Lam Research (LRCX) is among the top players in semiconductor manufacturing equipment but second only to Applied Materials (AMAT) in etching and deposition. The market very well acknowledges the short-term shortage in chips, but still, there is a great chance that the investors underestimate the long-term demand growth drivers for the sectors. With the fluctuating marketing conditions, the company also have a solid track record for consistent growth and attractive profitability. There are various large players who tend to dominate in this market, and among them, Lam Research has healthy competitive advantages powered by the production scale, which also generates cost efficiencies and intellectual properties.
Lam Research is in the right place to continue benefitting from booming demand for semiconductor manufacturing in the years ahead. Further, value is not unreasonable for a profitable business that has a strong profit margin. It is not even much of a stretch to mention that the stocks can be undervalued if the growth rates exceed the expectations. The chart is in the uptrend for the long term, but recently it has been pulled back, so it is not too extended in the short term.
Long Term Growth Prospects
Everybody must be aware of the semiconductor shortage that is extremely affecting different industries due to factors such as supply chain disruptions due to the pandemic, poor inventory planning from the clients, and geopolitical tensions. Semiconductors mainly provide the critical infrastructure for the Digital Transformation boom, but the demand is set to continue growing across different industries that range from computing to industrial and countless others. It is not because these industries are growing continuously, but chips are becoming extremely relevant for these industries in the years ahead. The automobile is a great example of that.
Even if there is a large room for errors, Wall Street analysts can actually make reasonable assumptions regarding the demand in a particular quarter or even a specific year. However, the market tends to underestimate long-term drivers when they focus on the short-term numbers, and in that case, demand from IoT, AI, and 5G are among the powerful tailwind that can boost sustainable growth over the years. Gaming and virtual reality are other areas that can generate accelerating demand, and healthcare applications in the areas such as connected devices used to measure blood oxygen or heart rate.
Those are some notable and obvious examples to consider, but the world may need more chips, and those chips will be more powerful and complex over the coming years and even decades. Further, today, the cold war with China is also at the forefront of priorities in the geographical landscape. President Biden has said that he will take $37 billion to supercharge chips in the United States. It will obviously be a matter of negotiations, but the fact remains that semiconductor manufacturing is actually becoming a strategic priority and Lam Research is in the right position to be one of the main beneficiaries of this trend.
In February, Lam Research announced its partnership with ASML for a breakthrough technology for developing a new dry resist technology that can help extend the resolution, productivity, and yield of EAU lithography.
Cyclical sectors make money in the most favorable phase of the cycle, but they start losing money when the cycle is down, and these industries are steel and autos. A semiconductor is again a different story, but the demand is cyclical in the short-term, but you will notice the long-term secular trend that can make a huge difference versus other cyclical but more mature industries.
The numbers for the first quarter of 2021 were extremely strong, with the revenue growth by 54% year over year that will surpass the expectations by $130 million. The adjustable operating margin has reached 31.6% of the revenue that is again a remarkably healthy figure. No doubt, Lam Research has missed the expectations for the revenue in some specific quarters, but it has created an impeccable track record when we consider its earnings. However, the management is also clearly focused on outperforming the expectations on the bottom line. Lam Research has consistently raised its dividends with time, and till now, it has an active share buyback policy. Even if the dividend yield is modest at 0.83%, the payout ratio is much safer at less than 20% of the earnings; that makes a lot of sense to expect sustained dividend growth and share buybacks from Lam Research in an improving economic landscape going forward.
Industry cyclicality and the potential short-term disruptions for the supply chain are the main risk factors in the short-term, but over the long term, there is always the competitive risk in such a dynamic sector. Even if Lam Research has a solid competitive advantage, we cannot take them for granted, and we need to monitor the investment thesis permanently.
Valuation and timing
On average, Wall Street analysts expect Lam Research to make around $26.43 and $31.3 in the earnings per share for the fiscal years that end in June of 2021 and in June of 2022, respectively. Due to these assumptions, the stock is trading at the ratio of price-to-earnings that are 23.7 and 20. Valuation is hardly excessive if you believe that Lam Research is going to sustain healthy revenue growth and vigorous profitability and is even better if the company can keep outperforming expectations. It can be in the same way as it has done in the past due to which the valuation would be cheaper than what current assumptions can actually indicate.
Lam Research stock is in a solid uptrend over the long-term, and recently it has pulled back somewhat so that the chart is not too extended, but the price action looks solid as long as the stock is above $600 to $590 in the shorter term.