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These Factors Could Improve AMAT’s Profitability in 2017

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Applied Materials’ profitability

In the previous part of the series, we saw that Applied Materials (AMAT) reported strong revenue growth in 4Q16 and expects this momentum to continue in 2017 as well. While revenue grows, the company’s profit margins are also expected to increase but at a slower rate as it increases its research spending.

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Gross margin estimates

For 1Q17, AMAT expects its non-GAAP (generally accepted accounting principles) gross margin to rise 43.8% from 43.7% in 4Q16. AMAT’s gross margin is lower than rival Lam Research’s (LRCX) gross margin of 46.4%.

The gross margin depends on a company’s product mix. Semiconductor Systems is AMAT’s most profitable segment. Foundry products are the most profitable products in this segment, and the company expects them to have a major contribution towards the company’s revenue in fiscal 2017. AMAT expects to increase its gross margin from 43.2% in fiscal 2016 to 44% in fiscal 2017.

Operating margin estimates

AMAT expects its non-GAAP operating expense to increase slightly to $625 million. However, this is unlikely to impact its operating margin as an improvement in gross margin would offset the increase in operating expenses. Thus, the company’s operating margin is likely to remain flat at 25.2% in 1Q17. AMAT’s operating margin is lower than rival Lam Research’s operating margin of 26%.

AMAT expects to improve its operating margin in fiscal 2017 with incremental profit coming from China (MCHI). At its analyst day, the company estimated that it would spend around $20 billion to $30 billion on wafer fabrication equipment in China over the next five years. Both domestic and multinational companies are expected to build nine foundries and four memory plants in the nation.

Next, we’ll look at AMAT’s most profitable foundry segment. You can get exposure in AMAT by investing in the iShares Russell 1000 ETF (IWB), which has holdings in large-cap US equities across various sectors including technology. It has 0.17% exposure in AMAT and 0.08% exposure in LRCX.

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