Semiconductor equipment maker Lam Research (NASDAQ:LCRX) reported Q1 FY2024 results beating Wall Street analysts' expectations, with revenue down 31.4% year on year to $3.48 billion. Guidance for next quarter's revenue was also better than expected at $3.7 billion at the midpoint, 1.41% above analysts' estimates. Turning to EPS, Lam Research made a non-GAAP profit of $6.85 per share, down from its profit of $10.42 per share in the same quarter last year.
Lam Research (LRCX) Q1 FY2024 Highlights:
- Revenue: $3.48 billion vs analyst estimates of $3.42 billion (1.94% beat)
- EPS (non-GAAP): $6.85 vs analyst estimates of $6.13 (11.8% beat)
- Revenue Guidance for Q2 2024 is $3.7 billion at the midpoint, above analyst estimates of $3.65 billion
- Free Cash Flow of $874.2 million, down 16.3% from the previous quarter
- Inventory Days Outstanding: 236, down from 252 in the previous quarter
- Gross Margin (GAAP): 47.5%, up from 46.1% in the 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).
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.
Lam Research's revenue growth over the last three years has been mediocre, averaging 15.6% annually. But as you can see below, its revenue declined from $5.07 billion in the same quarter last year to $3.48 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).
Even though Lam Research surpassed analysts' revenue estimates, this was a slow quarter for the company as its revenue dropped 31.4% year on year. This could mean that the current downcycle is deepening.
Lam Research's revenue growth has decelerated over the last three quarters and its management team projects growth to turn negative next quarter. As such, the company is guiding for a 29.9% year-on-year revenue decline while analysts are expecting a 0.19% drop over the next 12 months.
Product Demand & Outstanding Inventory
Days Inventory Outstanding (DIO) is an important metric for chipmakers, as it reflects a business' capital intensity 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.
This quarter, Lam Research's DIO came in at 236, which is 100 days above its five-year average. These numbers suggest that despite the recent decrease, the company's inventory levels are higher than what we've seen in the past.
In the semiconductor industry, a company's gross profit margin is a critical metric to track because it sheds light on its pricing power, complexity of products, and ability to procure raw materials, equipment, and labor. Lam Research's gross profit margin, which shows how much money the company gets to keep after paying key materials, input, and manufacturing costs, came in at 47.5% in Q1, up 1.5 percentage points year on year.
Lam Research's gross margins have been stable over the last 12 months, averaging 45.4%, and remain slightly below other semiconductor companies. These margins could be better but point to a likely stable pricing environment.
Lam Research reported an operating margin of 30.1% in Q1, down 3.2 percentage points year on year. Operating margins are one of the best measures of profitability because they tell us how much money a company takes home after manufacturing its products, marketing and selling them, and, importantly, keeping them relevant through research and development.
Lam Research's operating margins have been trending down over the last year, averaging 29.5%. The company's profitability is in line with the broader semiconductor industry and it's working to appropriately manage its operating expenses.
Earnings, Cash & Competitive Moat
Analysts covering Lam Research expect earnings per share to be relatively flat over the next 12 months, although estimates will likely change after earnings.
Although earnings are important, we believe cash is king because you can't use accounting profits to pay the bills. Lam Research's free cash flow came in at $874.2 million in Q1, down 16.7% year on year.
As you can see above, Lam Research produced $4.5 billion in free cash flow over the last 12 months, an eye-popping 29.4% of revenue. This is a great result; Lam Research's free cash flow conversion places it among the best semiconductor companies and, if sustainable, puts the company in an advantageous position to invest in new products while remaining resilient during industry downturns.
Lam Research's average return on invested capital (ROIC) of 64.8% over the last five years implies that it has a strong competitive position and was able to invest in profitable growth over time.
Key Takeaways from Lam Research's Q1 Results
Sporting a market capitalization of $85.9 billion, more than $5.16 billion in cash on hand, and positive free cash flow over the last 12 months, we believe that Lam Research is attractively positioned to invest in growth.
We were impressed by how significantly Lam Research blew past analysts' EPS expectations this quarter, driven by better-than-expected systems and customer support revenue. We were also glad its inventory levels shrunk. On the other hand, its operating margin declined. Overall, we think this was a strong quarter that should satisfy shareholders. The stock, however, is down 3.5% immediately after reporting and currently trades at $619.98 per share.
Is Now The Time?
When considering an investment in Lam Research, investors should take into account its valuation and business qualities as well as what's happened in the latest quarter.
We think Lam Research is a solid business. We'd expect growth rates to moderate from here, but its revenue growth has been solid over the last three years. And while its gross margins are weaker than its semiconductor peers we look at, the good news is its powerful free cash generation enables it to sustainably invest in growth initiatives while maintaining an ample cash cushion. On top of that, its high ROIC suggests it is well run and in a strong position for profitable growth.
Lam Research's price-to-earnings ratio based on the next 12 months is 22.4x. There are definitely things to like about Lam Research and looking at the semiconductors landscape right now, it seems that the company trades at a pretty interesting price point.
Wall Street analysts covering the company had a one-year price target of $699 per share right before these results, implying that they saw upside in buying Lam Research even in the short term.
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