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Off-the-run Lam Research paper provides attractive yield pick up
admin | September 18, 2020
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
While the demand for paper has kept the new issue market humming, concessions to secondaries have become more scarce. Highlighted last week was how SFD’s new issue should reprice its credit curve given that the most recent the deal came 55 bp through secondary spreads. In higher quality credits some off-the-run paper still provides an attractive yield pick up to newly priced on-the-run bonds. Although dollar prices tend to be higher in off-the-run bonds given their higher coupons, in some instances shortening one year provides enough of a g-spread pick up to offset the higher dollar price. One attractive example of this is in LRCX (A3/A-), where an investor can shorten 15 months into the 4.875% 3/15/49 bonds while picking 14 bp in g-spread.
In higher beta credits, the typical rule of thumb is a pick of 1 bp per $1 increase in dollar price when moving to an off the run bond. However, with high quality single A credits that rule no longer applies. Investors should look to pick anywhere from 10-to-20 bp when shortening to an off the run. Less volatile credits (like LRCX) would see the spread pick-up closer to the lower end of the range, while more volatile credits like IBM (A2/A (n)) would see the spread pick up closer to the higher end of that range.
Exhibit 1. Single-A Technology 20y-30yr Curve
Source: Bloomberg TRACE; Amherst Pierpont Securities
Resilient Cash Flow Prompts Upgrade
S&P upgraded LRCX one notch to A- earlier this year as the company was able to post consistent cash flow generation despite the recent semiconductor industry downturn. While LRCX witnessed a nearly 13% revenue decline in fiscal 2019, free cash flow for the year was a record $2.9 billion, up over $500 million from the year-ago period. Additionally, the company has expanded its services segment, now accounting for 25%-30% of revenues, which should help reduce revenue volatility going forward. S&P believes that LRCX will grow in line to slightly faster than the rest of the wafer fab equipment (WFE) industry over the next few years. Additionally, management is expected to adopt a more conservative financial policy, after a couple of years of significant shareholder remuneration, which should provide some cash flow headroom should there be any unexpected industry volatility.
Balance Sheet and Credit Metrics Solid for Ratings
LRCX remains in a net cash position, even after aggressive share buybacks totaling $7.8 billion over the last three fiscal years. LRCX ended fiscal 2020 with cash on hand of $6.7 billion versus total debt of just under $6 billion, translating to a net cash position of approximately $700 million. We note that LRCX has maintained a net cash position for the last 21 fiscal years. S&P adjusts the company’s debt by its cash balances when looking at leverage, therefore S&P calculates leverage to be 0x. The agency has a downgrade threshold of 1.5x and does not foresee LRCX hitting that threshold unless it were to pursue a very large all debt financed acquisition. We note that total debt/EBITDA stood at 2.0x and is expected to decline to 1.5x by fiscal 2021, absent any further debt reduction. We believe shareholder remuneration will remain within the confines of free cash flow going forward, thereby keeping LRCX’s balance sheet in a net cash position.
Exhibit 2. LRCX Financial Summary – Fiscal 2015-2019
Source: S&P Capital IQ
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