Why Lam Research Is a Good Pick for Growth Investors

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– By Dilantha De Silva

Lam Research Corporation (NASDAQ:LRCX) is an American semiconductor company that focuses on designing, manufacturing, marketing and servicing semiconductor processing equipment used in integrated circuit fabrication. Chipmakers can build smaller, faster and better-performing electronic devices with Lam’s cutting-edge wafer fabrication equipment and services.

Lam Research released its fiscal third-quarter earnings results on April 21, which included earnings per share of $7.49, beating analyst expectations handsomely.

Over the past 12 months, Lam Research shares have appreciated 138%, and consistent earnings beats were one of the main drivers of the stock price. Considering the expected increase in demand for high-end chips along with the rollout of 5G technology, Lam Research can be expected to deliver strong earnings in the next couple of years as well. Thus, even on the back of a strong year, I think Lam Research seems to be undervalued in the market relative to its peers.

Fiscal third-quarter earnings recap

For its third quarter of fiscal 2021 which ended in March, the company reported revenue of $3.85 billion, which was not only a year-over-year increase of 54% but also better than analyst estimates.

Commenting on this strong financial performance, Chief Financial Officer Douglas R. Bettinger said:

Our solid revenue performance was mainly due to an increase in Foundry related systems as well as record performance in our customer support business group or CSBG, where we had increases in all parts of that business. Our customers’ fabs are running at high utilization levels, which drives the need for consumption of spare parts and services.”

The company is laser-focused on its foundry business, which continues to see strong demand as chipmakers are continuing to invest millions of dollars to bring 5nm chips to the market. As illustrated below, the foundry business accounted for 31% of company revenue in the last quarter, which is a record high.

Why Lam Research Is a Good Pick for Growth Investors

The company generated 32% of its total revenue from China and 31% from South Korea, whereas the U.S. and Europe regions contributed 5% and 4% to its total revenue, respectively.

The company remains committed to distributing excess cash to shareholders as well and used $900 million to repurchase its stock in the market during the three months ended in March. These buybacks will not only prove to be a source of income for shareholders in the short run but a driver of earnings per share in the long run as a result of the reduction in the number of shares outstanding.

Recent developments

On March 3, Lam Research announced the release of a fully redesigned plasma etch technology and system solution which is aimed at providing chipmakers with advanced flexibility for future innovation. Considering the complicated requirements of product designers resulting from technological developments such as the rollout of 5G technology and increased use of Artificial Intelligence, the company’s decision to invest in improving its dry etch technology, which is a critical step in the chip manufacturing process, is likely to pay off handsomely in the future.

On Jan. 27, the company announced the launch of Vantex, which is designed to provide higher performance and greater extendibility for current and future generation NAND and DRAM memory devices.

As confirmed by CEO Tim Archer in the fiscal third-quarter earnings call, Lam has signed a multi-region data services license agreement with a major memory manufacturer to provide enhanced tool data to support their smart manufacturing roadmap. It has completed a multi-year equipment intelligence services contract with another memory producer as well.

Lam Research is one of the major vendors of semiconductor fabrication tools, and the company has strong ties with leading chipmakers in the world. The company, because of its scale, enjoys noteworthy cost advantages as well, which makes it difficult for a semiconductor manufacturer to replace the high-end tools offered by Lam Research.

Considering these competitive advantages, it would be reasonable to assume that Lam Research will be in a strong position to grow in the coming years along with the expected uptick in demand for high-end chips.

The outlook is promising

According to KPMG, the semiconductor industry has seen revenue growth of 6.5% in 2020, driven even higher by the global pandemic and the economic downturn. KPMG surveyed 156 senior executives from semiconductor companies worldwide in the fourth quarter of 2020, and its results show that 79% of respondents are optimistic about an increase in industry-wide profitability. A whopping 85% of executives also predict an increase in their companies’ revenue and 71% of survey respondents plan to invest in R&D with 73% of them planning to increase capital spending immediately to cater to the expected uptick in demand in the coming years. Higher spending by semiconductor companies will almost certainly be a positive development for fabrication tool manufacturers such as Lam Research.

The report also highlights that micro-electro-mechanical systems, analog/radio frequency mixed-signal devices and microprocessors, including graphic processing units, microcontrollers and memory protection units, have high growth potential in the next five years. Automotive applications are projected to be the third-largest driver of semiconductor revenue in the next few years. Automakers are likely to be prominent buyers of semiconductor products as they build more advanced electric and self-driving vehicles which are made possible by 5G, Artificial Intelligence and cloud technology. Lam Research has already identified these trends, which is evident from the below statement by CEO Tim Archer:

Secular tailwinds such as AI, 5G, and IoT continue to strengthen. And over the past year, COVID-19 related impacts, like work and learn from home have accelerated the adoption of these technologies. Second, the complexity of manufacturing advanced semiconductor devices continues to increase at a rapid rate, leading to a rise in equipment capacity across all segments. Third, innovative consumer products are incorporating more semiconductor enabled functionality, driving faster growth in semiconductor content per growth.

With the increase in the use of technology and remote work, the demand for wireless devices and computers has increased, which is another major contributor to the growth of the semiconductor industry. Lam Research stands to benefit from the expected increase in demand for advanced chips that are needed in laptops and handheld devices to support the work from home movement.

Overall, the macroeconomic outlook is very positive for Lam Research, and the company, as one of the leading suppliers of fabrication tools used in chip manufacturing, is well-positioned to translate this positive outlook into higher earnings.

Takeaway

Lam Research is focused on earnings growth and is investing in new products and infrastructure to cater to the increasing demand coming from chipmakers. Lam Research stock is trading at a forward earnings multiple of 23.77 in comparison to the sector price-earnings ratio of 33.35, which suggests the company is relatively undervalued. The strong growth expected in 2021 will likely be a catalyst in pushing the stock price higher this year, and I think the company could even potentially increase its dividend per share along with earnings growth as well.

Disclosure: The author does not own any shares mentioned in this article.

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This article first appeared on GuruFocus.