INVESTMENT THESIS
Lam Research Corp. (NGS: LRCX) appears well positioned to benefit from the continued recovery in memory demand and pricing. We also look for foundry and logic demand to remain healthy.
We believe that the pandemic has accelerated the process of digital transformation, and that even after widespread vaccine distribution, the world will retain important features of the pandemic economy. Ongoing work & learn from home, virtual collaboration, online gaming, and video streaming should continue to drive high volumes of traffic through data centers, necessitating further investment in both high-volume and high-availability memory.
The now-developing 5G device cycle is stimulating demand for mobile memory and should prompt semiconductor companies and partner fabs to invest in additional wafer fabrication equipment (WFE). A robust mobile device cycle also feeds demand for logic devices such as ARM-based processors.
On a secular basis, multiple technology inflections – including the rise of the cloud data center and the early cycle for 5G smartphones – position the company for extended growth coming out of the current crisis. We believe that Lam is well positioned for long-term market share gains, renewed margin expansion, and EPS acceleration.
LAM stock is recommended for patient investors, as the timing of industry and economic recovery remains uncertain.
RECENT DEVELOPMENTS
LRCX has had a strong move of late, rising 64% in the past three months. The stock fell 2% following its fiscal 1Q21 report on 10/21/20. Since then, it has risen just under $150. We believe improving industry fundamentals, strong company execution, and proactive shareholder returns have all contributed to the advance.
The specific circumstances of the shelter-at-home period – work & learn from home, virtual business collaboration, heightened social media traffic, video streaming and online gaming – have created a data flood that has driven surging demand across the electronics value chain. We believe the world has been permanently altered, with the pandemic serving to accelerate a digital transformation that would have taken a decade into a single year. Even as vaccines promise a return to normal socialization and face-to-face commerce, we expect technology companies to continue enhance the digital infrastructure that has become integral to everyday life.
We expect elements of enhanced digital infrastructure to continue driving high volumes of traffic through data centers, necessitating further investment in both high-volume and high-availability memory. The now-developing 5G device cycle is stimulating demand for mobile memory and should prompt semiconductor companies and partner fabs to invest in additional wafer fabrication equipment (WFE). A robust mobile device cycle also feeds demand for logic devices such as ARM-based processors.
In terms of company execution, WFE companies such as Lam were battle-hardened by circumstance in leaner times. In the two years immediately preceding the pandemic, semiconductor companies and their equipment suppliers were navigating tariffs and trade wars, including government-mandated prohibitions on doing business with some of their largest Asian customers such as Huawei. Additionally, demand was negatively impacted by inventory consolidation at data center customers, and tepid smartphone demand late in the 4G cycle as consumers awaited 5G devices.
In this period, as demand slackened due to geopolitical, secular and cycle challenges, Lam and other industry players successfully shifted their focus away from the memory market and to logic and foundry. The latter category has seen explosive demand growth, as fabless companies rely increasingly on merchant fabs for complex 7 nm and smaller form-factor chips. We believe the battle-testing experienced by these companies from geopolitical and cycle headwinds better prepared them to respond to the early demand shocks from COVID-19. When those demand headwinds turned into tailwinds, Lam and its peers were ready to ramp up production to meeting rising demand.
In October, Lam cited data indicating that key electronic product sales (notebooks, servers, etc.) reached 10-year highs in calendar 3Q20.
While focusing on sustaining operational excellence amid rising demand, Lam has also maintained focus on shareholder return. In November, Lam announced a $5 billion share repurchase authorization. Like many companies, it deemphasized buybacks in the early months of the pandemic, but now sees business returning to a more normalized trend.
That was higher than our expectations for a hike to $1.24. Lam has a relatively small share base of about 150 million shares, reduced from 180 million in FY17. On that basis, the $5.05 annual payout targeted for FY21 entails dividend costs of less than $750 million. That relatively low payout also means that cash flow from operations covers dividend costs by more than 5-times, while free cash flow covers dividend costs by more than 4-times.
Given the year’s soft opening, the freeze in activity in the spring, and furious digital economy demand in the second half, Lam’s outlook for calendar 2020 wafer fab equipment (WFE) spending is unchanged in the mid- to high-$50 billion range. Within this industry forecast, Lam looks for an improved memory mix compared with 2019. While the company is not yet ready to forecast WFE trends for 2021, management pointed to multiple positives that suggest continued acceleration going forward.
In DRAM too, supply growth lags bit demand growth. Lam promised to provide a full calendar 2021 WFE forecast in January 2021.
In terms of company-specific initiatives, Lam is investing over the medium term in two areas. The company is accelerating its vision for Equipment Intelligence solutions. That means integrating a suite of capabilities including data modeling, sensing, adaptive feedback algorithms, and self-maintenance hardware. Second, Lam is extending its technology leadership in critical high-aspect-ratio processing.
Improving memory demand combined with strong foundry demand is leading to accelerated growth. On a secular basis, multiple technology inflections – including the rise of the cloud data center and the early cycle for 5G smartphones – position the company for extended growth coming out of the current crisis. We believe that Lam is well positioned for long-term market share gains, renewed margin expansion, and EPS acceleration.
EARNINGS & GROWTH ANALYSIS
Lam’s revenue was above the $3.1 billion midpoint of management’s $2.9-$3.3 billion guidance range and also topped the consensus forecast of $3.11 billion.
For all of fiscal 2020, revenue of $10.04 billion rose 4% from $9.65 billion in FY19. Non-GAAP EPS was $15.96, up 10% from $14.55 in fiscal 2019.
For fiscal 2Q21, Lam forecast revenue of $3.1-$3.5 billion. The guidance midpoint of $3.3 billion was well above the $3.08 billion consensus and implies 30% annual growth. Lam also forecast non-GAAP diluted EPS in a wide range of $5.20-$6.00; the $5.60 midpoint was well above the $5.16 consensus forecast and implies 40% annual growth.
The FY21 EPS consensus, which was just above $21.00 in October, has moved to about $22.50 – though we believe the consensus continues to underestimate Lam’s earnings power. Our FY21 non-GAAP diluted EPS estimate is $23.49. We are maintaining our FY22 non-GAAP forecast of $25.88. We regard our estimates as fluid and subject to revision.
FINANCIAL STRENGTH & DIVIDEND
Cash & investments were $6.94 billion at the end of FY20, Total debt was $5.81 billion at the end of FY20, While those authorizations remain in place, Lam has slowed buyback activity. In August 2019, Lam raised its quarterly dividend by 4.5% to $1.15 per common share.
MANAGEMENT & RISKS
We believe Lam has the financial strength, market leadership, and growth characteristics to weather this storm and emerge a stronger player. We also believe the pandemic could drive a permanent increase in the percentage of hours worked away from the office. That should drive long-term demand for semiconductors that power connected devices used in remote applications and in the home.
VALUATION
On December 16 at midday, LRCX traded at $495.74, up $0.41.
Source: Argus
