LRCX AMAT KLAC Update

More important than EPS will be orders and forward guidance. Display related orders have been strong due to conversion to OLED.

Back in May when Applied reported $700M in display orders jumping from a prior $193M, Gary Dickerson went out on a limb to say that it was not a one shot deal but was actually a “sustainable” level of business. It will be key on the earnings report wether orders for display continue at a higher and perhaps more importantly less variable level than in years past.

DRAM bounceback…for how long?…
It’s clear from all the we hear in the industry that orders related to DRAM have picked up. It feels as if we can see two quarters of good DRAM in front of the industry. Key concerns will be how much for how long.

While its great to see a return in DRAM spend which has been lacking for a while, we think customers will be guarded in their spending (which is also good for the industry).

3D NAND and XPoint spending continue to be good as the demand in non volatile storage is much more elastic than DRAM and end users continue to suck up more and more and replace more hard drives.

How long a conversion to OLED?
In our view, OLED manufacturing capacity remains low so that spend will likely continue at a good pace. We would point out that demand is inelastic as compared to non volatile memory and also likely varies with consumer spending cyclicality so we will likely see more variability which could impact revenue and earnings and thus investors.

One of the key questions coming off the conference call will be continued sustainability of display and what growth in other markets AMAT will see.

AMAT the stock…
Investors and analysts will be focused on continuation of the growth we have seen since the beginning of the year. Obviously orders will be crucial and everyone will parse those numbers.

The size of the overall WFE market has been flattish over the past few years and while up slightly in the near term will not be the driver of growth for Applied. The bigger driver that investors will focus on is share gains and expansion of TAM & SAM.

One of the issues with share gains is that getting those share gains may require more aggressive pricing which could negatively impact gross margin and earnings. So far Applied has done a great job in this regard but there is a concern that this can be kept up once the easy work has been done in reducing costs or streamlining operations. This means that there will also be focus on how much more improvement can be wrung out of the model.

We think investors are coming into the call a bit dubious about how long the good times will last and need reassurance that it will continue or they may want to take some money off the table and look for other opportunities.

Lam analyst day
Lam pushed its analyst day back…..all the way back to the east coast after the KLAM merger was called off. Obviously investors and analysts are going to be looking for Lam’s new plan. In our view its hard to come up with a fall back plan in a month after a year of going in another direction but we will at least get an idea of the direction and strategy.

Smaller M&A?
Its going to be very, very tough to do enough small deals that would add up to the quality and size that KLAC could have added in one shot. It would also take a long time to do a string of deals as well as disruptive to constantly be integrating other companies.

However, we think Lam has no choice but to find selective deals that it will have to take a hard look at as organic growth will slow.

One of the issues is that the choice of remaining M&A targets is limited and most carry one or more flaws that make them less attractive, so we will likely see selective and opportunistic actions.

Lam put a very large stake in the ground during the KLA effort stating that customers wanted and needed better yield management and metrology integrated into their tools. The number of choices in this space is both limited and sub optimal…there is no good second place player after KLAC.

Lam could double down and go after more wafer processing companies but both quality and growth are limited in the remaining choices.

They could also go outside the box to the back end with companies like TER or Advantest but there is zero synergy and after just being burned on the KLAC deal they would likely shy away from another large deal that consolidates power in the industry.

Given all of the above, M&A, inorganic growth, is going to be hard…….

Organic growth?
LRCX has done a great job of growing SAM & TAM over the past few years and this also means that the availability of more space to grow into is limited as there is not that much real estate left in their home space.

Lam grew while AMAT was looking the other way with TEL and while AMAT was not as focused. This is not the case any more as Applied has made strong moves in the core space. Pricing and margins have come under pressure in dep and etch and have been less impactful while demand has been high but as demand slows pricing will drop rapidly as competitors fight for bigger slices of a smaller pie.

Multipatterning was like hitting the lottery, but it wasn’t due to anything great that Lam did and was due more to the failings of EUV and the industry desperately needing an alternative to keep Moore on track. EUV is now a node or two away and while it will start with double patterning, Lam’s dreams of Quad and Oct patterning driving etch and dep will quickly fade.

This suggests that organic growth will also be tougher going forward..

Continuing the momentum…
Lam has had great momentum in the business and the stock over the last several years, longer than we have seen in most companies in this industry. The growth has jumped and rolled over some small cyclical dips we have seen. The big question to be answered at the analyst meeting will be how Lam will continue that given that some of the roads to that growth have become much more difficult.

Lam’s dream of catching Applied has been put out of the investable future .

Lam now has to focus on improving its current position and fending off other competitors in its core markets and already strong share position, this is a fundamental shift from an offensive strategy to a more defensive strategy.