LAM RESEARCH CORPORATION Lam outperforms the large majority of publicly traded companies thanks to great execution in serving strong demand from a rapidly growing market place with superior products. Within its industry - semiconductor equipment providers - Lam has been outperforming its peers in terms of revenue growth over the past few years.
Although the stock has already gained over 100% since our purchase roughly a year ago, we believe that this is not the end of the line, as we explain in this article.
Background Information
Lam is market-leading equipment supplier (to producers of semiconductors) offering critical chip-processing capabilities, which helps companies produce the high-performing electronic devices that the world has gotten accustomed to in such a small number of years.
Producing the tiny, complex chips used in these devices involves the repetition of a set of core processes and includes hundreds of individual steps. To do this successfully, semiconductor manufacturers require sophisticated processes and fabrication equipment. Lam is at the cutting-edge when it comes to providing such equipment.
Advanced microchips are in many of the familiar products people use every day both knowingly and unknowingly —from mobile phones and computing devices to entertainment gadgets and the latest array of features on cars. Electronic products are everywhere and life without them has become unimaginable. As can easily be observed, the electronics market keeps on broadening out. Many of us remember the time when there was only one smart electronic device in the household, the PC, whereas nowadays a household is full of them not to mention the extensive new areas of application in new use cases, such as the cloud or artificial intelligence.
Creating the cutting-edge microprocessors and memory devices for today’s products is extremely challenging and requires precision control at the atomic scale. Against this backdrop, Lam continues to develop the new capabilities required to manufacture increasingly complex devices with shrinking dimensions. Its innovative technology and productivity solutions for transistor, interconnect, patterning, advanced memory and advanced packaging applications deliver a wide range of wafer processing capabilities needed to create the latest chips.
The steps of the wafer fabrication process are laid out below:
Source: Company Website
With an aim to maximizing its resources, Lam also caters to applications that do not require the most advanced wafer processing capability. In these cases Lam offers proven solutions with a suite of previous-generation legacy products and solutions for the MEMS and LED manufacturing markets.
As the leader for etch products (which connect the individual components that form an integrated circuit) Lam is very well positioned for the trend to verticality in devices. As the physical limits have been reached in terms of what can be built into devices in the two dimensional plain, designer are increasingly looking to build “the insides” of devices in three dimensions. Lam’s technology is ideally positioned to take advantage of this major trend.
Significant market share gains (in waver fabrication) provide evidence of Lam’s success. Its market share has grown from 26% to 35% over the past couple of years. This is on top of very strong market fundamentals meaning Lam is in the right place at the right time and doing all things right.
Recent growth rates have been impressive. Shipments in Q1 2017 were up by 25% relative to Q4 2016, revenue increased 16% qoq. During a recent investor conference, the company’s management indicated that numbers in Q2 2017 were up again significantly.
Lastly, a boost could come from a tax reform on cash parked abroad. Of Lam’s cash balance of USD 2bn roughly 75% is held abroad as the high US tax rate dissuades CFOs from repatriating cash. Donald Trump has vowed to enable companies to bring back their cash at a very favorable tax rate. This could put Lam in a position where it could return a significant amount of cash to investors.
Investment Case
- Lam experiences an expanding market place, which is expected to prevail for a number of years due to the omnipresence of electronic devices
- On top of overall market growth Lam has been gaining market share in recent years
- Attractive valuation with a 2018 PE ratio of 15.6x.
- Trend in upward revision of earnings estimates by analysts. This trend is unlikely to have reached its top
Risks and Weaknesses
The main risk perceived in the semiconductor industry is always cyclicality. However, more and more experts acknowledge that the cyclical nature of the industry has abated for several reasons. There has been a significant degree of consolidation. Investment is managed much more carefully. And, the extensive broadening of the client base (large variety of devices, AI, cloud, etc.) has led to a situation where the cyclicality in the semi conductor industry has become largely macro-driven.
Valuation
There are several reasons why we see additional upside for this stock.
First of all, Lam trades at a significant discount to certain peers, such as ASML (2018 PE of 15.5x vs. 22.7x). Secondly, as EPS have recently come in above the high end of guidance, analysts’ earnings estimates will see upward revisions, which will have the effect of lowering forward earnings based valuation. Thirdly, in light of a 2018 PE ratio of “only”15.6x it can be argued that the market is overlooking the fact that 25% of Lam’s revenue is derived from service business. This is essentially an annuity stream as Lam will generate service fee for spare, upgrades, refurbishment and service over product life cycles of 15-20 years. Typically, this type of revenue commands a higher multiple. At Lam, the service component within its revenue is forecast to go up from the current level of 25%.
Our target price for the stock over the medium term is USD 200, which represents an upside of 35%.
Disclosure: 4-traders.com’s Investor portfolio USA currently owns 45 shares in Lam Research Corporation.
