Lam Research Outshines Expectations: A Comprehensive Earnings Review

In recent quarters, Lam Research (NASDAQ:LRCX) has demonstrated a notable performance that has outpaced market expectations. The company's FYQ1 earnings and FYQ2 guidance have exceeded consensus EPS projections by 8% and 3%, respectively, largely due to a strong showing in the Chinese market. However, questions around the sustainability of this demand and potential subdued spending on leading-edge logic and memory have emerged. This analysis will delve into the specifics of LRCX's recent performance, its future outlook, growth drivers, potential concerns, and a detailed financial and valuation assessment.

Earnings Analysis

Note: All consensus numbers come from FactSet.

Lam Research has delivered an impressive performance in FYQ1 and upside to FYQ2 guidance, exceeding EPS expectations by 8% and 3%, respectively. This success can be largely attributed to the robust performance in the Chinese market. However, there are concerns about the sustainability of this demand and the anticipated subdued spending on leading-edge logic and memory.

In the September quarter, LRCX reported a revenue of $3.48 billion, a 9% quarter-on-quarter increase but a 31% year-on-year decrease. Despite the YoY decrease, this revenue figure surpassed consensus estimates by 1.7%. The gross margin of 47.9% exceeded consensus by 145 basis points, and the operating margin of 30.1% was 215 basis points higher than expected. The EPS of $6.85 was $0.72 or 11% above consensus. Even after excluding the impact of increased interest income, the EPS estimates were still $0.52 or 8% higher than consensus.

Looking ahead to the December quarter, LRCX is forecasting revenues of about $3.70 billion which is 1.5% above consensus. The gross margin is expected to be around 47.0%, 15 basis points above consensus, and the operating margin is expected to be around 29.5%, which aligns with consensus at the midpoint. The EPS outlook of $7.00 is $0.23 or 3% above consensus at the midpoint.

Market Outlook

LRCX has increased its 2023 WFE outlook from the "mid-70s" to $80 billion, driven by stronger growth in lithography. This aligns with our own estimate of $78 billion for WFE this year, which we believe may still be conservative.

The company's management has noted that they do not expect a significant impact from the updated export rules from the Department of Commerce, which suggests that LRCX's revenue forecast remains robust.

Growth Drivers

Several technology inflections are expected to drive medium- to long-term growth. These include Gate-All-Around, Backside Power Delivery, Advanced Packaging, and EUV Dry Resist. These technologies are expected to drive sustained market share growth for LRCX, particularly in leading-edge Logic/Foundry.

LRCX's revenues from China have doubled quarter-on-quarter, accounting for 48% of total revenues. In our view, without significant regulatory intervention from the U.S. government, we expect China's investments to continue in 2024. This will be driven by increased demand for trailing nodes and a push for local manufacturing.

Concerns

Despite the positive outlook, there are a few concerns. The sustainability of China WFE is a key concern. Given the ongoing (and unprecedented) supply-side actions taken by the DRAM and NAND suppliers, the timing and shape of any recovery remains uncertain given the fragile macroeconomic backdrop.

There are also concerns about the margin outlook for 2024. Management's comments indicate potential normalization in customer mix and an increase in R&D spending, which could lead to negative revisions to 2024 Street gross and operating margins. However, this could be seen as a one-time re-set predicated on higher R&D investments that will ultimately pay dividends in the form of above-industry revenue growth.

Financial & Valuation

Note: All historical data in this section comes from the company’s 10-K filings, and all consensus numbers come from FactSet.

Over the past three fiscal years, the company's revenue grew by a compound annual growth rate (CAGR) of 20.2%. While the sell-side consensus forecasts a revenue contraction of 16.0% this fiscal year, to $14.6 billion, it also predicts a rebound of 18.0% the following fiscal year, to $17.3 billion. It suggests the current downturn in revenue may be temporary, and LRCX could bounce back robustly.

The company's EBIT margin increased by 3.7 percentage points over the last three fiscal years, from 27.0% to 30.7%. An expected contraction this fiscal year to 29.1% is followed by a forecast expansion to 31.5% the next fiscal year. This trend indicates a solid profit-generating ability, which is encouraging.

LRCX's use of share repurchases to offset shareholder dilution, resulting in a decrease of 9.7% in diluted outstanding common shares over the past three years, suggests a management that is committed to rewarding shareholders. This strategy has aided in achieving an EPS CAGR of 28.8% over the past three fiscal years, outpacing its revenue growth.

The consensus estimates forecast for free cash flow also presents a promising picture. The FCF for the current fiscal year is expected to reach $3,415 million, indicating a 23.3% FCF margin. This is a significant improvement from four fiscal years ago, when FCF was $2,093 million with a 20.8% margin. Over the past four completed fiscal years, the company generated an average FCF margin of 23.7%, indicating a consistent cash generation capability.

Capital expenditure as a percentage of revenue averaged 2.9% over the same period, placing the business in the 'capital light' category. This suggests that LRCX is capable of driving growth without substantial reinvestment, another positive sign for investors.

In terms of performance, LRCX has outshone the S&P 500 over the past year, returning 84 percentage points more, or 102.0% in absolute terms. While the stock currently trades 5.4% above its 200-day moving average, it is 17% below its 52-week high and 94% above its 52-week low, suggesting potential upside.

On the valuation front, LRCX is currently trading at a forward 12-month P/E of 21.6, compared to its 5-year mean of 16.3. The current P/E is towards the high end of its 2-standard deviation range of 8.5 to 24.1, indicating a historically high valuation. This might suggest that the stock is overvalued. However, relative to its peers, Applied Materials (AMAT) and KLA Corp (KLAC), trading at forward 12-month P/Es of 18.2 and 20.5, respectively, LRCX's valuation seems justified considering its robust performance and growth prospects.

Conclusion

Despite concerns related to the sustainability of China's WFE and potential margin contractions in 2024, Lam Research's overall outlook appears positive. The company has displayed consistent growth, with various technological inflections projected to drive medium to long-term growth. Furthermore, the company's robust financial performance, along with its promising free cash flow and capital expenditure trends, demonstrate a high degree of profitability and cash generation capabilities.

However, the current valuation, which is at historically high levels, may indicate that the stock is overvalued. This, coupled with the possibility of regulatory intervention and increasing R&D expenses, might lead to potential volatility. Nonetheless, relative to its peers, LRCX's valuation appears justified given its strong performance and promising growth prospects. Investors should keep a careful eye on Lam Research's future performance and the macroeconomic landscape to make informed investment decisions.