What Does Martin Whitman’s Funds Manager Think Of Applied Materials?

Martin Whitman is the Chairman of the board of Third Avenue Funds. Here is what Ian Lapey, the manager of his Value Fund thinks of Applied Materials (source: Third Avenue 2012 second Quarter Shareholder Letter):

In March, I attended the Applied Materials investor meeting in New York along with my colleague Yang Lie, who has followed Applied Materials and other technology
stocks since joining the firm in 1996. Applied Materials’ Chairman and CEO Mike Splinter, along with several other members of the senior management team, presented a compelling long-term investment case for the company, which is the leading global provider of semiconductor capital equipment, driven by increasing consumer demand for mobility. While it is difficult to predict who will produce the next top-selling consumer electronics gadget (although the odds appear to favor Apple at the moment), it seems to be a safe bet that the demand for equipment and services provided by Applied Materials should increase, given its market dominance in many areas of semiconductor equipment, as semiconductor chips become more ubiquitous and more complex, necessitating a greater number and more advanced tools.

This favorable longer-term outlook seems to have been lost on many, as the company’s modest reduction in 2012 earnings guidance triggered a 3% decline in the stock price that day and a subsequent 4% decline through quarter end. Specifically, owing primarily to weak demand for solar power capital equipment, the company projected fiscal 2012 earnings of $0.85 to $0.95 per share, compared to the previous Wall Street consensus forecast of $0.96 per share. As a result, we added to our position in Applied Common at very attractive multiples of about 9 and 13 times 2011 and expected 2012 earnings, respectively. Importantly, we believe that earnings are likely to exceed recent peak 2011 earnings of $1.30 per share in the next few years, driven by the favorable dynamics noted above, as well as an increase in addressable market from the recent acquisition of Varian Semiconductor. Although Applied Materials paid a rich price for Varian ($4.2 billion; 18 times earnings), the transaction was financed with excess cash and very low cost debt and should be accretive next year. Varian is the market leader in the ion implant market, a critical step in semiconductor chip manufacturing, which enables the manufacturing of high performance chips, e.g., for applications requiring faster speeds and longer battery lives. Even after the Varian acquisition, Applied Materials has a very strong financial position, with about $3 billion of cash and $2 billion of debt consisting of senior unsecured notes due from 2016 to 2041 at rates ranging from 2.7% to 7.1%. Applied Common accounted for 1.3% of the Fund’s net assets at quarter end, and we have been increasing our position on further share price weakness this quarter.

I also read the investor presentation and saw its webcast. I was deeply impressed by it. Mostly due to its comprehensibility and above all because I agreed with the idea that whoever wins on the new computing gadgets race (be it Apple, Intel, ARM, Microsoft, Google, Nokia, Blackberry… ?), Amat will keep on selling their machines to build semiconductors. It seems to offers a safe way to invest in the mobility and computing trend without betting for the winner.

I liked to read about someone who basically invested in Applied Materials for exactly the same reasons as I did.

Besides the top quality of their machines and technological moat I would also highlight their strong free cash flows and point out the reduction in shares as well as the stability of it’s dividend as signs of shareholder friendliness.

While Applied Materials had worse earnings than expected in 2012 Ian Lapey had the conviction and seized the opportunity to keep on substantially increasing his positions both in the 3rd and 4th quarters of 2012. Applied Materials’ worse earnings were mostly due to the low capital expenditures from their clients as well as a write down in their solar business. Capital expenditures in the semiconductor industry is generally hard to predict and is very lumpy. This makes Applied Materials earnings very unstable. Personally I do not care about that, on the contrary, that generates volatility on the stock, which makes it ideal for long term holders to build a position at good entry points. It might explain why Ian Lapey kept on adding.

Cheers!
jrv

About jrv

I was born in Spain and lived in Belgium, Chile, France, USA, Argentina among other places. Currently I am trying to settle down in a wild place. I am "retired", even though now I dedicate more hours "working" for my investments than I ever worked in the real labor market where I used to work in IT and Banking. I am a family man, I have a lovely wife, several sons and one step daughter. I have humble tastes, I like to stay home and read about companies and investments. I started investing at 25 before the internet bubble exploded. I did not know much about investing and liked technical analysis so my results were pretty bad. Fortunately I did not have much to lose. Some years later in 2006 bored of doing only real state investments and with quite a lot of money saved I opened an account in a cheap and excellent online broker and started again. This time I did not want to commit the same mistake, so I decided to follow a model. I heard that Warren Buffett was the best at making money via stocks so I started by reading a lot about him, all of his shareholders letters and several of the books that he recommended. I learned a lot, started applying his investing principles and reading a lot of 10K's. Digested news from lots of different sources. Basically I started buying very good and cheap companies and holding them for ever if possible and if nothing changed fundamentally. When the housing crisis started I was more than 75% cash. At that time I identified good companies at incredibly cheap prices so I invested most of my savings in stocks. In less than I year I doubled. By the second semester of 2009 I turned my software company into an investment vehicle and dedicated myself full time to it. My wife and I decided to change our lifestyle and moved from Belgium to the beach in a wild country. The goal was to keep fixed costs low in order to be able to live with a minimum 6-8% yearly return but specially to move away from the inhuman life of civilization and to have finally some peace and sunny weather to concentrate better on investing. Now I can think and study about companies 60 hours a week and I am doing great. I can finally do what I want full time and can proudly say that I have never been so happy, specially also with my just born 4th son, my other great kids and my sweet wife who supports me fully while I study most of the day and patiently wait for the opportunity to make a swing ! You can learn a bit more about my portfolio by viewing it at www.kuchita.com/view/sumo.php or you may learn more about me and my family by following the link "Author's site" from the menu above.
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3 Responses to What Does Martin Whitman’s Funds Manager Think Of Applied Materials?

  1. CplDaniel says:

    I like your comments and generally can’t fault any of it, but would throw out to you a word of caution about investing in AMAT because it allows you to invest in tech trends without having to pick a winner: I believe that could have been said about AMAT for the at least the last decade. In fact, IIRC, that was something I heard at or around the first time I ever heard of AMAT. If that was a plus then, and it was a plus in the iPad/Phone revolution, and is still a plus today, then WHY ISN’T THE STOCK ALREADY VALUED HIGHER ALREADY?? Or does the stock valuation already reflect that AMAT is safe because you do not need to pick the Tech-gadget winner? A lot of people seem bulllish on AMAT, and deep down, I am too. But I haven’t been able to make myself take the plunge yet and buy it.

    As the machines change, and get smaller, and smaller, using different materials and construction techniques, it is quite possible that AMAT comparative advantage at production could disappear. Like what happened to the US steal industry after WWII when the German steal industry was rebuilt starting from scratch. As the technology changes, potential new competators starting from scratch would face off against AMAT potentially burdened by it’s 20-year old factories.

  2. jrv says:

    Thanks CplDaniel for your interesting points of view they are valid and important to consider. I agree on several of them.

    That’s why if I ever would recommend to buy I would make sure you ask for a big margin of safety.

    i.e. don’t recommend to initiate a buy unless:

    1) the stock it goes below 11,
    2) or you feel you know the company very well and trust its technology.
    3) You like cyclical stocks

    Meanwhile I watch it closely. Historically the stock seemed to me overvalued, but I don’t mind the historical stock price. I do like the evolution of cash flows and base myself more on that than in the historical evolution of the stock. If AMAT fundamentals continue similar to its past I’m happy at current levels.

    I just had a deep look at it again after the huge run up. They have lots of cash, relatively small capex. It seems to me like a pure R&D company (which I like). Their tech has few competitors and they selectively buy companies to complement new techs. Their mask product is essential for lithography. I liked it’s position and future. 22 nm or 14 nm processors or 450 wafers create inflections that will require AMAT’s products more then ever. Varian with their ion implants nanolithography is integrating well. Ion beams are essential for small nm sizes and ever shrinking integrated circuits. Gary Dickerson, who doubled Varian’s market share while at charge of Varian seems like the real CEO at AMAT now. Along with the new CFO, also from Varian, they are managers I trust. AMAT seems shareholder friendly, they do nice buybacks and dividends were never reduced not even in the hard years of 2008/2009 when they hardly sold their machines.

    Free cash flows keep doing quite well, that’s key, few seem to be looking at that.

    Cheers!
    jrv

  3. pablo says:

    Dear jvr,

    It has been so long since i have sent you any comments, currently i am now in NY, as i think i told you i am a Doctor and i just love the stocks but i am not that good at it.

    The thing is that i read this terrible news in The New York times that i wanted to share with you since i trust your opinion so much. http://www.nytimes.com/2013/03/31/opinion/sunday/sundown-in-america.html?pagewanted=1&_r=2&ref=general&src=me

    By the way i have many books of Dale Carnegie, i got them through my dad who already passed away and i am really happy that you like them too.

    Cheers de tu amigo Pablo.

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