Post FQ2 Review on Lam Research – January 23, 2019

1/23/19
Time to start loving the unloved – Post FQ2 Review on Lam ResearchI’m going to keep this update relatively short and to the point.

Coming into this print, there was widespread fear about how bad Lam’s call would be. A few sell-side firms (including RBC and DA Davidson) issued pre-earnings reports “softening the beach” by highlighting how buy-side expectations were calling for Lam’s earnings to trough at ~$2.50 in the coming quarters (a good thing coming into the print as expectations were so low). Robert Maire at Semiconductor Advisors (who’s very good) was out saying that Lam is likely to be ground zero for all the weakness in memory semi land and he was passing along rumors that Samsung’s semi capex spend could be down 75% in 2019 (all I have to say to that is highly unlikely absent a 2008/2009 style global recession). CFRA was out with a report suggesting that Lam needed to be shorted due to its having changed its accounting to ASC 606 from ASC 605. On top of all that, we had the prior CEO forced to resign in the depths of December’s trading mayhem as what appeared to be another “me too” transgression by a semi CEO (but no clear full story emerging since the announcement of the departure).

With all that going into the call (and with ASML not having exactly knocked the cover off the ball in the AM with their earnings and ASML being the darling in the sector), it would be an understatement to say that many on the institutional side were expecting a difficult Lam report come today’s close. Lam reported much better than feared and provided a narrative that sets up for an excellent outlook for the stock over the next 12- 24 months.

Big picture:

–  Lam beat on FQ2 eps by $0.21 ($3.87 vs. $3.66) by delivering revenues, gross margins slightly above guidance – operating margins more meaningfully above guidance (+110-130bps depending on whether GAAP or Non-GAAP) and a share count 1mm shares below guidance.
–  More importantly, Lam guided to FQ3 Non-GAAP EPS of $3.40 (+/- $0.20) vs. fears that that number could come in at $2.50 or less (IBES consensus was at $3.36).
–  Lam announced completion of its prior $4bn stock repurchase authorization in January and a new $5bn program (which represents ~22% of its market cap).
–  Lam paid down over $300mm of commercial paper and increased its net cash position to $1.6bn.

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Disclaimers: All information gathered from sources believed to be accurate, but the accuracy of the information cannot be guaranteed. Past performance is no indication of future results. A number of points made in this update are a matter of opinion and opinion is subject to change without notice.

–  Lam laid out a conservative WFE narrative that allayed the greatest fears and seems consistent with what’s being conveyed by others. That narrative is that WFE is likely to be down a mid-to-high teen % in 2019 (my interpretation is that means $40-$42bn off an assumed 2018 $49bn base). Lam believes that WFE spend will be more 1H weighted than 2H weighted and be more logic and foundry intensive in the 1st H (presumably as Intel rushes to get its 10nm product to market) and then be stronger in memory in the 2nd H which should be better for Lam.
–  Lam indicated that FQ3 should be the low for its gross margins in calendar 2019 due to a combination of expense and mix factors (including an extra week to the quarter).
–  Lam also conveyed that their memory customers are likely to undersupply end- market bit demand growth throughout the year to work off excess inventories which should set them up (both the memory semis and the WFE companies) particularly well for 2020.
–  Lam also said some very constructive things about their installed base business. It is still growing considerably faster than their absolute chamber growth and Lam signed the biggest installed base service deal in its history in CQ4.
–  Lam also expects growth out of its customers in China in 2019.
–  Parsing Lam’s broad guidance, assuming significant continued share repurchase (I see no reason why Lam isn’t likely to buy-back another 10% of its stock in calendar 2019 when they are generating $500+mm per quarter of FCF, have $1.6bn of net cash, indicated that they have way more cash than they need on the call and have been pretty aggressive lately buying stock at higher levels), I think Lam is set up to deliver $14-$15 in calendar 2019 EPS. I also believe (assuming that the memory market does come back in-line later in 2019) that Lam is positioned to deliver 25%+ EPS growth in CY 2020.

With all of that said, how does Lam’s stock set up for the rest of 2019?

I believe Lam’s stock will trade in one of two ranges. The biggest determinant of which range Lam trades in comes down to does the US/China come to some kind of agreement to ratchet down trade tensions (which I believe is not only likely, but is looking increasingly like it could come sooner than later)?

Until tensions ratchet down with China: Lam trades at 9-11x 2019 earnings ($130-$160)

Should the US and China secure a path to reduced trade tensions: Lam trades at, a minimum, 12-15x 2019/2020 earnings ($192-$240).

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Disclaimers: All information gathered from sources believed to be accurate, but the accuracy of the information cannot be guaranteed. Past performance is no indication of future results. A number of points made in this update are a matter of opinion and opinion is subject to change without notice.

As Friday the 18th and Tuesday the 22nd’s price action in Lam (and the other major WFE stocks) highlights, these stocks have been driven more of late by rumors on China/US trade developments than anything else. Because this trade situation has such fundamental ramifications for these companies, it, to a degree, makes sense.

But what also needs to be appreciated by the longer-term, opportunistic investor is that Lam’s historical 3, 5 and 10 year median P/E (according to Ycharts) is 18x. As much as Lam (and Applied) have been out-of-favor for the past 9+ months due, principally, to how ratcheting up China/US trade tensions have impacted the semi industry, that sentiment can shift just as meaningfully to the positive if the clouds lift on China/US trade and the global growth outlook.

In sum, tonight’s Lam report was a very good one in that it seriously impairs the abject, negative narratives that had been swirling. It should help put a near-term floor in the stock and force some shorts to cover. It also suggests that Lam will be buying its stock back in size in 2019 as it did in 2018. While the report didn’t construct a narrative where operating performance will be up and to the right as 2019 progresses, it put in what seems a strong floor on likely operating performance. Between that understanding and the potential for a) a serious re-rating should US China trade tensions dissipate and b) material operating performance improvement come late 2019/2020, I believe that’s there’s an increasingly strong likelihood that Lam will recover the bulk of the ground it lost in its 2018 stock price. In so doing, that positions LRCX for superior stock price performance this year.
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Disclaimers: All information gathered from sources believed to be accurate, but the accuracy of the information cannot be guaranteed. Past performance is no indication of future results. A number of points made in this update are a matter of opinion and opinion is subject to change without notice.