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Morningstar | Lam Research Well-Positioned to Thwart Near-Term Headwinds; Shares Undervalued Relative to $185 FVE. See Updated Analyst Note from 16 Oct 2018

Lam Research reported fiscal first-quarter results consistent with our expectations, while providing forward guidance that thwarted recent negative sentiment that has plagued the semiconductor space. CEO Martin Anstice reiterated that the September quarter will be the trough of calendar 2018, while adding revenue during the first half of calendar 2019 will be incrementally higher than the second half of calendar 2018 for Lam. We continue to expect modestly lower wafer fab equipment spending in 2019, primarily due to weaker 3D NAND-related investments. However, we foresee firms such as Lam being able to achieve solid levels of profitability despite near-term headwinds by effectively controlling costs. Furthermore, Anstice noted logic, foundry, and DRAM investments should also help mitigate the NAND-related slowdown, as we anticipate share gains in key multiple patterning steps at logic and foundry customers such as Intel and TSMC. Each capital equipment firm has varied exposure to the different end-markets in WFE, but we remain very positive on the long-term prospects for many of the key WFE participants. Our $185 fair value estimate and narrow moat rating are both intact for Lam, and we believe current levels are fairly attractive. Close peers Applied Materials ($49 fair value) and KLA-Tencor ($128 fair value) also boast meaningful margins of safety and wide economic moats.

Fiscal first-quarter revenue was down 25.4% sequentially and 5.9% year over year to $2.33 billion. Sales to Japan and China accounted for 29% and 25%, respectively, of the total top line. We surmise the primary customers in these regions were Micron, Toshiba, and domestic Chinese manufacturers with equipment purchases supporting 3D NAND and foundry endeavors. Despite margins being typically dependent on business volume, we were pleased to see resilience in margins in the wake of the sales decline. Specifically, gross margins fell only 190 basis points to 45.4% from the prior quarter.

Management projects second-quarter sales to be at a midpoint of $2.5 billion, in line with our internal model that called for sequential growth. We attribute the recent sell-off across semiconductor stocks to an assortment of factors including macro-related concerns such as tariffs, the escalating trade war between the U.S. and China, inventory builds, and memory price declines. However, the end-market diversity beyond PC and smartphones for semis, which includes the shift to the public cloud, rise in automotive chip content, investments in 5G, and Artificial Intelligence should collectively allow for less cyclical behavior for overall WFE patterns, in our view. Anstice also highlighted that memory customers are better equipped to navigate “downturns” with greater cash cushions and profitability levels from the recent memory upswing, thanks to more rational behavior from a supply/demand standpoint. Consequently, short-term delays in equipment spending by Samsung and Micron shouldn’t last nearly as long as past downturns, which we concur.