Lam Research Corporation

Moat: 3/5

Understandability: 4/5

Balance Sheet Health: 4/5

Lam Research Corporation (LRCX) is a leading global supplier of wafer fabrication equipment and services to the semiconductor industry, with its products and services essential for the manufacturing of advanced microchips.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview & Moat Analysis

Lam Research is at the forefront of semiconductor manufacturing, a critical industry for modern technology. The company’s core business involves designing, manufacturing, marketing, and servicing wafer fabrication equipment and services used by semiconductor manufacturers. These systems are essential for creating microchips, the tiny brains in our computers, phones, and countless other electronic devices.

  • Competitive Advantage (Moat): LRCX has a moat that can be described as narrow, but solid for the time being. Here are the key reasons for that conclusion:
    • Intangible Assets (Patents and Specialized Knowledge): LRCX has significant technological know-how and proprietary processes, bolstered by patents and trade secrets. These patents provide a barrier to entry, but not one that is impossible to overcome. They do not protect the moat forever.
    • High Switching Costs: Once a manufacturer integrates LRCX’s equipment into its fab processes, switching to another vendor becomes extremely disruptive and costly. Customers become deeply integrated with LRCX’s systems, and that integration is a form of switching costs. Customers also know that it can take years to develop similar knowledge-base in production.
    • Customer Lock-In: There is significant customer lock-in due to the reliance on specialized equipment, knowledge, and integration into existing manufacturing systems. This effect is strongest in the most advanced semiconductor markets.

While LRCX has good customer lock-in and intellectual property, the nature of technology is to change rapidly, making long-term sustainability tough to measure.

  • Moat Rating: 3 / 5. While the moat is fairly solid, the company is reliant on their technological advancement. A technological leap from a competitor could lead to them falling behind. Hence, they do not get a very high moat rating. There are also multiple competitors like Applied Materials, Tokyo Electron and ASML.

Legitimate Risks That Could Harm the Moat and Business Resilience

  • Technological Disruption: The semiconductor industry is known for its rapid technological evolution. New, disruptive technologies could challenge LRCX’s leading position and render its existing products and processes obsolete.
  • Cyclical Demand: The semiconductor industry is inherently cyclical, and companies like LRCX can experience sharp downturns in demand during periods of oversupply or economic recession.
  • Trade and Geopolitical Risks: The company’s global operations expose it to trade restrictions, export limitations, and other geopolitical risks. Specifically the US-China and US-Russia tensions can impact. Also, tariffs can have implications.
    • The company mentions in the latest 10-Q (2024-09) that they are “subject to a variety of international and U.S. trade controls, sanctions, and export requirements, including those relating to Russia.” The Russia-Ukraine war caused “increased risk” relating to their contracts with customers in Russia, and they might not be able to get necessary licenses or approvals. Any geopolitical conflict can cause issues for them and their revenue.
  • Customer Concentration: LRCX serves a small number of large semiconductor manufacturers. The loss of a single significant customer could impact the company’s financials, despite attempts to diversify their customer base.
  • Dependency on Key Suppliers: Any disruption in the supply of critical materials or subcomponents could negatively affect their ability to deliver products. For example, in the latest 10-Q they mention the dependency on foreign suppliers and manufacturers in China and Southeast Asia.
  • Competition: As a capital-intensive business, there are not many competitors in their sector, but they are very capable. If a new player appears they could significantly affect ROIC for LRCX.
  • Labor/Employee/Talent Risks: As with every other technology business, they need highly skilled and well-versed employees to operate effectively. Hence it might be a problem to retain and attract the best and brightest. The company says that they may be affected negatively in case they can not attract or retain or they may have to pay a premium to attract the employees.

Latest Developments

  • Earnings Call October 25, 2023: The company is expecting to see a slowdown of revenues because of market dynamics in the near term. They are expecting the demand for memory to remain depressed and the demand for logic and foundry to decline. The company is expecting an increase in revenues in the last quarter of 2024. They are continuing to prioritize profitability by controlling costs, supply chain, and focusing on the long-term future. The management is “very optimistic about where it is and what is ahead of us.”
    • The company mentioned their new advanced technology for next gen-chips with higher speed and power efficiencies. They expect this to be important for the growth of the company in the future.
    • The company expects the semiconductor industry to recover fully by the second half of 2024.
    • The company mentioned that the customers are making significant investments into NAND memory which is also promising for the business.
    • The management highlighted how their business model is both cyclical but durable and has demonstrated to be long lasting through the economic cycles.
    • The management continues to be bullish on the long-term growth of the company and expects a rebound in revenues as the inventories and supply chain issues diminish.
  • Form 10-Q September 2024: In the latest 10-Q the management mentions the potential impact of AI and HPC in increased growth going into 2025 and beyond. They emphasize the need for their products in producing chips required by the data centers in the new emerging markets. They have also mentioned their focus on “high NA technology,” and its importance for the company and the long-term growth.
  • Form 10-K June 2023: The company mentions the impacts of global supply chain and logistical disruptions, and ongoing market volatility on their financial position. They are anticipating an increase in their labor costs which may affect their margins. In the risk section, they have also discussed the potential future risks to the company’s business and operations from the impacts of pandemic and climate change.

Detailed Business Description

  • Revenue Distribution: LRCX reports its revenues based on three geographical segments: China, Korea, and Rest of the world. Based on their latest financials, in the quarter ending in June, 2024, China represented almost 37% of the revenue, Korea accounted for 15% and Rest of World accounted for the remaining 48%. China has been the biggest and most important market for LRCX.
  • Industry Trends: The semiconductor industry is known for its cyclical nature. The market is prone to boom and bust cycles depending on the demand, technological developments, geopolitical events and economic conditions. The latest major trends are driven by the need for chips for applications like AI, EV, HPC, IoT, etc.
    • The semiconductor industry is poised for huge growth in the next decade as the world economy transitions to one that is more reliant on cloud computing, AI, connectivity and electrification.
    • The market is expected to become more diverse. The demand for chips with a variety of applications is expected to cause a shift in the market landscape, and that will result in multiple specialized segments, with different demand and profitability potential.
    • The technological progress is continuously driving improvements and new techniques are continuously being created. There is an increased focus on advanced packaging.
  • Margins: LRCX enjoys high profitability due to its technological leadership. In the last few years, the company has enjoyed a gross margin of over 40% . The operating margin can be seen as more than 20% for the company, but fluctuations are also expected as a result of competition, inventory and pricing.
  • Competitive Landscape: LRCX operates in a highly concentrated market, with very few other competitors. The key competitors include Applied Materials, ASML, and Tokyo Electron. These are all giant global players in their own rights, and competition is always intense. Other smaller players are also a problem.
  • What Makes The Company Different: A key differentiator is its deep specialization in certain parts of chip production. Their expertise in etching is one thing that most other companies can not match. This results in lower costs and higher margins for the company. They are also a leader in advanced packaging. Their strong customer relationships also set them apart. All these contribute to the creation of a strong but not impenetrable moat for the business.

It can be noted that, most companies in the same industry often are vertically integrated. Meaning that, they engage in all parts of business, including design, manufacturing, marketing, servicing, etc. LRCX however, is not an end user and it sells these machines to other companies that ultimately create and sell the chips. This helps the company to avoid being a direct competitor to its customers.

Financials (Analysis)

  • Revenue Growth: The company’s revenue has historically fluctuated based on the capital expenditure cycle of their customer base (chip makers) and macroeconomic conditions. The company experienced tremendous growth in the last 2 years because of increased demand, but it is showing signs of slowing down now as their customers are lowering demand as a result of economic and market conditions. Revenue increased 11% in 2023. For fiscal year 2024, revenues are expected to be mostly flat as the market is expected to bottom out.
  • Profitability: The profitability of the company remains good, with Gross margins at around 46% in 2023. While their cost of revenue has increased by nearly 20% in fiscal year 2023, they were able to maintain their margins through pricing. Operating margin also remained relatively flat.
  • Debt & Cash: The balance sheet is healthy, with $2.6 billion in cash and short term investments. The total long term debt is approximately $5 billion as of June, 2023. Total current liabilities are approximately $4.5 billion.
    • The debt to asset ratio is approximately at .28 for the company which indicates the low to moderate level of debt. A highly leveraged company usually has a ratio greater than 0.5.
    • The company has a debt to equity ratio around 1.3, so they are levered but at a reasonable level. The debt is in control, and not dangerously high.
  • Cash Flow: Operating cash flows have steadily increased in the past few years. This demonstrates that the company is very good at generating cash from its operations. Free cash flow is also in a similar situation, and as the company expects revenue increases in the future, free cash flows are also expected to increase. The company also returns a part of free cash flow via share buybacks.
    • The company spent $1.8 billion in 2023 in share buybacks. And they have recently approved a $5 billion share buyback program in April of 2024.
  • Dividends: Currently the company is paying approximately $1.15 in dividends per share. The dividend payments are growing year by year.

Overall, LRCX is a profitable, well-established company with good financial standing. They have shown good revenue growth over the years with some variations based on industry cycles and they have a solid business model. They are expected to perform well in the future.

Understandability Rating: 4 / 5

LRCX’s business is relatively complex because it operates in an advanced technological sector, but it is somewhat easy to understand the core business model and revenue distribution of the business. Understanding of the financial metrics used in valuation are also comparatively easier to learn and understand. However, a deeper understanding of the underlying manufacturing process in the semiconductor industry requires a specialized knowledge base.

Balance Sheet Health Rating: 4 / 5

The company has a strong balance sheet, indicated by its high level of cash and short term investment reserves. It’s debt load is not that bad, and can be controlled. The debt to asset and debt to equity ratios are also within the acceptable range. This means that the company has enough liquidity and solvency to survive any possible negative changes in the market or downturns. However, they are not debt free and there is always a chance that external debt may cause problems in future.