LRCX - Lam Research: Quality On The Outskirts Of Technology Inflection Point

2023-06-06 23:47:30 ET

Summary

• LRCX’s revenue for the recent quarter hit the turbulence zone of the weak memory market, while orderbook remained resilient.
• The company has taken hold on cutting-edge technology investments, bracing for outperformance as WFE growth recovers.
• I am bullish on LRCX stock, as the company commands a high quality and key factor of success.

Lam Research Corporation ( LRCX ) reported relatively well for the January-March 2023 period amid the weak semiconductor demand environment, showing a predictable decrease in sales, while encouraging dynamics of deferred revenue. And despite the company's case being still fraught with risks, I am bullish on LRCX stock against the backdrop of the expected normalization of the chip market in the coming few quarters. I believe that LRCX’s focus on the cutting-edge provides a stellar opportunity to benefit from the broad adoption of advanced technologies, which provides a key factor of success in the upcoming new technology cycle, led by AI and other prospective areas. Moreover, the customer-support related business line ensures a quality and additional opportunity to benefit from the growing installed base for chip fabrication equipment.

Outlook for semi industry

The semiconductor prospects continue to be fraught with significant macro headwinds and cyclicality, where forecasts for capital investments of large chipmakers continue to decline. To gain a more precise picture, we can turn to the CAPEX guidance of Lam’s major customers, or Taiwan Semiconductor ( TSM ), Intel Corp. ( INTC ), Micron Technology ( MU ), Samsung ( OTCPK:SSNLF ) and SK Hynix. The mentioned top 5 expects slightly more than $110 billion in capital expenditures, which is about 15% lower than a year ago, or circa $130 billion. The major contributors of the decrease are SK Hynix and Micron, while Samsung is expected to remain flat on CAPEX. Although the falling chip sales have somewhat reduced the ambitions of leading manufacturers, the scale of the investments is still enormous.

The current market expectations are in line with the scenario of a gradual recovery in chip sales from the second half of 2023. And despite IC sales registering an 8.7% YoY drop , sales are exhibiting a gradual recovery with March alone sales being slightly up on a monthly basis, thus providing a bright spot going forward.

In addition, Q1 sales were just 2.9% lower than the corresponding period in 2021, when the semi boom kicked out, giving the sight of normalization. These trends set out hopes that with the recovery of demand in China and the awaited end of the Fed’s hawkish sentiment, the semi-market could begin to manifest more encouraging dynamics.

In the meantime, the government scramble for chip manufacturers is extremely positive for Lam Research. The generous incentives for chipmakers offered in the U.S. with the Chips and Science Act , as well as in other countries encourage new investments by the semi players, which could spur the demand for Lam’s equipment. Moreover, the management indicated on the latest earnings cal l that the company received clarification from the government on the export of equipment to China. In particular, the supply of certain products is treated as possible, which wasn’t underlying the company’s expectations. As a result, this could support the financial performance along with potential growth in the business activity of memory chip manufacturers, which seems to be unsustainable at the current level to support long-term NANS and DRAM demand growth . Add to that Lam’s strong deferred revenue, which unexpectedly remained at slightly above $2 billion, due to the orders uptake from the new lines of the company’s equipment.

Nonetheless, the remainder of the year could be quite a challenging, where the semi market is expected to register a 10.3% downturn . However, the projections are for an 11.8% recovery in 2024, where the main weakness of this year, or Memory segment, should become the main gainer, stipulating a positive outlook for the company.

Financials and valuation

The financial results in the Jan-Mar quarter of 2023 revealed a 27% revenue decline sequentially to $3.87 billion amid a weak demand environment and regulatory restrictions on exports to the Chinese market. The memory market took a significant hit in demand, with the share in the revenue mix dropping to 32% from 50% in the December quarter. In the meantime, foundry system revenues demonstrated record levels, thanks to solid progress in leading-edge and specialty technology segments.

For FY2023, the company expects shipments to memory manufacturers, primarily NAND, to halve due to inventory balancing and low factory utilization. The most obvious reason could be the loss of exports to Yangtze Memory Technologies, which specializes in NAND flash memory. On the other hand, the positive dynamic in the deferred revenue could be ascribed to an agreement with a major player to switch to dry photoresist products supplied by Lam.

Profitability also sagged during the quarter as a result of one-off costs related to restructuring activities and product rationalization charges, as well as unfavorable product mix. Still, the company’s premium business lines contributed to the adjusted operating profitability reaching 28.3%, and beating the guidance. In fact, this enabled Lam Research to over score the expectations for the bottom-line, where the adjusted EPS amounted to $6.99 vs $6.53 consensus.

Going forward, the management gave a revenue target of $3.1 billion for the June 2023 quarter, which indicates about 20% further decline, reflecting the soft memory market environment and normalization of backorder systems. At the same time, the adjusted gross margin should remain flattish at 44%, according to the executives.

Let’s turn to the valuation now and compare how Lam Research ranks against its competitors in the face of Applied Materials ( AMAT ), KLA Corp. ( KLAC ) and Tokyo Electron ( OTCPK:TOELF ).

LRCX stock is currently trading at 16.9x P/E ratio, which is lower than the peer selection median of 17.7x. Applying the latter ratio to the company’s TTM EPS of $38.9, the implied equity value per share should come at $670, or 10.6% above the current market price, and is in line with a Buy recommendation.

Takeaways

Lam Research is experiencing a downturn in financial performance due to the memory chips, which is a completely normal pattern during the semi down cycle. However, we are witnessing the origination of a new technology cycle where AI, along with other prospective innovations, will obviously demand advanced technologies of semiconductor fabrication equipment. The secular trend towards smaller and more advanced chips appears like a stellar opportunity for Lam Research’s offerings, where the EUV patterning and gate-all-around are two inflection technology points where the company is pushing and making significant investments. Management's striving for cost optimization is an extremely prudent decision that could allow the company to sustain its R&D expenses in the weak market environment, which shows that the innovations are not a cost item where the company is cutting back. I will put it another way, investments in order to keep up at the cutting-edge is a key determinant of the success against the future demand of advanced technologies, and the company is clearly executing on this point with the recent R&D expenses reaching nearly 70% of OPEX.

The company is building a moat in the memory segment, expanding the installed base by 40% compared to the last cyclical downturn. This provides a solid foundation to drive revenue growth as far as memory customers start to ramp up fab utilization to normal run levels. However, it is going to take at least one or two quarters of pain before the semi-industry returns to growth. In addition, with new fabs breaking ground , the company would have a plenty of room to install the WFE in.

Customer support-related revenue shaped 40% of the quarterly revenue and amounted to $1.61 billion, registering a moderate decrease of around 6% QoQ, while providing a significant spot for the company’s performance against the backdrop of the challenging market environment. Going forward, I am even more optimistic about the CSBG segment, as the more advanced and complex the WFE becomes, the more important the support-related revenue could be in the top-line mix. As a result, this could provide a quality, in my view, or more resilient financial performance pattern in the future. Moreover, Lam’s focus on cutting-edge technology stipulates some degree of resilience itself, as the development of AI, cloud computing, IoT and other advanced areas is inevitable, ensuring a secular tailings to the WFE demand.

Risk factors

The key premise for a return of growth in demand in the semi-market is normalization of the global macroeconomic environment, which could appear more prolonged than expected. Another significant risk for Lam Research is related to the Chinese market, due to the significant impact on the revenue from U.S. trade restrictions on exports. Although the company received clarifications regarding some offerings, there is no guarantee that the company will retain a license to export semiconductor equipment to other Chinese clients.

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