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No Surprises In Lam Research's (NASDAQ:LRCX) Q1 Sales Numbers


Full Report / November 02, 2021
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Semiconductor equipment maker Lam Research (NASDAQ:LCRX) missed analyst expectations in Q1 FY2022 quarter, with revenue up 71.9% year on year to $4.3 billion. On the other hand, guidance for the next quarter exceeded analyst expectations with revenues guided to $4.4 billion, or 0.24% above analyst estimates. Lam Research made a GAAP profit of $1.17 billion, improving on its profit of $574.7 million, in the same quarter last year.

Lam Research (LRCX) Q1 FY2022 Highlights:

  • Revenue: $4.3 billion vs analyst estimates of $4.32 billion (small miss)
  • EPS (non-GAAP): $8.36 vs analyst estimates of $8.20 (1.91% beat)
  • Revenue guidance for Q2 2022 is $4.4 billion at the midpoint, roughly in line with what analysts were expecting
  • Free cash flow of $321 million, up 27.1% from previous quarter
  • Inventory Days Outstanding: 112, down from 115 previous quarter
  • Gross Margin (GAAP): 45.9%, down from 46.6% same quarter last year

Founded in 1980 by David Lam, who pioneered semiconductor etching technology, Lam Research (NASDAQ:LCRX) is one of the leading providers of the wafer fabrication equipment used to make semiconductors.

Lam Research is one of a handful of companies in the world that makes the tools used in deposition, etching, and cleaning wafers. It has a concentrated customer base made up of the biggest chip makers in the world like TSMC, Intel, Samsung and Micron. Its biggest customer base are the producers of memory chips, which have traditionally accounted for about two thirds of Lam’s revenues.

Specifically, Lam’s tools are heavily used in the production of NAND memory, which has evolved into more complex 3D designs over the past few years, requiring more complex tools to etch and deposit more structures on ever shrinking memory chips. In the long run, DRAM will likely shift to 3D designs, providing an opportunity for Lam. Because Lam is so exposed to memory chips, which have the most volatile pricing within semiconductors, Lam’s model tends to be more volatile than its tool maker peers, such as Applied Materials or ASML.

Its primary peers and competitors are Applied Materials, (NASDAQ:AMAT), ASML (NASDAQ:ASML), KLA Corp (NASDAQ:KLAC), and Samsung Electronics (KOSE:005930).

Semiconductor Manufacturing

The semiconductor capital (manufacturing) equipment group has become highly concentrated over the past decade. Suppliers have consolidated, and the increasing cost of innovation have made it unaffordable to almost everybody, except the largest companies, to produce leading edge chips. The result of the increased industry concentration has been higher operating margins and free cash generation through the cycle. Despite this structural improvement, the businesses can still be quite volatile, as demand fluctuations for the semiconductor equipment are magnified by the already cyclical nature of underlying semiconductor demand. Read More Chip manufacturing is done in "batches" on a single round silicon disk, known as a "wafer". Multiple chips can be fabricated on a single wafer, which itself can cost over $10,000 today for the more advanced nodes. The actual chip fabrication process requires hundreds to thousands of steps that are executed at an atomic scale. From start to finish, including fabrication, testing and packaging, it can take 3 months to make a chip. The process to create a silicon wafer starts with sand, which is melted to extract silicon, then purified and formed into a cylinder, which is then sliced down into discs about 1mm thick that are then polished into wafers. Next, the wafers go to a semiconductor foundry and go through a process where successive layers of insulating, conducting, and semiconducting materials are stacked on top of one another to form many small complex interconnected 3D structures (wires, insulators, etc), with each layer consisting of 15-20 processes such as deposition, lithography, etching, stripping, testing, and cleaning.

Sales Growth

Lam Research's revenue growth over the last three years has been strong, averaging 21.1% annually. And as you can see below, last year has been especially strong, with quarterly revenue growing from $2.5 billion to $4.3 billion. Semiconductors are a cyclical industry and long-term investors should be prepared for periods of high growth, followed by periods of revenue contractions (which can sometimes offer opportune times to buy).

Lam Research Total Revenue

Despite missing analyst estimates this quarter, Lam Research's 71.9% revenue growth was still objectively impressive. This marks 7 straight quarters of revenue growth, which means the current upcycle has had a good run, as a typical upcycle tends to be 8-10 quarters.

However, Lam Research believes the growth is set to even accelerate, and is guiding for revenue to grow 75.7% YoY next quarter, and Wall St analysts are estimating growth 34.1% over the next twelve months.

Product Demand & Outstanding Inventory

Days Inventory Outstanding (DIO) are an important metric for chipmakers, as it reflects the capital intensity of the business and the cyclical nature of semiconductor supply and demand. In a tight supply environment, inventories tend to be stable, allowing chipmakers to exert pricing power. Steadily increasing DIO can be a warning sign that demand is weak, and if inventories continue to rise the company may have to downsize production.

Lam Research Inventory Days Outstanding

This quarter, Lam Research’s inventory days came in at 112, 6 days above the five year average, suggesting that despite the recent decrease the inventory levels are still higher than what we used to see in the past.

Pricing Power

Lam Research's gross profit margin, how much the company gets to keep after paying the costs of manufacturing its products, came in at 45.9% in Q1, down 0.7 percentage points year on year.

Lam Research Gross Margin (GAAP)

Lam Research's gross margins have been trending up over the last year, averaging 46.3%. This is around the average of what we typically see in semiconductor businesses, but the rising margin may be indicative of improving cost controls.

Profitability

Lam Research reported an operating margin of 32.3% in Q1, down 7.1 percentage points year on year. Operating margins are one of the best measures of profitability, telling us how much the company gets to keep after paying the costs of manufacturing the product, selling and marketing it and most importantly, keeping products relevant through research and development spending.

Lam Research Adjusted Operating Margin

Operating margins have been trending up over the last year, averaging 36.8%. Lam Research's margins remain one of the highest in the semiconductor industry, driven by its highly efficient operating model's economies of scale.

Earnings, Cash & Competitive Moat

Analysts covering the company are expecting earnings per share to grow 17.6% over the next twelve months.

Earnings are important, but we believe cash is king as you cannot pay bills with accounting profits. Lam Research's free cash flow came in at $321 million in Q1, down 34.4% year on year.

Lam Research Free Cash Flow

Lam Research has generated $1.91 billion in free cash flow over the last twelve months. This is a solid result, which translates to 15% of revenue. That's above average for semiconductor companies, and should put Lam Research in a relatively strong position to invest in future growth.

Lam Research’s average return on invested capital (ROIC) over the last 5 years of 55.9% implies it has a strong competitive position and is able to invest in profitable growth over the long term.

Key Takeaways from Lam Research's Q1 Results

With a market capitalization of $80.6 billion, more than $4.61 billion in cash and with free cash flow over the last twelve months being positive, the company is in a very strong position to invest in growth.

We were impressed by the exceptional revenue growth Lam Research delivered this quarter. And we were also glad to see that earnings outperformed analysts' expectations. On the other hand, it was unfortunate to see that Lam Research missed analysts' revenue expectations and operating margin deteriorated. Overall, it seems to us that this was a complicated quarter for Lam Research. The company currently trades at $570.9 per share.

Is Now The Time?

When considering Lam Research, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. There are a number of reasons why we think Lam Research is a great business. First, its revenue growth has been solid. On top of that, its impressive operating margins are indicative of an highly efficient business model, and its high return on invested capital suggests it is well run and in a strong position for profit growth.

Lam Research's price to earnings ratio based on the next twelve months is 16.5x. Looking at the semiconductors landscape today, Lam Research's qualities stand out, and we like the stock at this price.

The Wall St analysts covering the company had a one year price target of $716.5 per share right before these results, implying that they saw upside in buying Lam Research even in the short term.

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