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Will Strong EPS Push AMAT’s Cash Flows in Fiscal 4Q16?

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Nov. 15 2016, Updated 10:04 a.m. ET

EPS and cash flows

In the last few parts of the series, we saw that the Semiconductor Systems segment would drive Applied Materials’ (AMAT) revenue as the next-generation semiconductor technology becomes more materials-based. Moreover, the company’s profit margins could also improve. The company aims to increase its EPS (earnings per share) from an estimated $1.75 in fiscal 2016 to $2.8 in fiscal 2019, growing at a CAGR (compounded annual growth rate) of 17%. An increase in EPS would also increase the company’s cash flows.

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Free cash flow

A 50% sequential increase in AMAT’s EPS in fiscal 3Q16 more than doubled the company’s FCF (free cash flow) to $931 million. The company expects its fiscal 4Q16 EPS to grow 30% sequentially. If the company maintains the same trend, FCF could rise by at least 50% to $1.4 billion.

The company increased its shareholder returns program between fiscal 3Q15 and fiscal 2Q16. During this period, it spent between $600 million and $900 million every quarter in share buybacks. This was the same period when the company reported revenue declines. However, it reduced its share buyback in fiscal 3Q16 and increased its cash reserves.

Even Qualcomm (QCOM) resorted to aggressive buybacks in fiscal 2015, when its revenues fell, to restore investor confidence. However, it reduced its buyback in fiscal 4Q16 after announcing NXP Semiconductors’ (NXPI) acquisition.

Cash and debt position

As of July 31, 2016, AMAT’s cash reserves and long-term investments stood at $4.2 billion as compared to its long-term debt of $3.3 billion. The company might accumulate its FCF to increase its cash reserves to around $5 billion by the end of fiscal 4Q16.

The company is investing aggressively in future technologies, especially display. There is a possibility that the company is looking to increase cash reserves to enhance its financial flexibility to invest in long-term opportunities.

AMAT’s rival Lam Research (LRCX) increased its cash reserves from $4.3 billion as of September 2015 to $7.2 billion as of September 2016 as it prepares to acquire KLA-Tencor (KLAC) for $10.8 billion. Even Qualcomm is increasing its cash reserves as it prepares to acquire NXP.

While the acquisition news worked well for other companies, strong order book and guidance worked well for AMAT. The record high earnings in fiscal 3Q16 increased AMAT’s shares. If the company hits a new record in fiscal 4Q16 as well, shares are likely to increase further.

Next, we’ll look at the company’s stock performance in fiscal 4Q16.

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