Lam’s Q3 report was nothing too spectacular, with a slight revenue beat in the quarter and a solid EPS beat. Q4’s guide pointed to relatively flat revenue and a slight sequential decline in EPS.
We have a 4% placeholder on Lam, which may be a tad early for the material rebound that is expected 2025-ish. Primarily, Lam’s rebound is dependent on NAND recovering. Discussions around the incoming NAND rebound were important, as well as the discussions on DRAM.
China is both an opportunity and a risk for Lam. China’s revenue contribution remained above 40% in the quarter, though Korea’s contribution increased 500 bp sequentially to 24%, suggesting major memory manufacturers may be increasing WFE (wafer fabrication equipment) spend. Given the high exposure to China, there is risk in more customers being added to the banned entity list, which would result in a loss of revenue for Lam.
Overall, this is not the standout quarter for Lam and we didn’t expect it to be. Instead, we were provided important clues as to when the standout quarter might occur. The story is intact, the fundamentals have likely bottomed, yet the stock is overvalued and has been for some time. Therefore, primarily due to valuation concerns, we realize the allocation we currently have is unlikely to be our lowest entry.
Revenue and EPS:
Lam’s revenue peaked in Q2 FY2023, with the current FY2024 Q4 guide pointing to flat revenue for three straight quarters as Lam digests a trough in NAND spending coupled with strong China and DRAM demand. Fiscal Q1 is expected to break this trend with revenues projected to push back to $4 billion and higher.
- Revenue of $3.79 billion beat estimates by 1.6%, representing a YoY decline of (2.1%) but a QoQ increase of 0.9%.
- For fiscal Q4 (June 2024 quarter), Lam guided for revenue of $3.8 billion, +/- $300 million, representing YoY growth of 18.5% and approximately flat QoQ growth at midpoint. Prior to earnings, our information shows QoQ growth in the September quarter of 6% and December quarter of 7%.
- GAAP EPS of $7.34 beat estimates by $0.50, representing YoY growth of 22.1%. Non-GAAP EPS of $7.79 beat estimates by $0.49.
- Q4’s GAAP EPS was guided at $7.20, +/- $0.75, representing YoY growth of 20.6% and a QoQ decline of (1.9%) at midpoint. Non-GAAP EPS was guided at $7.50, +/- $0.75, implying YoY growth of 25.4% and a QoQ decline of (3.7%). Same as revenue, the September quarter and December quarter is when QoQ growth returns.
Margins:
GAAP operating margin contracted slightly on a QoQ basis despite GAAP margin expanding due to customer mix in China. Q4’s margin outlook was also mixed, pointing to operating margin expansion and gross margin contraction.
It’s important to note that 46% is the normalized gross margin for Lam although customer mix can result in as high as 48% gross margin. Per management: “You're absolutely right, and thanks for mentioning the 46%. That's sort of where gross margin was after we had done some of the Malaysia stuff and before China popped up with those smaller customers. And so the fact that we're above that level is largely customer mix.”
- Fiscal Q3’s GAAP gross margin was 47.5%, representing a 70 bp QoQ and 600 bp YoY expansion from 41.5%.
- For fiscal Q4, Lam guided for a GAAP gross margin of 46.7%, representing an 80bp QoQ contraction but a 120 bp YoY expansion.
- GAAP operating margin was 27.9% up 350 bp YoY from 24.4%.
- Q4’s GAAP operating margin was guided at 28.3%, for a 40 bp QoQ and 170 bp YoY expansion compared to 26.6% in Q4 of last year.
- GAAP net margin was 25.4%, essentially flat QoQ and expanding 440 bp YoY.
Cash and Debt:
- Operating cash flow was $1.38 billion in Q3, compared to $1.76 billion in the year ago quarter. Lam’s OCF margin contracted from 44.6% a year ago to 36.5%.
- Free cash flow was $1.28 billion, compared to $1.61 billion in the year ago quarter. FCF margin contracted from 41.5% a year ago to 33.7%.
- Cash and equivalents totaled $5.67 billion.
- Debt and finance leases totaled $4.98 billion.
The company allocated $860 million to share repurchases and paid $263 million in dividends in the March quarter. Management also added: “And I would just mention, we continue to track towards our long-term capital return plans of returning 75% to 100% of our free cash flow.”
Key Metrics:
DRAM Revenue Dips QoQ:
We highlighted DRAM as one of the primary growth drivers for Lam coming out of this memory trough over the course of the next few quarters as Samsung, SK Hynix, and Micron work to significantly boost HBM3 and HBM3e production to meet elevated demand from Nvidia and AMD’s GPUs.
However, DRAM contributed only 23% of systems revenue in fiscal Q3, or ~$551 million, compared to 31% of revenue, or ~$713 million, last quarter. Through the first three quarters of FY24, DRAM revenue totaled ~$1.737 billion, an increase of ~73% YoY.
Management stated the following about the sequential weakness in DRAM: “I do just want to mention one thing. We are characterizing 1 customer's investment in specialty DRAM as a nonvolatile investment since it has a nonvolatile component to the device.”
The weakness is also relative as during peak revenue in the Q2 FY2023 quarter, DRAM was 11% of revenue. So, even with this sequential weakness, it’s more than doubled in percentage of revenue from what it was at the cyclical top.
Non-Volatile Memory (NVM) Sales Pick Up:
Though DRAM’s contribution dipped sequentially, NVM sales offset much of this, rising from 17% of systems sales last quarter to 21% in Q3. Overall, memory accounted for 44% of Lam’s total systems sales in the quarter, down from 48% last quarter but up from 32% in the year-ago quarter.
Overall, systems sales rose to a ~63% contribution to total revenue, up from 61% in the prior quarter and marking a third consecutive quarter of increasing contribution. This suggests demand remains healthy.
Earnings Call:
Key Product Commentary and Timing for 2025-ish:
HBM and DRAM:
Our thesis is two-fold and management explained both points nicely in the call. The first is that we want to participate in the high bandwidth memory (HBM) boom being driven forth by AI acceleration. Our Members are quite aware of this trend as we’ve been hammering on it for a few quarters.
Here is what management stated about how Lam participates in this trend: “With respect to DRAM, AI servers use high-bandwidth memory or HBM to increase read write speed and reduce server power consumption. HBM stacks multiple DRAM dies using TSVs enabling 15x more data throughput than standard DRAM. However, HBM also requires an approximately threefold increase in wafers per bit compared to conventional memory. With this in mind, it's important that our SABRE 3D and Syndion tools not only provide best-in-class plating and etch capabilities, but also deliver industry-leading throughput and productivity to keep overall costs low for our customers. We are the leading player in TSV applications for HBM and expect our HBM related shipments to grow more than 3x in calendar year 2024.”
It was stated on the call that HBM is only 1-2 points of overall bit demand, and thus it’s “small today but growing quite rapidly.”
In terms of timing, especially as it relates to the CHIPS Act, which in turn will drive more equipment sales, the following was stated:
“And so we've always said these are more of a 25, 26, 27 time frame for — from the equipment side, especially the shorter lead time tools like we provide. So you see the fab coming up a lot of construction connectivity, you see long lead time tools go in. And then we know that our time will come. I mean — and so I think it's still a '25, '26, '27 opportunity for us. more of a 25, 26, 27 time frame for — from the equipment side, especially the shorter lead time tools like we provide. So you see the fab coming up a lot of construction connectivity, you see long lead time tools go in. And then we know that our time will come. I mean — and so I think it's still a '25, '26, '27 opportunity for us.
But the important thing is, while that's a lot of extra money maybe what's really exciting about is most of that is targeted towards to the leading-edge nodes […], but it's at nodes where we believe that we will actually do better from a SAM and market share perspective. And so we're patiently waiting. But we know it's going to come. You can go visit the sites, the fab buildings are there, and they're feverishly working to get them ready for equipment.”that we will actually do better from a SAM and market share perspective. And so we're patiently waiting. But we know it's going to come. You can go visit the sites, the fab buildings are there, and they're feverishly working to get them ready for equipment.”
The bigger picture at full utilization is that GPUs and AI servers will drive 8X DRAM and 3X NAND, which will equal “$1 billion to $1.5 billion incremental WFE” for every 1% server penetration, according to Lam.
NAND/Storage:
Non-volatile memory’s (NVM) acceleration this quarter could imply that the NAND uptick is already beginning, with a greater contribution expected in 2025. Since Korea commands a significant global share in both DRAM and NAND, its increased revenue share, at 24% in Q3 (up from 19% last quarter and 16% two quarters ago), hints at NAND spending and utilization resuming given that DRAM sales were weaker.
According to management, “More advanced AI applications need faster, more power-efficient and higher-density NAND storage. NAND-based enterprise solid-state drives or eSSDs, are 50x faster in read write capability, 2 to 5x more power efficient and use 50% less space at the system level compared to hard disk drives or HDDs. Today, over 80% of enterprise data is stored on HDDs. And we expect this mix to shift in favor of SSDs as NAND capability and cost continues to improve.”
In terms of timing and the 2025 rebound that is expected industry-wide, Lam stated the following:
“I mean, clearly, we all know that the NAND spending has been incredibly weak for the last 12 to 18 months. And so we're in the very early stages of starting to see that recover. And I think if you look at what most of our — we rely on our customer commentary that they make publicly for a lot of this, but they talk about the fact that maybe 90% of the bits they're shipping are at the leading edge.
But when we look at the installed base of our systems, that was my comment. I believe that there is still going to be a large portion of the installed base that will move forward to the next technology nodes. It's the most efficient way for our customers to to do that is to upgrade what they already have. And I think you'll see that move forward and therefore, NAND WFE move up in '25. But because it comes through a large — to a large degree, through upgrades, Lam's capture rate of every dollar of WFE spend will be much higher than in a greenfield capacity added. So when I think about Lam's opportunity to outperform in 2025, in NAND, I think it is obviously with high confidence because of the type of spending we would expect to be seen in 2025. And in the other market segments, it's also pretty high because of the — as I mentioned, the technology inflections that are occurring […] And so I just feel like there are a number of growth drivers for the company besides the one that is the most obvious, which is a NAND recovery in 2025.”And I think you'll see that move forward and therefore, NAND WFE move up in '25. But because it comes through a large — to a large degree, through upgrades, Lam's capture rate of every dollar of WFE spend will be much higher than in a greenfield capacity added. So when I think about Lam's opportunity to outperform in 2025, in NAND, I think it is obviously with high confidence because of the type of spending we would expect to be seen in 2025. And in the other market segments, it's also pretty high because of the — as I mentioned, the technology inflections that are occurring […] And so I just feel like there are a number of growth drivers for the company besides the one that is the most obvious, which is a NAND recovery in 2025.”
Gate All Around Technology Nodes:
In August, our deep dive discussed how gate-all-around transistors are replacing FinFET transistors. The company stated that shipments for gate-all-around nodes will exceed $1 billion this year. Per management, this is just starting:
“we're really just starting at gate-all-around. Our comment was $1 billion of shipments into the gate-all-around nodes this year. And it's across all of our types of products that help enable gate-all-around smaller technology nodes. And so what we've said is that every technology node, etch and depth intensity grows and our SAM opportunity expands.”
Utilization is Improving, Further Supports 2025 Recovery
Lam offered a lucid discussion around how utilization rates are showing signs the 2025 recovery is on track.
In the opening remarks it was stated: “In NAND, we continue to expect year-on-year growth in WFE spending in calendar 2024. Encouragingly, we have seen an uptick in fab utilization. And in the March quarter, this has translated into double-digit percent growth quarter-over-quarter in our spares revenues. As supply and demand continues to normalize through the remainder of the year, we see a strong setup developing for 2025 NAND spending. As supply and demand continues to normalize through the remainder of the year, we see a strong setup developing for 2025 NAND spending.”
There was follow-up on this in the Q&A:
However, through this downturn, the cuts in fab utilization were so severe that we actually saw spares revenue come down, which surprised us a bit, so maybe to your point of expectations.
We knew that as soon as customers started to utilize the fabs and bring some of the tools back online, we would see spares increase. We said that would be the first sign that the end market was really starting to improve. And so the reason we called it out was that, obviously, it's — it further confirms, I think, what you're hearing from our customers, which is that utilization is starting to improve.it further confirms, I think, what you're hearing from our customers, which is that utilization is starting to improve.
It doesn't tie to WFE because utilization of what you have is one issue. When you choose to spend more to either upgrade technology or add capacity is a second decision. We've said that, that is likely still more of a 2025 event on the equipment spend side. But you have to get the first indication, which is utilization improvement, spares improving and then the rest would comeWhen you choose to spend more to either upgrade technology or add capacity is a second decision. We've said that, that is likely still more of a 2025 event on the equipment spend side. But you have to get the first indication, which is utilization improvement, spares improving and then the rest would come.
China Sales Remain High
It was discussed in-depth that China is first-half weighted and revenue from this region is expected to declining as the year progresses.
In the Q&A, it was brought up that perhaps management is expecting more weakness as the year progresses due to customers being added to the blacklist. It was not confirmed directly but also was not denied.
Question
Timothy Arcuri (Analysts)Question
Timothy Arcuri (Analysts)
So I wanted to ask about China. So it's going to modulate through the year, the mix, but it sounds like it's still going to be up year-over-year for domestic China this year. So I guess my question is, we've seen some headlines on a few entities being potentially added to the entity list. And I'm wondering if these comments reflect the potential addition of these entities? Or does it basically say, hey, if the status quo remains, this is what your assumption is, meaning that if there were entities added that, that would be downside to these comments?And I'm wondering if these comments reflect the potential addition of these entities? Or does it basically say, hey, if the status quo remains, this is what your assumption is, meaning that if there were entities added that, that would be downside to these comments?
Answer
Timothy Archer (Executives)Answer
Timothy Archer (Executives)
Yes. Tim, I mean, obviously, we can't forecast changes in U.S. trade policy with respect to China that we don't know about. And so we're basically giving you our best view of what we think our China business will be through the rest of the year and recognizing that there could be changes that we don't foresee. And so we're basically giving you our best view of what we think our China business will be through the rest of the year and recognizing that there could be changes that we don't foresee.
Well, what I will say is we — obviously, we've built up what we believe is a strong government affairs team were plugged into all the relevant discussions. And I think over the last couple of years, you've seen we have a pretty strong track record of working with the U.S. government responding to export control policy and that's just what we plan to do going on into the future.
Conclusion:
Lam has broken key support and it’s likely we trim some of the position with the goal of adding back at lower levels. Across the board, Lam is trading about 2X higher than its median top line and bottom-line valuations. The PE Ratio is 34 compared to a 3-year median of 19. The forward PE Ratio of 30 is easily the highest it’s traded in three years. It’s the same scenario for the top line. This report may not be enough to justify these valuations in the near-term. Therefore, you can expect us to actively manage this position as we try to seek whatever alpha we can find in the current market.
For reasons clearly outlined above, we expect this will be a high allocation for 2025. The company carries a level of complexity that we are comfortable navigating, and it’s to our benefit that management is being quite clear on when to expect their largest segments to rebound. Therefore, whatever we trim will be added back at lower levels.
Damien Robbins, Equity Analyst at the I/O Fund, contributed to this analysis
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