Heading into its 2Q19 report yesterday, expectations for
semiconductor equipment company Lam Research (LRCX 158.42, +19.09, +13.70%) were quite muted. Of
course, the reason for that is related to a well-known slowdown occurring in
the semiconductor and memory space. When Micron (MU) sharply cut its quarterly
guidance on December 18, followed by Samsung (SSNLF) doing the same on January
8, it confirmed investors' escalating concerns that the industry has already
reached peak earnings potential.
Better-Than-Feared, But Outlook Dims
Given that both Samsung and MU are 10%+ customers of LRCX, it seemed all but certain that the company's quarterly results and guidance would be bleak. So when LRCX delivered a surprise bottom line beat ($3.87 vs. $3.68), coupled with in-line guidance for Q3, investors were pleasantly surprised by the better-then-feared report. On top of that, the company announced a new $5.0 bln stock buyback program, helping to insulate its earnings per share from a deteriorating memory market. Hence, why the stock is enjoying a 14% pop today.
However, whether this bullish sentiment has staying power is questionable; the market dynamics facing LRCX remain challenging. During its earnings call last night, management stated that based on interactions with its customers, it expects this downturn in the wafer fab equipment and memory industries to extend throughout 2019. That is in contrast to what both MU and Samsung stated a few weeks ago. At the time, those companies said they expected conditions to improve in 2H19. Perhaps LRCX is simply taking a more cautious approach to its expectations this year, but the differing outlook certainly caught our attention.
When main LRCX competitor Applied Materials (AMAT) issues its Q4 report in mid-February, it will be interesting to see whether it concurs with LRCX or instead sees a thawing in conditions later this year. On that note, while not a direct competitor of LRCX's, semiconductor testing equipment company Teradyne (TER) commented during its earnings call this morning that it expects a soft SoC (System on Chip) market in 2019.
Market Share Gains & Cost Management
On the positive side, LRCX did an admirable job in terms of executing its growth strategy and managing costs. Toward the former project, the company has been focused on driving market share gains through its strong position in etch and deposition processes. In simple terms, etch processes chemically remove layers from the surface of a wafer during manufacturing. In doing so, the process creates chip features and precisely shapes electrical components like transistors. Furthermore, etch provides insulations that protect the wafer. Deposition, meanwhile, is any process that grows, coats, or transfers a material onto the wafer.
The company stated that during the quarter it gained momentum in both DRAM and NAND, including through new application wins, particularly in the area of high aspect ratio etch. Over the past several quarters, the company has been significantly investing in R&D to drive innovation and improve its capabilities in etch. Those investments seem to be paying off, and the company believes that its focus on etch and deposition technology positions it well for longer-term growth.
With regard to cost management, the company’s operating expenses as a percentage of revenue actually declined to 27.4% from 28.6% in the year ago period -- even though revenue fell by 2%. Consequently, its operating margin expanded by 180 basis points to 28.8%. This came in above LRCX's expectation for operating income as a percentage of revenue of 27.5%, provided in its Q1 earnings report.
Market Recovery Delayed?
The main story here is the aforementioned contradicting remarks LRCX made about the memory market for 2019. Adding to the concerns, this morning, South Korean company SK Hynix (HXSCL), which is another major customer of LRCX (and the world's second largest memory chip maker), reported that its Q4 revenue fell by 13%, leading to its first profit decline in two years. Its woes stem more directly from the weakening Chinese economy, as about a third of its revenue is generated from that country, as opposed to 15% for LRCX.
From a global perspective, LRCX is now forecasting wafer fab equipment spending to be down in the mid-to-high teens range for 2019. This deceleration is expected to mainly come from a contraction in DRAM production as manufacturers make adjustments to capacity. Overall, LRCX expects that DRAM supply will decline in the mid-teens as we exit 2019. The weak conditions figure to be an ongoing drag on Micron, Samsung, and Hynix, as the largest DRAM producers in the world, going forward. As for LRCX, DRAM represents about a quarter of total system revenue.
Additionally, according to LRCX, the 2019 outlook for NAND (55% of system revenue) doesn't look much brighter, describing the year as a "solid long-term set up" as bit growth rate decelerates throughout the year.
In our opinion, the key takeaway from LRCX's quarterly report, guidance, and commentary is this: By managing its costs, the company is executing well in a very challenging environment, and it is actively supporting its stock and shareholders via its substantial buyback program, speaking to its confidence in its longer-term prospects, but market fundamentals are quite dim, with no reprieve expected any time soon. Therefore, it becomes difficult to pinpoint any meaningful near-term catalyst for the stock that could translate into a sustained upward move.
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