Summary

• Lam Research has a large global presence in the semiconductor fabrication equipment industry.
• The company is facing declining revenue and earnings in 2019.
• However, growth may return in 2020 and continue as the internet of things and cloud driven businesses increases demand for Lam’s equipment.

Lam Research (LRCX) operates as a global supplier of wafer fabrication equipment and services for the semiconductor industry. The company’s specialties include: chemistry, plasma, fluidics, nanoscale applications enablement, and advanced systems engineering.

Lam Research helps customers build faster, smaller devices with improved performance by enabling them to manufacture the components used in these devices. Examples of these devices includes: smart phones, PCs, wearables, auto devices, storage devices, and networking equipment.

Lam’s customers are semiconductor manufacturers (memory, integrated device, foundry) that produce memory (NVM, DRAM) and logic devices. The company is benefiting from demand in cloud computing and the internet of things [IoT]. Lam Research is also benefiting from the technical challenges in 2-dimensional scaling, creating the need for 3D designs and multiple patterning to enable shrinks.

source: Lam Research Q2 2019 Presentation

Strengths

Lam Research differentiates themselves through: R&D expertise, engineering sustainability, and product/process development. 

• Over $1 billion per year or 10% to 13% of total revenue is spent on research and development. This is to ensure that the company remains on the cutting edge of wafer fabrication equipment technology to give customers the products that they need.
• Lam has an extensive global presence and large distribution network to get products to customers efficiently. 
• The company has a strong ability to innovate. This is the result of having significant engineering expertise to design equipment that customers need as technology continues to advance.
• The company achieved steady growth in installed base units: 

source: Lam Research Q2 2019 Presentation

• High returns: ROE of 44%, ROIC of 17%. This is significantly higher than the sector median ROE of 7.4% and ROIC of 5%. The high returns allow Lam Research to get a good bang for the buck for their R&D and other investments.
• High margins: Gross Margin of 45.7%, EBITDA margin of 30%, net income margin of 25.6%. The gross margin is about in-line with the sector median, but the EBITDA and net income margins significantly exceed the sector median EBITDA and net income margins of 12% and 4% respectively.
• The strong balance sheet shows that the company can effectively manage long and short-term debt: Current ratio of 3.37; more total cash than total debt; 1.7x more total assets than total liabilities for shareholders’ equity of $5.3 billion. 
• Positive operating and free cash flow: allows for expansion, repaying debt and for share repurchases/dividend payments. 

Weaknesses

Lam Research has a few internal weaknesses that gives the company certain risks, which could negatively affect the business and the stock as an investment.

• The business is subject to sharp fluctuations in demand for semiconductor equipment (boom and bust) cycles. Demand changes for electronics, semiconductor economic fluctuations, broader economic cycles, industry supply/demand dynamics, and customers’ ability for semiconductor manufacturing in any given time period. 
• The company depends on a small number of large customers. The loss or change of business from one customer could significantly impact the company’s revenue and earnings.
• Significant revenue is derived from a small number of products (lack of product diversification). Lam’s products cost up to $11 million per system.  Therefore, the loss of one system could have a significant negative effect on the company’s revenue.
• Lam Research experiences fluctuations in revenue and earnings. For example, in 2019, the company is expected to experience a 12% decline in revenue and a 19% to 20% decline in earnings (consensus).  However, in 2020, revenue is expected to grow about 0.4% and earnings are expected to increase by 2.2%. 

Opportunities

Lam Research can implement various strategies to drive growth and strengthen the business.

• Continue to innovate and create new products for IoT and cloud semiconductor-related customers. Both of these areas have multiple years of potential growth. Therefore, the company can drive growth by effectively meeting customer demand in these areas.
• Strategic partnerships and acquisitions can be implemented to drive growth and grow market share to maintain an edge over the competition. 
• Growth in existing markets: Lam can look for opportunities in their current global markets for further growth. This can include increasing business to existing customers (increase recurring revenue stream from their installed base) and taking on new customers in markets where the company already operates. 
• Growth in new markets: Lam can look for opportunities to grow by seeking out new business in emerging markets. New semiconductor companies could be created in emerging markets, creating new markets for the company. 

Threats

Lam Research faces various external threats that could negatively affect the company’s business.

• The company is at risk for declines in demand for semiconductor equipment due to economic declines or slowdowns in the semiconductor industry. The slowdowns in the semiconductor industry can occur more frequently than the slowdowns in the broader market. 
• The trade war between the United States and China creates uncertainty for Lam’s business. There could be a negative outcome from this situation that could negatively affect the business. International sales comprise 93% of Lam’s revenue. So, trade will be a key factor to evaluate in the near future.
• Increased competition could take market share away from Lam Research. Consolidation in the industry between competitors could make it more challenging for Lam to increase market share. Lam Research competes with Applied Materials (AMAT), Hitachi (OTCPK:HTHIY), Screen Holding (OTC:DINRF), Tokyo Electron (OTCPK:TOELY), and ASM International (OTCQX:ASMIY). 
• Decreases in the amount of the company’s suppliers as a result of consolidation could increase Lam Research’s input costs. 

Long-Term Lam Research Outlook

Lam Research experienced weakness in 2019 as a result of weaker demand in the memory market. Although the semiconductor industry can have their own bull and bear markets, which can occur more frequently than the broader market’s economic recessions, the long-term outlook for Lam Research looks positive.

The semiconductor industry growth is likely to be driven by increases in cloud and IoT demand. This will increase demand for the company’s semiconductor equipment as more complex chips will need to be manufactured.

Demand for Lam Research’s equipment has a good chance to see a boost as their customers move to more advanced 3D semi designs. The global 3D IC market is expected to grow at a CAGR of 18% through 2023 according to a research report by Technavio. This should increase demand for Lam’s equipment. 

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article was written by David Zanoni for Kirk Spano’s Margin of Safety investing service.

Additional disclosure: The article is for informational purposes only (not a solicitation to buy or sell stocks). David is not a registered investment adviser. Kirk Spano is an RIA. Investors should do their own research or consult a financial adviser to determine what investments are appropriate for their individual situation. This article expresses my opinions and I cannot guarantee that the information/results will be accurate. Investing in stocks involves risk and could result in losses.