Equipment for semiconductor manufacturing usually falls into one of the three categories: wafer fabrication equipment, assembly, or testing equipment. Water fabrication equipment (WFE) is a primary segment for Lam Research, specifically for memory and storage chips. The deposition process creates layers of insulating and conducting materials with techniques like chemical vapor deposition or atomic layer deposition, which allows for thin films of atomic layers to be coated onto surfaces.
The excess material is then etched away. Deposition and etch are processes that require complex machines for wafers to be built into integrated circuits. Lam Research has done well by specializing in memory chips. In order for Lam to do well, the WFE market must be growing and Lam must create new equipment and processes to maintain or grow market share. Our goal is to participate in memory with less cyclical risk through Lam’s specialization, especially with 3D NAND, which is an emerging market where Lam leads.
We pointed this out that Lam lets us participate in the memory market with reduced risk in our original analysis when we stated:
“Analysts covering Lam Research like to point out that the company is protected from supply and demand as memory manufacturers will continue to buy from Lam Research even during a low point in the cycle. This was proven during 2015 when Lam Research did not feel the effects of the memory trough.”
The price action below since we covered Lam helps to illustrate what we mean:
Lam has significant business in supplying equipment for leading edge nodes and this is the leading growth market for Lam. Two years ago, we discussed how Qualcomm will sell up to 50% more dollar chip content per device versus 4G generations, which refers to the dollar value of chips the device holds. Something similar is happening at the equipment level as complexity increases.
Management said the following in the most recent earnings call,
“At the leading-edge, semiconductor content growth, large die, and rising capital intensity are fueling increased wafer starts and strong WFE spending. In Foundry/Logic for instance, the next-generation processor chip for a top smartphone maker is more than 20% larger than its prior iteration. In DRAM, higher capital intensity is being driven by the increasing need to correct single bit errors through the addition of an extra on-chip bit. In 3D NAND, increasing device layer counts and the resulting higher degree of manufacturing difficulty is requiring the addition of new deposition and etch processes to address stress management, defect control, and multi-stack integration challenges.”semiconductor content growth, large die, and rising capital intensity are fueling increased wafer starts and strong WFE spending. In Foundry/Logic for instance, the next-generation processor chip for a top smartphone maker is more than 20% larger than its prior iteration. In DRAM, higher capital intensity is being driven by the increasing need to correct single bit errors through the addition of an extra on-chip bit. In 3D NAND, increasing device layer counts and the resulting higher degree of manufacturing difficulty is requiring the addition of new deposition and etch processes to address stress management, defect control, and multi-stack integration challenges.”
Lam’s Reliant equipment has also posted 11 quarters of record revenue. This equipment provides a lower cost of ownership for non-traditional chip markets, such as micro electromechnical systems (MEMS), power chips, radio frequency (RF) filters and CMOS image sensors for better connectivity and more powerful imaging. This particular segment refers to trailing edge nodes, which means larger nodes, such as 24nm, 28nm or 90nm processes. Although we’ve covered leading edge nodes, such as 5nm in the past when discussing AMD, Lam has also found success in supplying equipment for larger nodes as these are used in automotive and medical equipment. In fact, the emphasis on leading edge nodes may be why Lam has found success in the overlooked trailing edge market. Management stated that demand is exceeding WFE equipment.
As Bradley points out below, the following statement was quite encouraging in regards to Lam’s business overall: “As a result, we see the WFE investment required to achieve the same bit growth percentage over the next 5 years to be notably higherbe notably higher than the 5-year period just completed.” Lam has grown sales at a CAGR of 28% over the past five years. Consequently, the stock has seen over 550% gains in five years from a share price of $105 to $724.
While these comments are encouraging, we need to watch Lam Research closely into 2022 as Gartner is predicting a slowdown in WFE equipment in 2023-2024 as integrated circuit manufacturers and foundries “pause to digest the new capacity.”
There are other forecasts predicting a slowdown to occur sooner with 6% growth in equipment for 2022 following an estimated 34% in 2021. The foundry and logic segments, which are more than half the WFE sales, are forecast to grow 8% in 2022 following 39% in 2021. Similar forecasts are provided for NAND and DRAM equipment with a marked slowdown in 2022.
On the earnings call, however, the idea a slowdown would occur in 2022 was negated when an analyst asked about the potential for a slowdown:
Good afternoon and great job on the quarterly execution, guys. You know, the market is concerned that we're heading into a multi-quarter downturn in Memory, kind of similar to the 2018/2019 Memory downturn, which is a pretty severe 6-quarter downturn, but the one thing I clearly remember was that ahead of that downturn, your memory customers proactively cut their CapEx very, very rapidly.
Now, if I look at it this time around, there's some near-term pricing weakness in memory. But the overall memory demand environment remains pretty strong, and I think most memory companies seem optimistic right under the baton outlook for next year.
So I guess the question is, has the Lam team seen any signs similar to the 2018 downturn of customers either getting concerned or canceling or slight pushing out of shipments due to a concern on our projected memory downturn next year? -Harlan Sur, JP MorganHarlan Sur, JP Morgan
Here was management’s response:
“Yeah. Harlan, let me take that first. I think the simple answer is no. When the vast majority of our conversations with customers today is still about delivering equipment that they feel they badly need to meet their near-term requirements. And as Doug mentioned in his prepared remarks, I would say lead times have stretched out to the point where our visibility into demand in '22 is better than usual.. When the vast majority of our conversations with customers today is still about delivering equipment that they feel they badly need to meet their near-term requirements. And as Doug mentioned in his prepared remarks, I would say lead times have stretched out to the point where our visibility into demand in '22 is better than usual.
So I don't think that the hypes of initial indicators that you're talking about are things we're seeing right now. We feel much more constrained by supply chain challenges and ability to meet shipments and an over shipping situation.” -Tim Archer, CEO
Regarding the comment on supply chain challenges, Lam stated on the call that this is the biggest challenge the company faces right now. There are hundreds of parts for WFE and many are now supporting new process flows and 3D architectures. It only takes a delay on one of those parts to slow Lam’s delivery: “We're beginning to see constraints in the supply chain. So we have to work our way back up through some of those things. And that's the biggest thing we're dealing with right now.”
Lam’s Product & Growth Opportunities
Lam’s main competitors are ASML, Applied Materials, Tokyo Electron and KLA with Lam tied for third place. There are a few key products that Lam is developing and bringing to market that could help increase the company’s market share. Certainly, the manufacturing expansion in the United States, Korea, Taiwan and Malaysia hints towards Lam expecting it will need more capacity.
The first growth opportunity for Lam is 3D NAND. We covered 3D NAND in detail in our Micron analysis with the 176-layer release that is 40% higher than the nearest competitor, Samsung. The new NAND device is also 10 times denser than previous 3D NAND devices with increased power efficiency and capacity limitations removed. The data transfer rate is also very fast at 1,600 MT/s while maintaining the same height as the 64-layer device.
Here's an excerpt from the Micron analysis that will help frame Lam’s new etch solution:
“According to Micron, “current 3D NAND design has begun to reach the limits of its monolithic die-level maximum capacity. It will continue to fall short of the immense system-level storage capacities demanded by future data-driven applications. Cell-to-cell capacitive coupling complications and smaller etch requirements account for many of these limitations.” If Micron is correct, then this could be an opportunity for the company to see more market share on 3D NAND.”smaller etch requirements account for many of these limitations.” If Micron is correct, then this could be an opportunity for the company to see more market share on 3D NAND.”
Micron is trying to move very quickly with their new replacement-gate design which replaces the traditional floating-gate design before Samsung or others catchup while Lam is busy solving the issue from the front-end WFE perspective with a high-productivity cryogenic etch solution. The etch removes the material in devices at cold temperatures below 100 degrees Celsius for high-aspect ratios with 200+ layers. The cold temperatures are achieved with liquefied nitrogen gas. You can click here for an article that describes this process.
According to management on the call, the cryogenic etch solution has already gone through QA and is being shipped this year. If the company is successful with this solution, it could extend to leading edge 3D DRAM and foundry/logic (3D DRAM is not on the product road map right now but management hinted that it will be put into production in the future).
“As one example, Lam has developed a new high-productivity cryo etch solution, which increases etch rates in high-aspect ratio features required for NAND devices with greater than 200 layers. We have installed this new capability at every major 3D NAND manufacturer for qualification with additional systems now shipping to support planned ramps to high-volume production next year.”We have installed this new capability at every major 3D NAND manufacturer for qualification with additional systems now shipping to support planned ramps to high-volume production next year.”
In the Micron report, we also discussed EUV or Extreme Ultraviolet Lithography where we stated the following:
“This manufacturing method uses smaller 13.5nm wavelengths of ultraviolet light to etch wafers as opposed to lasers from Deep Ultraviolet Lithography (DUV). You could argue that EUV is a point of weakness for Micron as Samsung is using this manufacturing method while Micron is delayed until 2024.”
EUV photomasks reflect light with alternating layers of molybdenum and silicon as opposed to conventional photomasks that block light with a quartz substrate or chromium layer. TSMC and Samsung are leaders with EUV for 5nm production. This process adds capital intensity, and this is good for Lam.
“In patterning, we're using the learning we have acquired over many years of multi-patterning etch leadership to win new applications as the industry adoption of EUV progresses. EUV requires use of special photoresist materials which, given the material composition, can amplify existing challenges with pattern roughness, and defectivity.
Unaddressed, these will lead to performance in yield loss, especially at smaller device dimensions. Lam has developed critical etch and deposition technologies to help solve these EUV implementation issues. In etch, we introduced earlier this year a new pulse plasma etch capability that has demonstrated an order of magnitude reduction in EUV-related pattern defectivity.” -Tim Archer, CEO opening remarksLam has developed critical etch and deposition technologies to help solve these EUV implementation issues. In etch, we introduced earlier this year a new pulse plasma etch capability that has demonstrated an order of magnitude reduction in EUV-related pattern defectivity.” -Tim Archer, CEO opening remarks
Conclusion:
Lam’s management stated they feel confident that they have visibility into next year and that the company has “significant unmet demand.” The company also stated there are “tailwinds relative to the business” for 2022.
Does that mean every quarter will meet or exceed guidance? No, it could be lumpy and that’s the nature of semiconductor stocks. The analyst on the call mentioned a 6-quarter slowdown. If this doesn’t happen in 2022, it could happen in 2023, etcetera. Semis are especially challenging right now because they’re expected to be cyclical but are transitioning into a more secular trend. Therefore, a slowdown could actually be much further out due to the drivers we discussed in the Micron report.
However, the key reason we think Lam could fare better than its peers is because as 3D layers increase, capital intensity also increases. The process does not scale linearly, instead it’s non-linear because it takes longer than 2X to etch a stack that is 2X high and requires more complex etch and deposition equipment.
Here’s one of the more important statements the company said on the call in regards to our thesis and stock position: “In 3D NAND, increasing device layer counts and the resulting higher degree of manufacturing difficulty is requiring the addition of new deposition and etch processes to address stress management, defect control, and multi-stack integration challenges.” This in turn, leads to increased investments in WFE to maintain percentages in bit growth.
As Micron, Samsung and others continue to compete on 3D NAND, and maybe even 3D DRAM in the future, we think Lam will become a clear winner. Cryo etch is leaving R&D for the first time and this is because Lam is pushing the envelope to serve this emerging trend. Lam is the leading equipment provider on 3D NAND and being a first mover here is key in serving the memory market moving forward. EUV patterning is another area where Lam leads and is seeing demand as the company aims to solve EUV implementation issues and the pattern defects that occur with equipment from its competitors.
Lam Q1 FY2022 Results
By Bradley Cipriano
Lam’s sales, earnings and cashflows all increased over 30% in the most recent quarter, signaling the unique position the company is in. We believe that Lam’s growth and earnings will continue to be robust going forward as the memory market nears an inflection point. Furthermore, capex from key customers signals that sales will continue to be strong in the near term.
In the latest quarter ending in September, Lam’s Q1 FY22 sales grew 36% YoY to $4.3 billion, which met the Street’s estimate. System revenue, which includes Lam’s leading edge equipment in deposition, etch and clean markets, increased 36% YoY to $2.9 billion while customer support and other increased 34% YoY to $1.4 billion. Management guided for Q2 sales to grow 39% YoY to $4.4 billion, which would mark the ninth consecutive quarter of YoY topline growth.
Gross margin declined 150 bps YoY to 45.9% as supply chain issues impacted margins. GAAP earnings increased 48% YoY to $8.27 per share, while non-GAAP earnings were $8.16/share, which beat estimates by 2%. TTM free cashflow increased 51% YoY to $3.2 billion and cash on hand remained high at $4.9 billion, but declined QoQ due to $1 billion in share repurchases during the quarter.
Demand was driven by memory, as 64% of equipment sales were for memory, up from 58% in the year-ago quarter. Lam described the key drivers for its products in its 10Q as “3D device scaling, multiple patterning, process flow, and advanced packaging chip integration, [which] will lead to an increase in the served addressable market for our products and services in the deposition, etch, and clean businesses.”
Lam is benefitting from a secular tailwind in semiconductor demand, and there are signals that memory is becoming less cyclical as the boom and bust cycles of years past are smoothing out due to rising demand from AI, 5G, IoT and edge computing.
Since Lam provides equipment that is used by its customers to manufacture semiconductors, we can measure their capex levels to get an understanding of where the market is moving. As shown below, quarterly capex trends from our sample group of semiconductors (n = 72) have accelerated during 2021. Capex grew 10% QoQ both in Q1 and Q2 and then increased 9% QoQ in Q3 to ~$78 billion.
Aggregate capex is up 32% YTD in 2021, well above the prior five-year Q3 YTD average of 13%.
The above capex trends add support to CEO Tim Archer’s comments on the Q1 call that “[Lam is] exiting this year with significant unmet demand… on the supply side, rising capital intensity, different architectures, new processes that need to be inserted into process flows to deal with increased manufacturing complexity. And those will be drivers for WFE structurally for a very long time. So I think there are a lot of things that will be positives for WFE in 2022, from an equipment perspective.”
The strong capex outlined above and demand for WFE provides more visibility into Lam’s 2022 sales. However, the caveat of the strong capex is that some of the capex should turn into output next year, which could lead to overcapacity. However, there are signs that the memory market is becoming less cyclical as technological innovations drive structural demand. I discuss these innovations in more detail next.
Lam and 3D NAND
Looking forward, Lam is also preparing for new technologies in the memory market. One of the new technologies is 3D NAND – which Beth had previously discussed in Lam’s premium analysis here.
3D NAND moves memory from a 2D plane to a 3D plane, which dramatically improves the storage capacity. It also requires a lot more equipment to manufacturer, which Lam provides.
CEO Archer added that “we see the WFE investment required to achieve the same bit growth percentage over the next 5 years to be notably higher than the 5-year period just completed. However, as the leading equipment supplier to the 3D NAND market, we are investing in new and differentiated capabilities to ensure scaling remains cost effective”
As 3D NAND nears an inflection point, there will be a structural increase in demand for WFE investments, benefitting Lam’s sales, earnings and cashflows. The equipment required to manufacturer 3D NAND is significantly higher. So, if the market increasingly adopts 3D NAND, then demand for Lam’s WFE should also increase at a relatively faster rate than prior years.
A risk to our thesis going forward is that Lam does not innovate fast enough to keep pace with changes to the memory market. While Lam’s research and development expense has increased YoY for sixth consecutive quarters, it fell to just 9% of sales in the most recent quarter. This is below the five-year seasonal average of 12% of sales.
On a TTM basis, R&D expense declined to 10% of TTM sales, which was also below the five-year average of 12% of TTM sales. However, R&D may seem low relative to sales due to the company’s rapid increase in sales recently. Nonetheless, this is a trend we will need to monitor going forward
It is likely that Lam’s prior R&D investments are now starting to pay dividends. Lam is well positioned to benefit from the rise in capital intensity from key customers. We had previously discussed in our Micron analysis that Micron was expected to continue to ramp capex, driven by investments in 176-NAND. Micron disclosed on its most recent conference call (12/20/21) that it expects capex to be around $11 to $12 billion in FY2022. This would represent a 15% increase in spending, which followed a 22% rise in FY2021. In the most recent quarter (q1 FY22), Micron’s quarterly net capex increased 22% to $3.3 billion, a record high. The growth in Micron’s capex is a forward looking metric that translates into demand for Lam’s WFE, driving topline growth at Lam.
Conclusion
Lam’s sales, earnings and cashflows all grew over 30% in the most recent quarter. Management guided for continued growth next quarter and stated that visibility into CY2022 was clear due to strong demand for semiconductors and memory. The company has tailwinds with new technological innovations such as 3D NAND, but needs to keep investing into R&D to ensure it can compete in the future. The company should continue to do well in the near term but we will need to monitor its investments in innovation going forward to make sure growth is sustainable.
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