DRAM business resilience exceeds expectations! Morgan Stanley is bullish on Applied Materials' (AMAT.US) long-term growth potential and maintains a $563 price target.

Morgan Stanley, after attending Applied Materials' (AMAT.US) recent investor breakfast and EPIC R&D center open house, said it has greater confidence in the company's long-term development strategy and competitive position. The firm believes Applied Materials is performing better than expected in the DRAM equipment market, that its front-end process control business is showing strong growth momentum, and that management's long-term targets are achievable, with potential upside if the semiconductor equipment market develops in line with company expectations. However, given share pressure in advanced logic processes and the fact that it remains to be seen whether the new R&D center can a sustained competitive advantage, Morgan Stanley maintained its "Hold" rating and $563 price target on Applied Materials. Based on the October 19 closing price of $413.11, that implies potential upside of about 36.3%. Morgan Stanley noted that one of the biggest positive findings from the event was that Applied Materials' competitiveness in the DRAM equipment market is clearly stronger than previously expected. As DRAM manufacturers migrate from D1a to more advanced processes such as D1d, the use of extreme ultraviolet (EUV) lithography continues to increase, raising lithography's share of overall wafer fab equipment (WFE) investment and, in theory, squeezing the equipment market share Applied Materials can address. According to the firm's estimates, as DRAM processes migrate from D1a to D1d, WFE investment per 100,000 wafers per month of capacity will rise from about $8 billion to $12 billion. At the same time, increased EUV equipment investment could shrink Applied Materials' serviceable market share by about 6 percentage points. However, Morgan Stanley estimates that Applied Materials' share of the overall DRAM WFE market will decline by only about 1 percentage point, far less than previously expected. This means that even though EUV technology has changed the structure of equipment spending, Applied Materials has still achieved significant share gains in the segments where it can compete. The firm believes this performance reflects Applied Materials' strong product competitiveness and execution in DRAM and increases the likelihood that it will continue to benefit in future memory chip capex cycles. By contrast, Morgan Stanley remains cautious on Applied Materials' performance in advanced logic chip manufacturing. The firm noted that as advanced processes migrate from 3nm to 2nm and more advanced nodes, Applied Materials may face greater market share pressure than previously expected. Morgan Stanley estimates that as processes migrate from 3nm to 1.4nm, WFE investment per 100,000 wafers per month of capacity could rise from about $25 billion to $36 billion. Although equipment investment required for advanced processes continues to increase, according to the firm's model, both Applied Materials' serviceable share and overall market share in the relevant markets are trending downward. Therefore, Morgan Stanley believes Applied Materials' competitive position in DRAM is improving, but its advanced logic business still needs to prove it can maintain market share in the new round of process upgrades. The process control business was another highlight of the investor event. Morgan Stanley noted that Applied Materials is expected to be one of the most prominent beneficiaries in the 2026 process control equipment market, with related business growth forecast to exceed 50%, well ahead of peers' growth of about 20% to 30%. Front-end optical inspection equipment deserves particular attention. Morgan Stanley estimates the market at about $9 billion, currently dominated by KLA (KLAC.US), with gross margins on related products in the mid-60% range, giving it high commercial value. Applied Materials has increased investment in its front-end optical inspection business in recent years. Morgan Stanley believes the company's strong 2026 growth shows it is recovering market share it previously lost, but it is too early to conclude that it has established a new long-term competitive advantage. The firm stressed that even with related business growth exceeding 50% in 2026, Applied Materials' market share may still be below its historical peak. If it can achieve another significant share gain in 2027 and surpass its previous peak, that would have a more profound impact on the existing competitive landscape. However, Morgan Stanley is relatively cautious on the outlook for Applied Materials to further expand its back-end process control business. The firm noted that the back-end process control market is significantly smaller than the front-end market. For KLA, for example, its related business corresponds to a market of about $1.1 billion in 2026, and competition is more fragmented, with players including KLA, Onto Innovation (ONTO.US), Nova (NVMI.US) and Camtek Ltd (CAMT.US). In some materials metrology sub-markets, a single tool can cost millions of dollars while customers typically buy only one or two tools, making it less economical to use multiple suppliers. This market structure may limit Applied Materials' room to rapidly gain share through new products. Beyond the existing equipment business, Applied Materials' new EPIC R&D center is also a long-term strategic investment that Morgan Stanley is focused on. Applied Materials hopes to use the center to conduct earlier-stage joint R&D with customers, participating in technology development in the early stages of new-generation chip architectures and advanced packaging technologies, thereby gaining advance insight into customers' R&D roadmaps for future product generations and increasing the chances that its equipment is adopted in new process flows. Morgan Stanley believes the large-scale capital investment and long-term cooperation commitment embodied by the EPIC center will help strengthen Applied Materials' relationships with customers and improve its competitive position in the next round of semiconductor technology change. However, the firm stressed that whether R&D investment can truly sustained market share growth still needs to be verified by actual results. Citing Applied Materials' advanced packaging R&D center established in 2012, Morgan Stanley noted that despite years of continued investment in related technologies, the company has yet to establish a clear lead in the advanced packaging equipment market. The outcome of hybrid bonding technology development remains uncertain. The firm expects the EPIC center's positive impact on the front-end equipment business may take years to materialize, but in advanced packaging its potential contribution could be more direct. As advanced packaging technology evolves rapidly, Applied Materials' broad equipment portfolio and opportunities to deepen cooperation with customers are expected to help the company accelerate technological innovation and strive to re-establish a stronger competitive position in the advanced packaging equipment market. On earnings forecasts, Morgan Stanley expects Applied Materials' revenue to reach $34.311 billion in fiscal 2026, grow further to $48.324 billion in fiscal 2027 and reach $57.424 billion in fiscal 2028. Non-GAAP earnings per share for the same periods are expected to be $12.76, $19.60 and $24.68, respectively. The firm also expects Applied Materials' gross margin to rise from 48.8% in fiscal 2025 to 50.1% in fiscal 2026, and to 51.6% and 52.8% in fiscal 2027 and fiscal 2028, respectively. Continued profitability improvement is expected to support a valuation above prior semiconductor equipment industry cycle troughs. Morgan Stanley noted that the market is increasingly focused on whether WFE demand can continue growing through 2028. Applied Materials' stock trades at about 16x expected 2028 calendar-year earnings, above the roughly 13x valuation at the previous cycle trough in April 2025. The firm believes that given Applied Materials' significantly improved gross margin versus past cycles, the market should no longer value the company at prior cycle-trough levels. However, although Applied Materials' current valuation is already somewhat attractive, Morgan Stanley still believes its upstream suppliers may offer greater investment return potential. The firm is particularly favorable on Advanced Energy Industries, Inc. (AEIS.US) and MKS Instruments (MKSI.US), believing the market is pricing these suppliers' future results more pessimistically and that their potential upside may therefore be greater. For Applied Materials itself, Morgan Stanley maintained its $563 price target, equivalent to about 22x its expected 2028 calendar-year earnings per share of $25.61, a premium of about 10% to the company's roughly 20x cycle-average valuation since 2020. In a bull case, if DRAM equipment investment and demand in mature processes, automotive and power semiconductors remain strong while gross margin expansion accelerates, Morgan Stanley expects Applied Materials' stock could reach $811. Conversely, if DRAM equipment investment slows in 2027 and advanced logic chipmakers scale back expansion plans, the stock could fall to $339.