Analysis: LRCX RTN

After you receive this Alert, we will be initiating a position in Lam Research (LRCX) , buying 100 shares at roughly $182.20. Following the trade, LRCX will represent 0.69% of the portfolio.

We are bringing LRCX out of the Bullpen and into the portfolio as our recent sale of Raytheon (RTN) has provided us with a war-chest of capital and made room for this additional name. You can read our initial bullpen Alert on the company here. The company's financial results for the quarter ended Dec. 23 can be found here. The company's 2018 annual report can be found here. The company's 2018 Investor Meeting presentation can be found here.

We provided a deep-dive look into our Lam Research thesis during our February members-only conference call, which can be replayed right now on our homepage here. Tomorrow, the call will be located under our Videos tab here and the transcript will be provided in the coming days. Thank you to all who could attend!

Our bullish thesis on LRCX is mainly predicated on:

  • We believe the industry dynamics support a strong, upcoming inflection to profitability
    • Although the company's earnings are expected to decline on a sequential basis during the first few quarters of 2019, we expect an uplift cycle to begin in the back half of this year.
    • In order for memory-based companies to salvage profits and maintain cash flow, they have sacrificed industry capex and wafer fab equipment investment.
    • Because long-term demand for these components are growing on a secular nature, the lack of spending on the supply side is causing growth trends in DRAM/NAND supply to be below demand growth trends for the second half of 2019.
    • Strong demand growth combined with tighter supply should cause memory prices to inflect, leading to heavier cap ex/investment in the future.
    • The current dynamic resembles the first half of 2016, a period that immediately preceded an inflection in prices, which lead to a sharp increase in Lam's earnings
  • A prescient history with share buybacks
    • Management recently announced an aggressive $5 billion share repurchase program
    • We believe this program is a "call" that the industry dynamic is about to turn and the stock has bottomed because the earnings decline is about to end. As typical with these stocks, the stock prices bottom before the industry does.
    • This move echoes the 2007 buyback from Novellus System (where CEO Tim Archer previously worked; merged with Lam in 2012), when the company drastically reduced the company's overall share count right before a highly profitably period.
  • Longer term, we expect positive revisions to earnings estimate should management deliver its target of adjusted earnings per share of $23 to $25 in calendar year 2021.
  • Commitment to returning at least 50% of free cash flow to shareholders. The current dividend yield is ~2.42%.
  • Long-term tailwinds in the semiconductor driven by demand for more advanced, interconnected technologies that analyze increasing amounts of data.

We are initiating the position with a $210 price target, reflecting roughly 14.5x the FactSet consensus calendar-year 2019 earnings estimate. That being said, we believe there is more room for upside here, both on further multiple expansion and also on earnings growth, driven by the upcoming inflection.

We are starting very small in LRCX as we want to leave plenty of room to scale into this position over time. While we believe the stock has significant room for upside and can grind higher long-term, we also recognize how both the stock and the broader markets have had a strong start to 2019. By adding a small amount, we'll be able to participate in further upside should the rally continue, and in the event the stock pulls back a few points, we'll gladly build up this position at a discounted price.