Market Commentary EQUITY RECOMMENDED LIST (ERL) - Davenport & Company LLC
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EQUITY RECOMMENDED LIST (ERL)
Market Commentary
April 2018
Tweets, Tariffs and Trade were all key market forces whipsawing equities in March which, ultimately, pushed down large cap indices
for the month. Trump Tweets plus fears that import tariffs might brew a global trade war, seemed to propel traders to “sell first and ask
questions later” against an uninspiring market backdrop. Despite this market turbulence, economic fundamentals continued to appear
relatively strong supporting what we think could be a more constructive environment as the year progresses. Volatility, although not as
extreme as in February, was elevated relative to the one-year pattern and the VIX Index ended the month over 20. For the full month,
the Dow Jones Industrial Average decreased 3.7%, the S&P 500 index decreased 2.7%, and the smaller cap weighted Russell 2000
increased 1.1%.
S&P 500 performance by sector during March was led by stocks in the utilities sector up a strong 3.41% followed by the real estate sec-
tor which advanced 3.26%. The weakest performance in the month was posted by financials which dropped by 4.46% closely followed
by materials down 4.45%. For the full year, the information technology sector was the best performer with a 25.98% increase followed
by financials up 15.95%, while telecom services stocks have lagged the most with a yearly drop of 9.56%.
The Commerce Department significantly boosted the fourth quarter GDP growth estimate to 2.9% from 2.5%. The increase reflected
stronger consumer spending and higher investment in business inventories. Consumer spending advanced 4.0% in the revised esti-
mate which is up from 3.8% previously. The good news in Q4 may have slowed in Q1 with the Atlanta Fed GDPNow forecast slowing
to just 1.8%. We note that adverse weather appears to have been a challenge in Q1 and could have impacted spending patterns in
the quarter.
Housing data reports were mixed in March reflecting higher prices and mortgage rates against a tight supply backdrop. The Case-
Shiller national home price index reported in late March covering the three months ending in January was up 6.2% versus the prior year.
Higher home prices and mortgage rates represent an affordability road block to new buyers. Nevertheless, there were signs of life in
housing with existing home sales in February up 1.1% year-over-year to a 5.54 million seasonally adjusted annual pace according to
the National Association of Realtors. Limited supply of homes for sale also present a market challenge with the measure reaching the
lowest level for any February on record at down 8.1% versus the prior year.
As expected, the Fed under new Chairman Jerome Powell tacked a quarter percentage point on the Fed Funds rate mid-month high-
lighting that the economic outlook has recently strengthened while also pointing out moderating trends in household and business fixed
investment. The Fed maintained the outlook for a total of three rate increases in 2018 while also noting that inflation continues to track
below the 2% target on a 12-month basis. Against a choppy market backdrop, the ten-year treasury yield dropped from 2.86% at the
start of the month to end March at about 2.74%. We note that ten-year rates are now up over 35 bps since the beginning of the year.
With rates expected to further rise this year, the consensus forecast, according to Bloomberg, for the ten-year treasury yield at year-end
2018 is 3.14% which represents an increase from last month’s forecast of 3.02% and reflects the consensus expectation of gradually
rising rates in 2018.
We continue to look for benefits from tax reform as a catalyst that could move markets upward as earnings estimates continue to adjust
higher. We also continue to monitor the interest rate environment given recent moves in key rates. We remain focused on high quality
domestic-oriented equities and continue to think the long-term outlook remains favorable with an improving GDP and steady jobs envi-
ronment. This view is somewhat tempered by uncertain consumer behavior particularly given the dependency of the U.S. economy on
consumer spending. In addition, we view corrections as a normal part of long-term stock market behavior recognizing that there remain
macroeconomic and geopolitical uncertainties that could impact results.
We hope you find this version of the Davenport Equity Monthly useful in building or enhancing your portfolio. Since the publication of
our last monthly report, we have added Cummins, Inc. (CMI), Electronic Arts, Inc. (EA), and MetLife, Inc. (MET) to the Equity Recom-
mended List. No stocks were removed from the ERL during the period.
DAVENPORT EQUITY RESEARCH TEAM
Ann H. Gurkin Jeff Omohundro, CFA Brian Ward, CFA
(804) 780-2166 (804) 780-2170 (804) 698-2664
agurkin@investdavenport.com jomohundro@investdavenport.com bward@investdavenport.com
F. Drake Johnstone Joel M. Ray, CFA David M. West, CFA
(804) 780-2091 (804) 780-2067 (804) 780-2020
djohnstone@investdavenport.com jray@investdavenport.com dwest@investdavenport.com
Please see important disclosures in the Disclosure Section at the end of this document.
© Copyright 2017 Davenport & Company LLC. All rights reserved.MARKET AND ECONOMIC STATISTICS
Market Indices: 3/29/2018 12/29/2017 % Change YTD 2/28/2018 % Change (Monthly)
S&P Composite 2,640.87 2,673.61 -1.22% 2,713.83 -2.69%
Dow Jones Industrials 24,103.11 24,719.22 -2.49% 25,029.20 -3.70%
NASDAQ Composite 7,063.45 6,903.39 2.32% 7,273.01 -2.88%
Russell 2000 1,529.43 1,535.51 -0.40% 1,512.45 1.12%
FTSE 100 7,056.61 7,687.77 -8.21% 7,231.91 -2.42%
Shanghai Composite 3,160.53 3,307.17 -4.43% 3,259.41 -3.03%
Nikkei Stock Average 21,159.08 22,764.94 -7.05% 22,068.24 -4.12%
Stoxx Europe 600 370.87 389.18 -4.70% 379.63 -2.31%
MSCI Emerging Markets 1,169.27 1,158.45 0.93% 1,195.19 -2.17%
MSCI Emerging Markets Small Cap 1,192.57 1,195.44 -0.24% 1,211.86 -1.59%
Performance of S&P 500 by Industry: % of Index as of 03/29/18 1 Month 3 Month Year to Date 12 Months
Consumer Discretionary 12.67% -2.46% 2.76% 2.76% 15.24%
Consumer Staples 7.65% -1.32% -7.77% -7.77% -3.57%
Energy 5.74% 1.55% -6.58% -6.58% -3.06%
Financials 14.73% -4.46% -1.38% -1.38% 15.95%
Health Care 13.71% -3.21% -1.63% -1.63% 9.42%
Industrials 10.21% -2.77% -2.02% -2.02% 11.67%
Information Technology 24.87% -3.95% 3.20% 3.20% 25.98%
Materials 2.86% -4.45% -5.96% -5.96% 8.40%
Telecommunication Services 1.92% -1.12% -8.68% -8.68% -9.56%
Utilities 2.86% 3.41% -4.20% -4.20% -1.58%
Real Estate 2.78% 3.26% -5.79% -5.79% -1.72%
S&P 500 (Absolute performance) 100.0% -2.69% -1.22% -1.22% 11.77%
Interest Rates: 3/29/2018 12/29/2017 YTD Change (Basis Points) 2/28/2018 % Change (Monthly)
Fed Funds Effective Rate 1.68% 1.33% 0.35 1.35% 24.44%
Prime Rate 4.75% 4.50% 0.25 4.50% 5.56%
Three Month Treasury Bill 1.77% 1.45% 0.32 1.65% 6.97%
Ten Year Treasury 2.74% 2.41% 0.33 2.86% -4.25%
Spread - 10 Year vs 3 Month 0.97% 0.96% 0.02 1.21% -19.60%
Foreign Currencies: 3/29/2018 12/29/2017 % Change YTD 2/28/2018 % Change (Monthly)
Brazil Real (in US dollars) 0.30 0.30 0.2% 0.31 -2.0%
British Pound (in US dollars) 1.40 1.35 3.7% 1.38 1.9%
Canadian Dollar (in US dollars) 0.78 0.80 -2.4% 0.78 -0.4%
Chinese Yuan (per US dollar) 6.29 6.51 -3.3% 6.33 -0.7%
Euro (in US dollars) 1.23 1.20 2.5% 1.22 0.9%
Japanese Yen (per US dollar) 106.43 112.69 -5.6% 106.68 -0.2%
Commodity Prices: 3/29/2018 12/29/2017 % Change YTD 2/28/2018 % Change (Monthly)
CRB (Commodity) Index 436.88 432.34 1.1% 443.89 -1.6%
Gold (Comex spot per troy oz.) 1325.54 1303.05 1.7% 1318.38 0.5%
Oil (West Texas int. crude) 64.94 60.42 7.5% 61.64 5.4%
Aluminum (LME spot per metric ton) 1986.75 2256.00 -11.9% 2153.50 -7.7%
Natural Gas (Futures 10,000 MMBtu) 2.73 2.95 -7.5% 2.67 2.5%
Economic Indicators: 2/28/2018 12/31/2017 % Change YTD 1/31/2018 % Change (Monthly)
Consumer Price Index 249.6 247.9 0.7% 249.2 0.2%
Producer Price Index 202.1 201.3 0.4% 202.7 -0.3%
Q4 2017 Q3 2017 Q2 2017 Q1 2017 Q4 2016
GDP Growth Rate (Quarterly) 2.90% 3.20% 3.10% 1.20% 1.80%
Unemployment Rate (End of Month) February: January: December: November: October:
4.1% 4.1% 4.1% 4.1% 4.1%
*GDP growth rate is calculated as the percent change from the previous period seasonally adjusted at annual rates. **S&P Sectors were re-named at the end of 2001. The sector Industrials is a combi-
nation of the former sectors Capital Goods & Transportation.
Sources: Wall Street Journal, Bloomberg, The Department of Labor, The Bureau of Labor Statistics, The Bureau of Economic Analysis, US Treasury website.
April 2018 2Table of Contents
Market Commentary...............................................................................................................................................................1
Market and Economic Statistics........................................................................................................................................................2
Additons to the Equity Recommended List
Cummins Inc...............................................................................................................................................................................4
Electronic Arts........................................................................................................................................................................5
MetLife Inc..................................................................................................................................................................................6
Company Updates
Analog Devices.............................................................................................................................................................................8
BioMarin Pharmaceuticals....................................................................................................................................................................9
CarMax, Inc.....................................................................................................................................................................................10
Enterprise Products Partners.................................................................................................................................................11
General Mills................................................................................................................................................................12
Ingersoll Rand......................................................................................................................................................................13
Invesco...................................................................................................................................................................................14
Lam Research Corp.................................................................................................................................................................15
Martin Marietta....................................................................................................................................................................16
Masco Corp.............................................................................................................................................................................17
McCormick & Co..................................................................................................................................................................18
Merck & Co.................................................................................................................................................................................19
Mondelez........................................................................................................................................................................20
Oracle .........................................................................................................................................................................................21
Starbucks......................................................................................................................................................................................22
Synchrony Financial.............................................................................................................................................................23
Texas Instruments....................................................................................................................................................................................24
Total S.A......................................................................................................................................................................................25
Williams-Sonoma...................................................................................................................................................................26
Equity Recommended List By Sector....................................................................................................................................27
Events Calendar....................................................................................................................................................................28
Recent Third Party Research Reports.....................................................................................................................................29
Economic Calendar................................................................................................................................................................30
Disclosures................................................................................................................................................................................. 32
April 2018 3Cummins Inc. (CMI)
CSFB: Outperform $205 Target
S&P: Strong Buy $210 Target
Morningstar: 3 Star $164 Fair Value
Price $160.10
52 Week Range $143.83 $194.18
Dividend $4.32
Dividend Yield 2.7%
Market Cap (Billions) $26.57
Consensus FY EPS / P/E
Last Year Current Year Next Year
$10.62 $12.65 $13.42
15.1x 12.7x 11.9x
Source : Bigcharts.com
Added to the ERL
We added Cummins (CMI) to the ERL based upon the Outperform and Strong Buy ratings from our research correspondents
CSFB and S&P CFRA. The firm is a leading global designer, manufacturer and distributor of diesel, natural gas, hybrid, and electric
powered engines and related power and emission related components such as filters, turbochargers, fuel, air handling, transmis-
sions and electric power generating systems. Manufacturing takes place around the world including major company-owned and
JV operations located in the USA, Australia, Brazil, China, France, Germany, India, Mexico, Nigeria, Romania, South Africa, South
Korea, Turkey and the UK. In addition, CMI exports USA manufactured products (~11% of total sales) to clients located in Mexico,
Canada, Australia, UK, China, Belgium, Japan, and Singapore.
In 2017, revenues totaled $20.4B with product sales going to original equipment manufacturers (OEMs) of truck, agriculture,
marine, and light duty vehicles/buses produced by Paccar, Daimler, Navistar, Fiat-Chrysler, Bluebird, John Deere, Hyundai, Kom-
atsu, Nissan, and Volvo to name a few. In addition, CMI also distributes its components for use in aftermarket maintenance of its
engines and those of other manufacturers via a network of 500 distributors (both company owned and independents) as well as
through 7,500 dealers located in over 190 countries around the globe.
Manufacturing JV’s have been formed with customers targeted to drive increased market penetration of CMI products into new
geographies (notably China and India), while reducing capex risk and streamlining local supply chains. In 2017, these JV’s de-
livered ~15% of CMI’s pretax profits. For 2017, revenues were split 54%/46% domestic/international with Engines representing
34% of sales/40% of EBIT; Distribution of aftermarket products at 27% of sales/16% of EBIT; Components such as transmissions,
turbochargers and fuel systems at 23% of sales/32% of EBIT and backup Power Generation Systems employed by hospitals and
IT centers as well as in mining and oil & gas industries representing 16% of sales/12% of EBIT.
Cummins R&D remains at the cutting edge of newer technologies to enhance performance and durability, while meeting or ex-
ceeding emission standards that continue to steadily intensify worldwide – investing ~4% of sales per year into research efforts. A
significant $500 million R&D investment is currently underway over the next three years focused on next generation electrification
and hybrid technologies, while in August 2017 CMI invested $600 million in a JV with Eaton Corp. (ETN) to develop advanced
transmissions.
Although many of CMI’s customers could potentially be competitors, CMI’s narrower niche in engines/drive systems has provided
a competitive advantage via focused, world class R&D, production economies of scale, and a broad delivery network that has
allowed Cummins to generally take ~40% share for heavy duty trucking and > 75% share in medium duty vehicles in most major
regional markets.
Demand for Cummins’ products is closely tied to: global and regional economic growth; infrastructure development; and, emission
regulations. We sense that synchronized global economic growth is poised to be sustained into 2019, while attention to pollution
and global warming issues are not going away. As such, demand for CMI’s innovation in transportation is expected to persist over
the next years.
Our correspondents anticipate that CMI shares have the potential to return to a P/E multiple of 15.0–15.5x as the firm delivers on
2018E results and recent volatile market conditions abate with sustained solid GDP growth forecast this year. Such a move would
offer a 30% total return potential over the next 12-15 months with upside appreciation potential to the $205/$210 range.
April 2018 4Electronic Arts (EA)
CSFB: Outperform $143 Target
S&P: Hold $130 Target
Morningstar: 2 Star $103 Fair Value
Price $119.51
52 Week Range $87.94 $131.13
Dividend $0.00
Dividend Yield 0.0%
Market Cap (Billions) $36.84
Consensus FY EPS / P/E
Last Year Current Year Next Year
$3.18 $4.29 $5.00
37.6x 27.9x 23.9x
Source : Bigcharts.com
Added to the ERL
Electronic Arts, Inc. was added to the Equity Recommended List based on CSFB’s Outperform rating and $143 target price. Elec-
tronic Arts develops, publishes, markets and distributes electronic games, content and services across a range of platforms. The
company has a broad array of intellectual property with owned and/or licensed brands such as FIFA, Madden NFL, Star Wars,
Battlefield, The Sims, and Need for Speed. Electronic Arts was the number one publisher in FY17 on PlayStation 4 and Xbox One
consoles.
The existing game portfolio represents a combination of brands that are either owned or licensed. Wholly owned brands include
Battlefield, Mass Effect, Need for Speed, The Sims and Plants v. Zombies. Electronic Arts licenses certain brands such as FIFA,
Madden NFL and Star Wars that play an important role in the company’s game portfolio. The company also publishes and distrib-
utes games that were originally developed by third parties such as Titanfall.
Long-term growth drivers for Electronic Arts primarily include expansion of existing game franchises and introduction of new
games. The company sees potential in segment expansion such as in the action/adventure segment with new intellectual property
as well as with potential future Star Wars expansions. Further fueling top line growth is the industry shift towards increased mobile
gaming which has the potential to expand the user base well beyond the installed PC and console industry footprint.
Over the past several years there has been a digital transformation occurring around how consumers purchase electronic games.
Increasingly, consumers are choosing digital game purchases and supplementing that experience with add-on digital content and/
or features through incremental micro-transactions. The video gaming industry has benefited from technological improvements
in data transmission which has facilitated rapid full game downloads of games and incremental content direct to consumer. This
dynamic has served to boost full game sales and margins while also providing a ready platform for the sale of additional download-
able content known as DLC. Sale of DLC has supported a move towards an industry model of growing recurring revenue which
could have the potential to smooth revenue cycles for the industry.
Electronic Arts has significantly grown digital net revenue which has increased from $2.20 billion in fiscal year 2015 to $2.87 billion
in fiscal year 2017. Digital revenue generally has a higher gross margin relative to the company’s traditional packaged goods sales
and, therefore, has been a contributing factor to margin expansion.
We note that in the FQ3 period, total digital revenue grew 14% with 12% digital net booking growth while packaged goods dropped
18%. Live services revenue which includes extra content and subscriptions increased 29%. Live services growth was fueled
primarily by Ultimate Team game mode, Battlefield 1 Premium and mobile net revenue growth. Full game downloads dropped in
the quarter primarily due to lapping Battlefield 1 launch revenue from October 2016.
With a secular growth strategy tied to video game industry growth and increasing digital game direct downleads, we agree with our
third party research source’s favorable opinion of Electronic Arts.
April 2018 5MetLife Inc. (MET)
CSFB: N/A N/A
S&P: Strong Buy $56 Target
Morningstar: 3 Star $52 Fair Value
Price $45.63
52 Week Range $43.38 $55.91
Dividend $1.60
Dividend Yield 3.5%
Market Cap (Billions) $47.53
Consensus FY EPS / P/E
Last Year Current Year Next Year
$3.93 $4.93 $5.43
11.6x 9.3x 8.4x
Source : Bigcharts.com
Added to the ERL
We added MetLife Inc. (MET) to the Equity Recommended List with a target price of $56 based on a Strong Buy recommendation
from CFRA S&P. MetLife’s recent announcement of a material weakness in internal controls led to a sharp sell-off in late January.
This appears to be an opportunistic time to establish a long-term position in an industry leader with a compelling valuation. These
shares have a history of positive correlations with higher interest rates. Given this historical precedent, this could add to MET’s ap-
peal for many income-oriented investors. In addition, the company has an investment grade balance sheet and an attractive cur-
rent dividend yield. MET recently won a court ruling that resulted in the desired loss of the systemic important financial institution
(SIFI) designation. Combined with recent efforts to focus on less capital-intensive products, the status as a non-SIFI should allow
MET to accelerate the return of capital to shareholders in the future. Inclusive of a planned share exchange for its Brighthouse Fi-
nancial (BHF) holdings, MET is likely to return approximately $5.0B to shareholders in buybacks and dividends in the current year.
Investment Considerations:
The recent sell-off in MET shares appears to be overdone. The company recently announced it would incur a $510MM pre-tax, or
$331MM post-tax charge to build group annuity reserves that were previously released in error. The reserve correction goes back
approximately 25 years affecting ~13.5 thousand “unresponsive and missing” annuitants. Management called the event a “deeply
embarrassing operational failure” and is taking initial steps to remediate its administrative practices. The company postponed its
4Q17 earnings call by two weeks in order to correct current and past earnings. While we acknowledge the release was highly
embarrassing for MET, a sell-off of nearly $6.0B in market capitalization appears excessive relative to a ~$500MM pre-tax charge.
An additional unrelated reserve adjustment benefitted earnings to an even greater degree. These incidents did result in MET’s
auditors, Deloitte and Touche LLC, declaring a material weakness in the firm’s internal controls. MET hopes to remediate this
deficiency prior to the release of 2018 year-end results. These self-identified and self-reported reserve release errors and ensuing
market reaction seems to provide a very attractive entry point in MET shares.
The company has simplified its structure and distribution to focus on higher return, less capital-intensive products. MET completed
two significant transactions in the last two years. In 2016, MET sold MetLIfe Premier Client Group (MPCG) to Mass Mutual. MPCG
was formerly the captive career sales force for MET. Management felt this form of distribution was expensive and struggled to
earn its cost of capital. On August 4th, 2017 MET spun-off Brighthouse Financial (BHF) to MET shareholders and retained a 19.2%
ownership as of year-end. BHF products consist 80% of annuities and 20% of life insurance/other products previously placed
into run-off. These two significant transactions resulted in a more streamlined company with a less capital-intensive structure and
helped MET to shed its SIFI designation.
MET should see a significant benefit from rising interest rates. In the recent past, MET stock has displayed a significant correlation
with the yield on the 10-year US Treasury. (MET traded higher when the 10-year yield increased and vice versa.) This is under-
standable given the long duration of the company’s assets and liabilities and its reliance on net investment spreads for profits. The
previously cited reserve action triggered a notable exception to this pattern as it occurred during a period of rising interest rates.
The historic relationship to the 10-year is likely to reassert itself in the long-term and MET could act as an effective hedge to many
income-sensitive securities that trade on an inverse basis to treasury yields.
An aging demographic should drive demand for life insurance products. The shift away from defined benefit plans to defined con-
tribution plans should help the sales of products designed to provide safe and stable income. A higher interest rate environment
would likely make these products more attractive as well.
MET has a strong brand and balance sheet. MET has an A3 rating from Moody’s and an A- rating from S&P at the holding com-
pany level. Both rating agencies currently have a stable outlook. The company maintains a liquidity buffer of $3B -$4B at the hold-
ing company and its $3.0B line of credit had nothing outstanding at year-end. MET’s long-term debt has staggered maturities with
approximately $1.0B maturing this year and next with coupons in the 6.8% to 7.7% range. MET has an exclusive global license to
use the Peanuts characters for marketing within financial services until year-end 2019. The latter is being de-emphasized given
April 2018 6recent changes to the corporate structure.
The company should be a beneficiary of recent corporate tax reform. Management expects a 2018 effective tax rate in the 18% -
20% range. This is a primary driver of the projected 25% increase in 2018 operating results compared to last year.
Reserve Action Detail:
On December 15, 2017 MET announced it was undertaking a review of its practices and procedures used to estimate its reserves
related to Retirement and Income Solutions (RIS) group annuities that had been unresponsive or missing over time. For the past
25 years, it had been the practice to release reserves after two failed attempts to contact a presumed annuitant. The number of
impacted annuitants never numbered more than 1,000 in any one year and approximated 13,500 in total as of year-end 2017.
This represented about 2% of the group annuitant population of 600,000. Management called the event a “deeply embarrassing
operational failure” and is taking initial steps to remediate its administrative practices. This incident did result in MET’s auditors,
Deloitte and Touche LLC, declaring a material weakness in the firm’s internal controls. The self-identified and self-reported reserve
release error and ensuing market reaction seems to provide a very attractive entry point in MET shares.
Further complicating this situation was a review of variable annuity guarantees associated from a former joint venture in Japan.
This review concluded that customer withdrawals had not been adequately factored into the reserve and a release of $896MM
of reserves was warranted. This change benefitted earnings and more than offset the negative impact of the RIS reserve action.
This action contributed to the correction of historical financial statements, but was considered immaterial in total. Deloitte and
Touche LLC did render an unqualified opinion on the current and historic financial statements.
Risks:
• Material Weakness in Internal Controls – this recent disclosure resulted in a sharp sell-off in MET shares. There can be no
assurance this situation will be corrected in the near-term and it could remain an overhang on this stock for a prolonged time.
• MET is a Heavily Regulated Company – MET’s core insurance products are actively regulated at the individual state level. In
addition, federal jurisdiction extends into healthcare regulations, consumer protection laws and securities regulations. MET is
subject to some of the provisions of the Dodd-Frank legislation as well.
• Interest Rate Risk – investment spreads are a key driver of profitability, so both the shape and magnitude of the yield curve
can have a significant impact on long-term profitability.
• Investment-Related Risks – exposure to economic and market-related volatility, real estate risks and investment spreads.
• Maintenance of Investment Grade Ratings – this is important to provide access to the capital markets and to maintain MET’s
well-regarded brand. Lower ratings could also negatively impact consumer confidence and hurt sales.
• Exposure to Catastrophic Risks – MET’s property/casualty operations and its life insurance operations both provide exposure
to CAT events.
• Availability and Affordability of Reinsurance – this allows MET to hedge specific exposures or risks.
• Foreign Exchange – MET operates internationally and has particular exposure to the yen/dollar relationship.
• Derivative Risks – MET uses a variety of derivatives to hedge and manage its various risks. The effectiveness and cost of
these derivatives are a part of operational risk as is counterparty risk.
• Systems Failure or Cyber-Security Breach – Any financial institution’s operations and reputation could suffer if it suffers a
material systems failure and/or a loss of personal confidential information.
April 2018 7Analog Devices Inc. (ADI)
CSFB: Outperform $100 Target
S&P: Buy $109 Target
Morningstar: 3 Star $96 Target
Price $89.52
52 Week Range $74.65 $98.38
Dividend $1.92
Dividend Yield 2.1%
Market Cap (Billions) $33.74
Consensus FY EPS / P/E
Last Year Current Year Next Year
$4.72 $5.54 $5.69
19.0x 16.2x 15.7x
Source : Bigcharts.com
Company Update
We concur with our correspondents’ positive view of Analog Devices (ADI), since the company should continue to benefit from
growth in its auto, communications infrastructure, and its diversified industrial business. ADI appears attractively valued, with a
2%+ dividend yield and a P/E of less than 16x FY19 EPS, compared to long-term annual EPS growth of 10-12%.
Analog Devices recently acquired Symeo GmbH (based in Munich, Germany), a leading provider of industrial Radar solutions
(including both software and hardware) for aerospace, self-driving cars and industrial applications. Symeo’s high precision Radar
technology was originally developed by Siemens and then was spun-out as an independent company in 2005.
Symeo’s innovative signal processing algorithms will enable ADI to offer customers a Radar platform with substantial improve-
ments in angular accuracy and resolution. ADI’s industry leading product portfolio combined with Symeo’s technology will enable
ADI to provide its customers with more accurate radar systems for self- driving cars. The automotive sector represents 16.5% of
ADI’s revenue.
In addition, Symeo has unique radio frequency (RF) and sensor technology that enables real-time position detection and distance
measurement. This technology (in combination with ADI’s existing solutions) allows system integrators and OEMs to develop high
precision Radar solutions for industrial companies. The industrial segment represents 49% of ADI’s revenue.
April 2018 8BioMarin Pharmaceutical (BMRN)
CSFB: Outperform $116 Target
S&P: Buy $105 Target
Morningstar: 4 Star $107 Fair Value
Price $77.42
52 Week Range $76.27 $100.51
Dividend $0.00
Dividend Yield 0.0%
Market Cap (Billions) $13.93
Consensus FY EPS / P/E
Last Year Current Year Next Year
-$0.97 $0.53 $1.18
-79.5x 145.5x 65.5x
Source : Bigcharts.com
Company Update
Last month, our research correspondent, CSFB, raised their price target on Biomarin (BMRN) to $116, while both Morningstar
and CFRA also remain Buyers of the shares. We concur that BMRN’s focus on genetic driven diseases – often via orphan drugs
that offer prolonged exclusivity - reduces risk of generic competition offering sustained growth potential.
The firm’s existing products deliver valuable enzyme replacement therapies for patients having debilitating genetic-based medical
conditions. One such condition, Morquio A is experienced among patients whose genome does not produce an important enzyme
used to clear out materials from cells causing a buildup in lysosomes of cells throughout the tissues and organs of the body that
can cause serious heart disease, skeletal abnormalities, vision and hearing disorders. Vimizin – BMRN’s leading product – is
a replacement therapy that delivers the deficient enzyme to sustain health. A second genetic based condition, Phenylketonuria
(commonly known as PKU) is an inherited disorder that increases the levels of a substance called phenylalanine in the blood.
Phenylalanine is a building block of proteins (an amino acid) derived through the diet (all proteins) that if left untreated can cause
intellectual disability and other health problems. BMRN’s second leading product, Kuvan, is a replacement therapy that permits
patients to maintain appropriate phenylalanine (Phe) levels, while also allowing for consumption of a more normal diet including
proteins.
These and other smaller enzyme replacement therapeutics drove 2017 revenues to $1.31 billion – growing at ~15% - but with R&D
investment eating up much of profits. However, with the pending late stage development of Pegvaliase for PKU our correspon-
dents anticipate BMRN is poised to deliver ramping EPS in the 2018-2020 time frame. Pegvaliase is currently under review by
the FDA with a decision date (PDUFA) of May 25th. An FDA approval if forthcoming could represent a catalyst for BMRN shares as
some anticipate product sales could reach $500+ million in 2-3 years. Phase 3 trials showed the product to be tolerable/safe and
very effective for PKU patients that have a genetic defect that results in their inability to totally digest protein. Patients having this
condition are placed on almost totally protein free diets that is difficult to manage. Those taking the drug were able to consume
a diet containing 75% of recommended daily protein, while maintaining normal Phe levels in the blood. Today, BMRN serves the
PKU market with Kuvan that faces patent expiration into 2020. Further, Kuvan is viewed as less effective at managing PKU rela-
tive to Pegvaliase – with the latter product representing a potential important new product for both the 50,000 Americans suffering
with PKU and for Biomarin.
Other R&D that could have meaningful impact for patients and investors into the 2020 – 2022 time frame involves Valrox – an
emerging potential therapy for hemophilia A. In phase 2 clinical trials involving 15 patients with severe cases results showed that
after one course of treatment patients retained > 50% levels of clotting factor over a 52 week period resulting in:
• 97% Reduction in Mean Annualized Bleed Rate (ABR) with 6e13 vg/kg Dose Compared to Prophylaxis
• 94% Reduction in Mean Annual Factor VIII Infusions with 6e13 vg/kg Dose Compared to Prophylaxis
Thus, Valrox could dramatically change the landscape in treating hemophilia that impacts one in every 5000 male births = to >20K
Americans and >150K males globally. The street awaits mid-2018 data readouts on phase 2 clinical trials that if positive as with a
prior study could represent a catalyst for the shares.
We anticipate learning more about clinical data and R&D development efforts when Biomarin reports 1Q18 earnings on or about
May 3rd. Street forecasts point to 1Q18 revenues of $350 million (up 15%) as delivering EPS of $0.11.
April 2018 9CarMax (KMX)
CSFB: Outperform $78 Target
S&P: Hold $70 Target
Morningstar: 3 Star $67 Fair Value
Price $59.96
52 Week Range $54.29 $77.64
Dividend $0.00
Dividend Yield 0.0%
Market Cap (Billions) $11.70
Consensus FY EPS / P/E
Last Year Current Year Next Year
$3.70 $3.84 $4.41
16.2x 15.6x 13.6x
Source : Bigcharts.com
Company Update
CarMax reported FQ4 GAAP EPS of $0.67 with adjusted EPS of $0.77 which was below the Bloomberg consensus outlook for
$0.87. Total used vehicle unit sales decreased 3.1% while comparable store used unit sales decreased 8.0% with management
indicating that they were impacted by lower store traffic with relatively flat conversion. It appears that hurricane induced used ve-
hicle pricing gains and higher new vehicle incentives contributed to the quarterly sales results with a shrinking new to used pricing
spread. Used vehicle gross profit declined 2.5% while gross profit per unit increased slightly to $2,147 vs. $2,134 last year. CAF
income increased 21.9% to $101.1mm benefiting from a decline in loan loss provisions and growth in average managed receiv-
ables. SG&A was 10.0% of sales versus 9.5% representing a 6.1% increase due to store expansion and discretionary bonuses
somewhat offset by a drop in stock based compensation. Tax rate in the quarter was 41.9% up from 37.0% in the prior year period.
The tax rate reflected an $11.9 million increase in taxes due to the 2017 Tax Act. The company indicated that in future quarters
the effective tax rate will generally be around 25%.
KMX repurchased 1.9mm shares of common stock during the quarter for $127.8 mm which was above the FQ3 rate of 1.5mm
shares for $107.2mm. As of February 28, 2018, the company had $1.02bn remaining available under the company’s share re-
purchase authorization. KMX opened four new stores during the quarter with two opening in the new television markets of Myrtle
Beach, SC and Portland, ME. CarMax has 189 stores in 41 states. Management indicated that the company expects to open 15
stores in fiscal 2019 with 9 new television markets and 10 openings planned in small markets. CarMax capital expenditures YTD
through FQ4 2018 were $296.8mm which was down from $418.1mm in the prior year. Management indicated that in fiscal 2019
capex should increase to about $340mm.
On the quarterly earnings call, management highlighted that the fourth quarter was the toughest year-over-year comparison and
was further impacted by macro pricing factors. The company commented on the impact that last fall’s hurricanes had on used car
acquisition prices in the period. Although prices have fallen from elevated fall levels, they were still significantly higher compared
with last year. Compounding the impact on the new versus used pricing spread has been soft new vehicle prices with incentives
still higher than last year. CarMax management noted that the used market has historically been self-correcting and that off-lease
supply entering the market should drive used prices lower.
Despite the tough top line, CarMax reported improved gross profit per unit which appears to reflect on the company’s operating
discipline. On the earnings call management noted that the company is striving to achieve the dual goals of maximizing sales and
maximizing total gross profit dollars. While acknowledging that the company could have sold more cars through lowered margins
and prices, they do not believe that pursuing that strategy would have necessarily resulted in more gross profit dollars. To that
end, the company continues to test elasticity of demand through pricing test initiatives.
CarMax continues to pursue a host of online efforts to grow traffic and conversion and indicated that web traffic grew by 16% in the
quarter as the company enhanced website offerings and improved search engine optimization or SEO which the company reports
is generating leads just like paid advertising. Management indicated that the company has rolled out the mobile appraisal platform
for buyers at nearly all stores while also completing the full roll-out of the new enterprise wide customer relationship management
or CRM system. The company appears enthusiastic about the new CRM platform indicating that it should enable a more seamless
and personalized car buying experience across all locations.
With a secular growth strategy tied to consumer used vehicle shopping, we agree with our third party research source’s favorable
opinion of CarMax.
April 2018 10Enterprise Products Partners (EPD)
CSFB: N/A N/A
S&P: Buy $32 Target
Morningstar: 4 Star $30 Fair Value
Price $24.57
52 Week Range $23.10 $29.51
Dividend $1.70
Dividend Yield 6.9%
Market Cap (Billions) $52.51
Consensus FY EPS / P/E
Last Year Current Year Next Year
$1.36 $1.53 $1.66
18.1x 16.0x 14.8x
Source : Bigcharts.com
Company Update
Note: This is a publicly-traded limited partnership and investors do receive an annual K-1 for income tax purposes. This
partnership can generate unrelated business taxable income (UBTI). The generation of UBTI could trigger taxable income
for individual retirement accounts and tax-exempt organizations. Please consult your tax advisor for further details.
We remain attracted to Enterprise Products Partners L.P. (EPD) based on multiple recommendations from our third-party research
providers. CFRA/S&P has a Buy rating with a $32 target and Morningstar has a 4 Star ranking with a $30 fair value. This recom-
mendation is for income-oriented accounts seeking current income with modest capital appreciation potential.
EPD is widely regarded as a “bellwether” equity in the MLP sector with one of the industry’s few investment grade balance sheets.
The company has a very attractive set of assets with a particular niche in natural gas liquids (NGLs). (NGLs include ethane, bu-
tane and propane for example.) NGL Pipelines and Services generated 57% of EPD’s operating margin in 2017. This extensive
and unique set of assets provides both product and geographic diversification. This partnership is particularly well situated to
serve the projected growing needs of the petrochemical industry that is expanding significantly in the Gulf region. EPD has no
incentive distribution rights (IDRs) at the general partner level. The interest of the general partner and limited partners are united.
A recent federal court decision prompted the Federal Energy Regulatory Commission (FERC) to reverse a long-standing income
tax recovery benefit for certain interstate pipelines owned by master limited partnerships (MLPs). This mid-March decision took
the market off guard and the MLP sector responded negatively to the development. The ruling apparently will vary enormously on
a partnership by partnership basis. The ruling only impacts interstate pipelines and will limit the recovery of an income tax allow-
ance in cost of service calculations.
EPD issued a press release in the wake of this FERC announcement. Management indicated the disallowance of the recovery for
income taxes would not have a material impact on EPD’s posted tariffs or its profits.
EPD has not formally announced a date for its Q1 release, but it is expected around May 1st. Current expectations call for $.37 in
GAAP earnings and $1.51B in EBITDA in the March quarter.
April 2018 11General Mills (GIS)
CSFB: Neutral $46 Target
S&P: Buy $51 Target
Morningstar: 5 Star $59 Fair Value
Price $44.30
52 Week Range $43.84 $60.69
Dividend $1.96
Dividend Yield 4.4%
Market Cap (Billions) $26.90
Consensus FY EPS / P/E
Last Year Current Year Next Year
$3.08 $3.10 $3.22
14.4x 14.3x 13.8x
Source : Bigcharts.com
Company Update
General Mills (GIS) remains a holding on the Equity Recommended List (ERL) based on S&P/CFRA’s 4-Star Rating and $51 fair value.
General Mills is a leading manufacturer of packaged food brands and continues to expand its portfolio of leading brands in the faster
growing organic segment. GIS remains focused on returning value to its shareholders and offers an attractive yield.
General Mills recently reported a top-line and earnings per share beat for its Q3. Stronger than expected volume was a positive, but
high logistic costs pressured the outlook for the year. GIS lowered its full year profit outlook and the stock weakened on the news. GIS
reported Q3 EPS of $0.79 vs. $0.72 last year, which exceeded the consensus estimate. Q3 net sales rose 2% to $3.9 billion, which
exceeded the consensus of $3.7 billion and compares with $3.8 billion reported last year. The top-line benefitted from broad-based
growth with stronger than expected contribution from new products. Organic sales rose 1% with flat volume and 1% gain for price and
mix. Q3 net sales rose for US Snacks, Meals and baking and Canada while showing sequential improvement for cereal and yogurt
as GIS successfully executes against a key FY18 strategy of improving its topline. While down, US yogurt sales reported a sequential
improvement reflecting innovation and core brand improvement. While stronger top-line is certainly a positive, the strength caught
management by surprise and has created higher than expected shipment and production costs. As a result, Q4 profit will now be lower
than expected. In addition, input costs are now expected to be up 4% for the year vs the prior estimate for a 3% increase. The broader
industry (including GIS) faces sharply higher transportation and logistic costs given tighter labor, trucking availability and changed driv-
ing laws. As a result, GIS along with the overall industry needs to pass though pricing to offset these costs as well as rework logistics.
The ability to raise prices remains a key question and an overhang on the packaged food group given the pressure by large retailers to
lower prices which challenges margins for packaged food companies. Innovation, focus on mix and relationship with retailers remain
key factors for the packaged food companies as they target higher prices. As a result of these higher than expected costs, GIS lowered
its full year outlook. Both Q3 gross and operating margin were lower vs last year due to higher input costs, trade expense phasing, and
higher brand support. A lower tax rate benefitted the results in Q3.
GIS maintains its outlook for organic sales to be flat with last year. Currency should be a positive 1 point benefit. Constant currency
adjusted EPS should now be flat to up 1% vs the prior estimate for an increase of 3-4%. Constant currency op profit should now be
down 5-6% vs the prior estimate of flat to down 1% due to higher-than expected supply chain costs, commodities and other operational
costs. Adjusted operating margin should be below the prior year. The tax rate should be about 26%. Free cash flow should still increase
15% given GIS’ focus on working capital improvement. The FY18 outlook does not include Blue Buffalo. Focus remains on FY19 and
GIS should deliver improved results driven by innovation, an accelerating topline, and improved cost management. GIS will focus on
balancing sales growth and margin expansion (upper teens) over the long-term.
General Mills previously announced that it will acquire Blue Buffalo for $40.00 per share in cash or 22x EBITDA. The transaction estab-
lishes General Mills as the leader in the U.S. Wholesome Natural pet food category, the fastest growing portion of the overall pet food
market, and accelerates its portfolio reshaping strategy. The transaction should be accretive to GIS’ topline and margin and neutral to
EPS. GIS will pay for BUFF with cash and $ 1 billion in equity. The transaction should close by the end of GIS’ FY. GIS will suspend its
share repurchase program.
FY18 remains a year of investment and the stock remains an attractive opportunity. GIS is trading both at the lower end of its historic
average and below its peer group. GIS should focus on balancing sales growth and margin expansion over the long-term. GIS remains
focused on returning value to its shareholders and offers an attractive yield. GIS’ FY18 priorities include to grow its cereal business glob-
ally, to improve its yogurt results through innovation, to invest behind key platforms of Haagen-Dazs, Snack Bars (Nature Valley), Old El
Paso and Natural & Organic (Annie’s), and to manage foundation brands to fund investment. Its e-commerce strategy includes its focus
on establishing strategies with leading, driving higher share and leveraging data to relate with its consumer. Outside of the US, focus in-
cludes to accelerate Haagen-Dazs in Asia, to expand Yoplait, to expand on its snacking platform and to drive sales of convenient meals.
GIS remains in the discussion as part of potential industry consolidation as either a suitor or a target. GIS has a joint venture with Nestle
and it remains speculated in the press that Nestle might be interested in acquiring GIS or Nestle may divest its stake in the JV to pursue
other options. A combination of GIS and Kraft Heinz also remains a potential.
April 2018 12Ingersoll Rand (IR)
CSFB: N/A N/A
S&P: Buy $105 Target
Morningstar: 3 Star $96 Fair Value
Price $84.48
52 Week Range $81.25 $97.67
Dividend $1.80
Dividend Yield 2.1%
Market Cap (Billions) $21.25
Consensus FY EPS / P/E
Last Year Current Year Next Year
$4.51 $5.20 $5.85
18.7x 16.2x 14.4x
Source : Bigcharts.com
Company Update
The Ingersoll-Rand senior management team presented at multiple industry conferences during March. The tone of the presenta-
tions were positive and communicated a bullish outlook across the company’s end-markets as well as segment level initiatives
expected to drive revenue growth and margin expansion throughout the year. The company is encouraged by the growth align-
ment at the Climate and Industrials segments entering 2018 and sees robust demand for IR’s innovative portfolio of products
and services across the global commercial, industrial and residential markets. Positive order trends and a growing backlog are
enhancing visibility into the 2019 timeframe and IR remains on-track to achieve the 2020 financial targets outlined at the May 2017
Investor Day.
Ingersoll-Rand expects to deliver mid-single digit top line growth in 2018 with operating margin expansion. Despite some inflation-
ary headwinds, pricing continues to be positive and the company has a strong history of delivering productivity across the organi-
zation. The Ingersoll-Rand portfolio generates significant amounts of cash, and management expects free cash flow to be equal to
or greater than net income. IR is committed to paying a strong and growing dividend at a rate equal to or higher than the rate of
EPS growth. In addition, the company intends to repurchase stock to offset dilution at a minimum but has flexibility to toggle excess
cash between buybacks and potential acquisitions.
Thermo King has become a diversified portfolio of businesses with global scale, selling products across trucks, airfreight, marine,
bus, rail, power management solutions and the refrigerated trailer markets. Management gave incrementally positive outlook for
the Thermo King North America Trailer business, now expecting the industry to be down 3% in 2018 vs. the prior estimate of down
10% for the year. The update is consistent with major industry forecasts. While the North American Trailer business is expected to
be down this year (~20% of total TK), the rest of the portfolio is expected to grow to offset that decline for a net flat revenue result or
better this year. The company believes they can hold margins in a flat top-line environment. One area of strength is the company’s
auxiliary power business, where the market is projected to grow approximately 30% over last year.
The headwinds related to the expansion strategy in China are anticipated to moderate as the year progresses. As a reminder, over
the last eighteen months IR has moved from an indirect model in China to a direct model with expansion into lower tier cities and
the addition of over 300 supporting staff. Management believes the recent level of investment is appropriate and meets current
needs, but they would not hesitate to boost the sales force if the returns were attractive. IR believes there is runway to double
the business in China over the next few years. Typically, the Applied HVAC business is split 50/50 between product sales and at-
tached service contracts. Given the large nature of these institutional projects in China the sales cycle tends to be longer and more
complex. Stronger than expected growth over 20%+ last year carried a temporary margin/mix headwind, but as the higher margin
services work starts to scale and as IR laps the prior year comparisons, regional margins are expected to regain momentum.
Over the last few years, IR’s diversified portfolio allowed management to redirect cash from the outperforming HVAC operations
and reinvest capital into the struggling Industrials segment. Operating performance has begun to show improvement leveraging
productivity efficiencies and better services mix while innovation within the product portfolio should support sales growth as end-
markets recover.
April 2018 13Invesco (IVZ)
CSFB: Outperform $43 Target
S&P: Buy $42 Target
Morningstar: 4 Star $42 Target
Price $31.31
52 Week Range $30.02 $38.43
Dividend $1.16
Dividend Yield 3.7%
Market Cap (Billions) $13.03
Consensus FY EPS / P/E
Last Year Current Year Next Year
$2.70 $3.02 $3.35
11.6x 10.4x 9.3x
Source : Bigcharts.com
Company Update
Invesco (IVZ) is on the Equity Recommended List with a target price of $42 based on positive recommendations from all three of
our third-party research providers. These shares have retreated in recent trading due to general market weakness and investor
concerns over IVZ’s ability to continue its record of organic growth. Invesco appears to be well positioned over the long-term
perspective with a global presence and a broad product offering. IVZ has reported nine consecutive years of organic net inflows.
Performance has been solid and its diversified platform of products provides both active and passive managed strategies. IVZ’s
PowerShares ETF platform is the fourth largest among asset managers globally. The company has a strong history of managing
its capital and these shares offer income-oriented investors an attractive and growing dividend.
IVZ announced its assets under management (AUM) were approximately $945.4B at the end of February. This repre-
sents a 2.8% ($27.2B) decline from the prior month-end. Market depreciation and FX were the primary reasons for the
decline and FX accounted for $5.1B of the decrease. All categories declined with the exception of money market that
saw a slight increase in AUM. Actively managed funds were $742.0B of AUM with the remaining $203.4BinI passive
strategies. (Passive includes ETFs, UITs, FX overlays and passive mandates.) Average AUM for the month was $954.4B.
IVZ has no formally announced its Q1 release date, but it should be around April 26th. The current consensus estimate
is $.67 that will compare to $.61 in the prior year. The market will be hoping to get an update on the timing and impact of
the pending acquisition of Guggenheim’s ETF platform that should occur in the second quarter.
April 2018 14Lam Research Corporation (LRCX)
CSFB: Outperform $275 Target
S&P: Buy $240 Target
Morningstar: 3 Star $185 Fair Value
Price $197.97
52 Week Range $124.91 $234.88
Dividend $2.00
Dividend Yield 1.0%
Market Cap (Billions) $32.86
Consensus FY EPS / P/E
Last Year Current Year Next Year
$9.98 $16.79 $16.64
19.8x 11.8x 11.9x
Source : Bigcharts.com
Company Update
In early March, Lam Research hosted its 2018 Investor Day in New York. Management reinforced their conviction that Wafer Fabri-
cation Equipment (WFE) spending is sustainable and the exponential growth in data generation will drive higher demand for semi-
conductor content in the future, particularly within the memory and storage markets. Company CEO, Martin Anstice believes the
industry has never been healthier, more balanced and disciplined, and expects Lam Research to grow faster than the WFE industry
over the next several years. Management provided a financial target model for the calendar 2021 timeframe, which incorporates
more than 50% revenue growth over the next four years and adjusted EPS in the $23-$25 range (CY17 EPS of $13.70). This outlook
assumes that WFE spending remains flat relative to the 2018 spending expectation in the low $50bn range. Given the global mega
trends and rising importance of a data driven economy, management believes industry spending can trend higher over time, and
the flat industry growth assumption for 2021 appears conservative.
Over the next five years LRCX expects to return at least 50% of free cash flow to shareholders. As a part of this policy, the company
announced a quarterly dividend increase of 120% to $1.10 per share ($4.40 annualized rate) effective with the June 2018 quarter
and a new $2bn share repurchase authorization expected to be completed over the next 12-18 months. This is incremental to the
existing $2bn program where less than $1bn in buybacks remain. The capital return initiatives speak to 1) management’s confidence
in the sustainability of the industry, 2) Lam Research’s favorable position against this backdrop, and 3) the comfort that the dividend
is supported by the annuity like cash flow stream derived from the install base/service business (~25% of total revenue).
As the wafer fabrication equipment industry has grown over the last several years Lam’s shipment volumes as a percentage of total
WFE have increased from 14% in 2013 to 21% last year. The company expects this trend to approach 27% of total WFE shipment
volumes by the 2021 timeframe. At the same time, the total served available market that LRCX competes for should expand from
36% to 40% of WFE. Management is focused on maintaining industry leadership in the deposition and etch segments of the market,
believing that applications across multi-patterning, new materials innovation and vertical scaling will remain critical to technology ad-
vances for the industry. LRCX estimates its current share of the deposition market in the low-40% range and the etch market share
in the mid-50% range. The company targets segment share expansion of 400-800bps over the next four years in each category.
Management noted that share gains do not always mean head to head vs. a competitor, but can mean gaining share from devel-
oping new applications and becoming the first mover into a new space, ultimately pushing out an old application from relevance.
LRCX remains focused on R&D investment and note the company spent over $1bn in research and development last year alone.
During the presentation, management detailed the multi-year lifecycle for Lam Research equipment. The key takeaway was that the
opportunity to capture revenue related to upgrades, parts and comprehensive services over the lifespan of the equipment exceeds
the value of the initial equipment sale. A new tool shipped today can generate predictable revenue streams for multiple decades.
The company noted that more than 20% of Lam Research equipment in the field have been generating revenues for more than
15 years. Management expects the growth in services/spare parts/upgrades to outpace the growth of the installed base over time.
These trends are projected to add an incremental $1bn in revenue over the next four years. The predictable nature of this business
fundamentally supports the company’s capital return initiatives and could lessen the impact of potential cyclicality in equipment
revenues over time.
Lam Research is a leading supplier of wafer fabrication equipment and services to the global semiconductor industry. The company
continues to believe that spending on WFE is becoming structurally more sustainable driven by end-market diversification and
increasing capital intensity to make technology transitions. New industry demand drivers have emerged including big data, cloud
computing, the internet of things, autonomous vehicles and industrial automation. As the world becomes interconnected, big data
analytics and the rise of Artificial Intelligence are driving sustainably higher demand for semiconductor content. Data generation is
growing exponentially and that in turn is driving the need for faster processing speeds along with higher requirements for memory
and data storage capabilities. Given the critical applications of Lam Research’s equipment throughout the wafer fabrication process, the
company plays a significant role in enabling technical innovation across the industry. LRCX has leadership positions in these end-markets, which
are expected to grow faster than the WFE industry. We agree with our third-party source’s favorable view on LRCX.
April 2018 15You can also read
