The upcoming economic downturn caused by the COVID-19 outbreak may actually speed up some long-term technological trends. These include teleworking, e-commerce, and automation. At the center of all these is artificial intelligence, in which machines process vast data sets, learning to "react" to incoming information without human intervention.
Thus, the terrible downturn may have opened up long-term opportunities in stocks at the center of future AI applications. Nevertheless, in uncertain times like these, it's best to look at companies with best-in-class profitability, safe business models, and solid balance sheets. The following three AI-oriented companies all fit that bill.
The advent of AI will require vast amounts of storage and processing capability. That means faster and faster, smaller, and smaller chips that occupy less space in servers while also doing more work. Lam Research (LRCX 4.61%) makes the machines that allow chipmakers to produce smaller, more powerful chips.
Today's chips are so advanced that they're becoming harder and harder to manufacture without defects, which is why Lam's machines and services are so important. Specifically, Lam produces etch and deposition machines used across foundries as well as memory-makers. Last year, its revenues were almost evenly divided between logic and foundry and memory deployments, even in a recessionary year for memory spending.
Lam was one of the best-performing stocks in 2019, but its stock has been punished this year, down over 37% from its recent all-time highs, and the company's PE ratio has fallen to just under 16. Lam's results do fluctuate with semiconductor spending, but investors should know that Lam was already coming off of a down year in 2019. Prior to the coronavirus breakout last month, Lam had projected wafer equipment industry revenue in the mid-to-high $50 billion range in 2020, up from around $47 billion in 2019. So even if the industry has a severe downturn, the total wafer fabrication equipment industry is likely to be closer to what it was last year, not significantly down. Moreover, Lam has a great service and spare parts business, which accounts for about 30% of revenue and can grow even without growing new machine sales.
Meanwhile, Lam has outperformed its industry peers. Over the last two semi cycles, Lam grew revenue at 1.6 times the industry, with operating income growing faster than revenue, and earnings per share growing faster than operating income. Over the past four years, Lam's return on invested capital has been extremely high, averaging over 50%, which has enabled it to buy back lots of stock and increase its dividend every year. Importantly, the company has a strong balance even after these generous capital returns, with $4.6 billion in cash and investments versus just $4.4 billion in debt as of last quarter.
Basically, while Lam's near-term results are a bit uncertain, it's still a profitable business with great long-term growth prospects. Down this much, investors may want to pick up some shares at these discounted levels.
On the software side of artificial intelligence, Alteryx (AYX 0.06%) may be worth a look as well, as its stock is down about 50% from its 52-week highs. While Alteryx's valuation had likely gotten ahead of itself earlier this year, at the current discounted price, it deserves a long look.
Alteryx is becoming an important core software platform for corporations, as its main product is an end-to-end, comprehensive software suite, which allows both data scientists and non-data scientists to work together building and deploying machine learning algorithms. Alteryx was an early mover in the space and focused exclusively on the core customer usability, making it a hit with clients. Alteryx was also not afraid to integrate seamlessly with other big data offerings, even those with which it might compete in some areas. That has led to impressive customer adoption. Last year, Alteryx grew customers by 30% while also achieving a net expansion rate of 30%, good for 65% overall growth.
No doubt, the company's growth will slow this year. Management had already anticipated a deceleration to just 34% growth in the coming year even before coronavirus. Yet while the near-term environment is no doubt challenging, a 50% haircut on the stock price is also significant.
But the real reason Alteryx could be a safe pick is because it's one of the rare software-as-a-service platforms that actually makes profits. That's true of both GAAP as well as adjusted non-GAAP earnings. Last year, Alteryx made $27 million in net profits on a GAAP basis, as well as non-GAAP net income of $64.6 million. The company also has cash, cash equivalents, and long-term investments of $975 million versus just $700 million in convertible debt.
While growth may slow in the near term, Alteryx's solid profitability, balance sheet, and "sticky" product make the stock look much more attractive at its current discount.
One of Lam Research's memory clients is Micron Technology (MU 5.01%), which also deserves a look after the recent sell-off. Micron's product portfolio will be essential to future artificial intelligence applications, which will require lots and lots of DRAM memory and NAND flash storage. In addition to these products, Micron is also one of only two companies to have 3D Xpoint, a new kind of non-volatile memory that is faster than NAND, though also more expensive. Micron is the only company to have all three technologies.
While memory companies have traditionally been dangerous to buy in a recession, that's been because these companies can't just "turn off" supply very easily. So if demand plummets, memory prices tend to crash.
However, the memory industry was already at the trough of the last cycle when COVID-19 hit. That means memory companies had already greatly pulled back on supply growth, and was already projecting this year's supply output to be below demand. That's why even with the current downturn, research website DRAMeXchange is still projecting DRAM prices to increase this year, though NAND prices could either increase or decrease a little.
Memory is also a bit different because memory content per unit is increasing. So, even if smartphone shipments fall by 10% this year, new 5G phones will have increased amounts of memory. If a phone goes from, say, four gigabytes to six gigabytes of DRAM, that's a 50% increase, so overall demand may increase even though units go down. In addition, some segments like servers and gaming are seeing increasing demand from teleworking and other in-home activities. That's why despite the downturn, Micron's management is seeing pockets of supply shortages. On the recent earnings release in late March, management actually forecast increasing revenue and earnings for the current quarter, even with knowledge of the widespread quarantines by that time.
Micron is a bit of a wildcard in the near term, but it's still generating profits in a downturn, and has a solid net cash position, with $10.6 billion in cash versus $7.9 billion in debt. That means Micron should be able to weather the current storm rather well. And with the stock down by about a third since the market collapse, Micron seems poised for upside once the crisis subsides.