Nomura analyst, Romit Shah, believes investors are preoccupied about how Applied Materials (NASDAQ: AMAT) will respond to Lam Research, and underappreciating an attractive return profile that should improve over the next three years. Today, the company offers 9% FCF yield and mid-teens growth but could grow into double digits.

The analyst estimates adjusted free cash flow per share of roughly $1.46 in calendar 15, which implies an enterprise value/FCF yield of 9%. Our estimate excludes changes in working capital and non-recurring charges.

Applied has several levers to improve free cash flow per share:

1) A 100bps increase in gross margin could drive 5% FCF growth. Gross margin of 42% is 300 bps below a prior peak on higher revenue; however, GM should improve in 2H16 as product mix shifts toward Foundry and new products ramp

2) Opex leverage could drive FCF by 2.5% per year. Mgmt. reiterated that opex will decline in 16 and longer-term will grow at half the rate of sales

3) A buyback of 75% of FCF drives growth of 5%.

Applied repurchased $1.3b over the past two quarters and is on track to buyback $3b by Oct 16. No change to Buy rating or $22 PT.

For an analyst ratings summary and ratings history on Applied Materials click here. For more ratings news on Applied Materials click here.

Shares of Applied Materials closed at $17.24 yesterday.