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Lam Research (NASDAQ:LRCX) Q1 Sales Beat Estimates, Provides Optimistic Guidance For Next Quarter


Full Report / October 19, 2022
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Semiconductor equipment maker Lam Research (NASDAQ:LCRX) reported Q1 FY2023 results topping analyst expectations, with revenue up 17.8% year on year to $5.07 billion. On top of that, guidance for next quarter's revenue was surprisingly good, being $5.1 billion at the midpoint, 7.64% above what analysts were expecting. Lam Research made a GAAP profit of $1.42 billion, improving on its profit of $1.17 billion, in the same quarter last year.

Lam Research (LRCX) Q1 FY2023 Highlights:

  • Revenue: $5.07 billion vs analyst estimates of $4.9 billion (3.36% beat)
  • EPS (non-GAAP): $10.42 vs analyst estimates of $9.54 (9.19% beat)
  • Revenue guidance for Q2 2023 is $5.1 billion at the midpoint, above analyst estimates of $4.73 billion
  • Free cash flow of $1.04 billion, up from $318.1 million in previous quarter
  • Inventory Days Outstanding: 145, up from 142 previous quarter
  • Gross Margin (GAAP): 46%, in line with 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.

Lam Research's 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 24.9% annually. But as you can see below, last year has not been especially strong, with quarterly revenue growing from $4.3 billion to $5.07 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

This was an OK quarter for Lam Research with revenues growing 17.8%, ahead of analyst estimates by 3.36%. This marks 12 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.

Analysts believe that Lam Research appears to be headed for a downturn. While the company is guiding to growth of 20.6% YoY next quarter, analyst consensus sees 3.42% declines 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 145, 29 days above the five year average, suggesting that that inventory has grown to higher levels 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 46% in Q1, up 0.1 percentage points year on year.

Lam Research Gross Margin (GAAP)

Despite declining over the past year, Lam Research still retains industry average gross margins, averaging 45.7%, pointing to a good competitive offering, decent cost controls, and only modest pricing pressure.

Profitability

Lam Research reported an operating margin of 33.2% in Q1, up 0.9 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 stable over the last year, averaging 31.5%. Lam Research's margins are higher than most companies' in the semiconductor industry, pointing to a business that is efficiently managed across all departments.

Earnings, Cash & Competitive Moat

Wall St analysts are expecting earnings per share to decline 10.6% over the next twelve months, although estimates are likely to change post earnings.

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 $1.04 billion in Q1, up 226% year on year.

Lam Research Free Cash Flow

Lam Research has generated $3.28 billion in free cash flow over the last twelve months. This is a solid result, which translates to 18.2% 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 75.4% 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

Sporting a market capitalization of $44 billion, more than $4.37 billion in cash and with positive free cash flow over the last twelve months, we're confident that Lam Research has the resources it needs to pursue a high growth business strategy.

We were impressed by how strongly Lam Research outperformed analysts’ earnings expectations this quarter. And we were also glad that the revenue guidance for the next quarter exceeded analysts' expectations. Overall, we think this was a strong quarter, that should leave shareholders feeling very positive. The company is up 2.37% on the results and currently trades at $338.29 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. Although we have other favorites, we understand the arguments that Lam Research is not a bad business. We would expect growth rates to moderate from here, but its revenue growth has been solid, over the last three years. And on top of that, its impressive operating margins are indicative of an highly efficient business model.

Lam Research's price to earnings ratio based on the next twelve months is 10.7x. In the end, beauty is in the eye of the beholder. While Lam Research wouldn't be our first pick, if you like the business, the shares are trading at a pretty interesting price point right now.

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