LRCX - Lam Research: The Challenging Memory Downturn Won't Last

2023-06-06 11:57:11 ET

Summary

• Lam Research Corporation is facing challenges in the current macro environment and a downturn in the memory market. Nevertheless, this is a highly profitable semiconductor equipment manufacturer.
• Once the memory market stabilizes, the company is expected to rebound and potentially achieve significant free cash flow, making it a promising investment.
• I believe that Lam Research Corporation stock is priced at approximately 13x forward free cash flows.

Investment Thesis

Lam Research Corporation ( LRCX ) is a highly profitable semiconductor equipment manufacturer.

Presently, the macro environment looks extremely challenging, and the cyclicality of this sector is being reflected in Lam Research's unimpressive revenue guidance.

However, beyond the headlines, at the more nuanced level, there's a lot to like here. Indeed, lest we forget, Lam Research is highly free cash flow generative and the stock already trades for less than 13x my estimated forward free cash flows.

Why Lam Research? Why Now?

Lam Research provides semiconductor manufacturing equipment.

The near-term demand environment for semiconductor equipment remains challenging, with expectations of lower WFE (wafer fab equipment) spending. Furthermore, as anyone that follows the semiconductor space will know, presently, the memory market is in a tough environment.

This led Lam Research's CEO Tim Archer to declare several weeks back during the earnings call,

Memory customers continue to lower fab utilizations, slow technology conversions and reduce investments in capacity additions to limit bit output and drive inventory down to normalized levels. We expect memory spending for the year to decline approximately 50% from 2022, and led by NAND.

At the time, many investors were attempting to parse through those comments and hoping to hear some sort of commentary around this being as bad as it's going to get for memory. However, less than a week ago, this is what Archer had to say ,

[...] AI being one of the big topics of the day that may end up accelerating the consumption of memory and you have heard our customers in the memory space. So they are at better talking about their end markets.

But clearly, they have been signaling perhaps increased demand from some of the newer AI applications as well, both on the memory side, the DRAM side, as well as on the NAND side and so I think we have to see how those play out.

Clearly, Archer isn't making the case that the bottom is quite in yet. And this leads me to discuss Lam Research's outlook for the near term.

Revenue Growth Rates Fully Fizzle, But What's Next?

The question that investors are clamoring for is, what's next for this advanced semiconductor manufacturer? Is this where the story ends for Lam Research and the demand for leading-edge semiconductor equipment?

Or, could it be, that there's just one more brutal quarter ahead before Lam Research's prospects start to improve?

Anyone investing in the semiconductor equipment space is extremely familiar with the vicissitudes this sector offers, both on the downside and the upside.

Profitability Profile Could Start to Improve

Lam Research's non-GAAP gross margin for the quarter ahead is guided for 44% at the midpoint.

Given that fiscal Q3 2023 (quarter ending March 26) finished with 44% gross margins too, means that in the quarter ahead, despite having significantly less revenue to work with, its gross margin profile isn't suffering.

What's more, consider what Archer reiterated last week,

[...] we have put out a long-term model that has our margins in the high 40s. I think we are still driving towards that. Obviously, COVID set us back, we felt -- pre-COVID we were on a nice trajectory.

In sum, all signs point to a company that is having to navigate a truly brutal once-in-a-decade fall in memory demand, but despite all the macro challenges, it's a company that is still highly profitable.

Case in point, despite all this turmoil in memory, Lam Research believes that it can continue to return to shareholders around 75% to 100% of its free cash flow.

Recall, in the prior quarter, fiscal Q3 2023, the capital return figure dipped below this target, at 45% of its free cash flow.

However, during last week's fireside, CEO Tim Archer reiterated Lam Research's ambition to return around 75% to 100% of Lam's free cash flow to shareholders.

I believe that Lam Research could probably report around $6.5 billion of free cash flow over the next twelve months. Meaning that the stock is being priced at less than 13x forward free cash flows.

For a company that is at the moment reporting suboptimal performance, once the memory market improves, it's entirely possible that Lam Research could be on a run-rate of around $7.5 billion to $8 billion of free cash flow in the next 18 months.

The Bottom Line

The very short summary is this, Lam Research Corporation is navigating a very challenging environment right now. But once the memory market stabilizes, this stock is prime for takeoff.

The more nuanced summary is this. Despite the challenging macro environment and the current downturn in the memory market, the company's strong free cash flow generation and attractive valuation make it an appealing investment opportunity.

While near-term revenue growth rates have declined, the company's profitability profile remains intact, with stable gross margins.

I make the case that once the memory market stabilizes, Lam Research Corporation stock is expected to bounce back and could potentially generate significant free cash flow, making it a promising long-term investment.

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