It has been a difficult year for companies in the semiconductor businesses, including Lam Research Corporation (NASDAQ:LRCX), which sells etch and deposition equipment to chip companies, with a majority of sales in the memory industry. Currently, there's a debate as to whether the recent dip in memory prices is a near-term, shallow blip or a harbinger of a more severe downturn.
Last week, UBS Group held its global technology conference, where Lam Research CEO Martin Anstice answered pointed questions about the negative sentiment surrounding the industry.
Hand-wringing over the semi cycle
Skeptics believe that since the industry has had such a large "boom" over the past couple of years, the ensuing "bust" will be just as severe. Many are scarred by the last downturn, in 2016, which was much worse than many were anticipating.
Anstice articulated the opposite view, however, saying, "... it's true that our customers are spending more money than ever in history on wafer fabrication equipment, it's also true ... at least in recent years ... they've never spent a smaller proportion of their profits, which is a commentary for me on sustainability." [Transcript via Seeking Alpha.]
In other words, Lam's customers are enjoying profitability so much greater than in the past that even if profits were to decline, these customers would still likely be able to afford investments in next-generation technology, including Lam's equipment).
Of course, earnings are likely to decline as memory prices have been coming down in 2018 and leading chip companies have issued cautious guidance amid the current U.S.-China trade war.
Regarding a current spending pause among customers, Anstice said, "... the adjustments are quick and direct and I think we live in a world of variability and less cyclical, in the traditional definition; more secular I think to the fundamentals to the industry."
In other words, Anstice believes that memory manufacturers are slowing down their spending earlier in the cycle than they have in previous years, not overproducing in an effort to gain market share. Anstice added, "For the last five or seven years I've felt like it's an entirely different industry and an entirely different dialogue with the customers than was true when I joined the company, and one element of that is, is discipline and proactiveness."
What about the NAND flash crash?
Currently, the weakest sector of the chip market is NAND flash memory, which is currently in a state of oversupply. Flash suppliers have increased 3-D NAND production in 2018, leading to an explosion of supply. At the same time, the cloud industry is stepping off the gas after years of heavy investment, and mobile phone sales are stagnating.
This is a potentially dangerous setup for Lam, which derives a majority of revenue from the NAND flash industry.
However, Anstice maintains that while the next few quarters may be challenging, the long-term picture for NAND is bright: "If I would have to pick ... part of the industry [that] has more clarity than any other in terms of technical roadmap, I pick NAND flash. And if I would pick ... the industry that I think has more fundamental demand drivers, I would pick NAND flash."
The AI-powered economy of the future means huge amounts of data will need to be stored safely and processed quickly. That means NAND flash will be in demand over the long term, even if the current surge of supply has overwhelmed demand in the near term.
Equipment makers are also dealing with a new ban on sales to China's Fujian Jinhua Integrated Circuit Co., which was recently accused by the U.S. Commerce and Justice departments of stealing intellectual property from U.S. companies. While rival KLA-Tencor was relatively sanguine about the ban, Lam's other rival, Applied Materials, just guided for sequential revenue declines, driven entirely by the missing sales to Jinhua. Still, Anstice doesn't think the impact on Lam will be severe: "I can't speak to other companies, we've been more or less paid for what we've shipped. And to the extent that we are now unable to ship new systems or spare parts or support an installation with labor, the impact to the company is not material."
Anstice followed up by saying that even if China's memory industry were permanently stalled, growth would come from somewhere: "If one customer doesn't spend, another one usually does, because at the end of the day there is a global marketplace for devices."
Despite Anstice's reassurances, semi equipment manufacturers have been hit hard. But if you believe Anstice's narrative of less cyclical, long-term growth, all of these stocks look pretty cheap. I happen to think this whole space is undervalued, but the near term may be turbulent, so invest accordingly as it pertains to your risk tolerance.
Billy Duberstein has the following options: short April 2019 $33 puts on Applied Materials, short December 2018 $87.50 puts on KLA-Tencor, and short February 2019 $125 puts on Lam Research. His clients may own shares of some of the companies mentioned. The Motley Fool recommends Lam Research. The Motley Fool has a disclosure policy.