most comprehensive portfolio of equipment for semiconductor manufacturing. Its product lines run the gamut of chip manufacturing, able to serve logic and memory chipmakers alike with cutting-edge equipment, and offerings in nearly every category that span the cost and capability spectrum. While many other WFE peers occupy one or two corners of the market (like Lam with etch and deposition and KLA with process control), Applied Materials plays in them all in a meaningful way. The only exception is lithography, where ASML has a vise grip.

Deposition makes up roughly one fourth of the total WFE market, and Applied Materials' 40%-plus share more than doubles that of its nearest competitor. In etch and process control, Applied Materials holds third- and second-place share, respectively, and is the only player above 10% share in all three of these markets. Applied Materials also dominates smaller subsections of WFE, such as thermal processing and doping (the intentional introduction of impurities into an intrinsic semiconductor for the purpose of modulating its electrical, optical, and structural properties). To us, these strong share positions are the result of unmatched portfolio breadth and depth, fed by a market-leading $3 billion annual R&D budget. This budget dwarfs all but the largest of WFE competitors and enables Applied Materials to continue building its immense base of intangible assets. The strength of its offerings helps the company generate healthy non-GAAP gross margins in the mid- to high 40s.

Applied Materials' broad and deep portfolio helps it win customers, and we see it embedding customers once installed. Chipmaking is extremely complicated and precise. Applied Materials' equipment is responsible for creating transistors more than a thousand times smaller than a human hair and packing trillions of them into a 12-inch diameter wafer, with minimal defects. Customers demand the ability to produce millions of these wafers a month. Development and manufacturing to this level of precision is calibrated to specific customer product lines, and chipmakers build workflows around their equipment with the singular goal of efficient production. Applied Materials sends on-site service engineers to customer fabs to operate as an extension of the chipmaker's engineering team. These service engineers help to calibrate equipment during R&D, tweak and fix bugs during production, and work with chipmakers on meeting manufacturing requirements. They also work on equipment upgrades or recalibration to repurpose equipment. The high complexity of WFE machines and the integration of Applied Materials' service engineers make the company hard to replace, in our view.

Beyond the cost of purchasing new equipment ($1 million or more per machine), chipmakers would need to redesign manufacturing workflows and learn wholesale new hardware and software interfaces, as well as restart knowledge sharing with new services engineers. Applied Materials' equipment can last in the field for multiple decades, which generates deep connections with customer engineering teams and augments this stickiness. Applied Materials' deep customer relationships also entail forward-looking project roadmaps up to 10 years out, giving the firm a leg up in winning new placements as it can target new machines to exact customer requirements. Finally, with its broadest-in-class portfolio, Applied Materials increasingly sells integrated solutions to customers, sometimes combining seven different process steps and chambers in one unified piece of equipment. This can offer better performance, cost, and development time to chipmakers and also makes Applied Materials' equipment even stickier, in our view.

The combination of Applied Materials' large portfolio, sticky customer relationships, and immense ongoing investment gives us confidence in the durability of its competitive position and healthy profitability. We believe this will allow the company to continue earning strong economic profits, more likely than not, for the next 20 years and results in a wide economic moat.

Applied Materials is the largest WFE provider in the world, with the broadest portfolio and the largest R&D budget of its peers.

We expect Applied Materials to benefit from drivers of chip complexity like gate-all-around transistors and advanced packaging.

Applied Materials has strong profit margins and cash flow and sends most of its cash flow back to shareholders.

We consider Applied Materials to be a generalist in WFE. More-specialized firms like Lam Research and KLA could outcompete it in their respective markets.

Applied Materials faces cyclicality in the semiconductor market that can lead to years with lower sales and margin compression.

Applied Materials faces risk from geopolitical tensions between the US and China that may further inhibit its ability to ship to Chinese chipmakers.