Although Lam Research's (LRCX) stock price has risen 47.4% since the beginning of 2013, it is still an excellent buy right now. This compared to 28.1% rise of the S&P 500 index, and 36.2% rise of the Nasdaq Composite Index at the same period. In this article, I will show why, in my opinion, Lam Research stock is a remarkably promising long term investment.
Lam Research Corporation is a major supplier of wafer fabrication equipment and services to the worldwide semiconductor industry, where they have been advancing semiconductor manufacturing for more than 30 years. Lam's recent merger with Novellus Systems, Inc. (NVLS), has created a broad portfolio of complementary product capabilities that includes Lam's leadership in etch and single-wafer clean and Novellus' leadership in thin film deposition and photoresist strip. With corporate headquarters located in Fremont, California, the company maintains a network of facilities throughout Asia, North America, and Europe to meet the complex and changing needs of its global customer base.
Semiconductor and semiconductor equipment manufacturers have historically been highly cyclical, with periods of strong growth and high margins, which have caused companies to raise capital investment, and in effect have caused excess supply followed by periods of weakness. The economic data and companies' comments are all saying essentially the same thing, which is that the semiconductor equipment industry has already passed through the bottom of the current cycle. New internet applications will extend the compute environment to every day devices like smart television, wearable, cars, light bulbs and more. This development will increase the demand for semiconductor test equipment.
One very important parameter when analyzing a semiconductor company is the book-to-bill ratio, which is the ratio between new orders to actual sells. A ratio of above one implies that more orders were received than filled, indicating strong demand, while a ratio below one implies weaker demand. On December 19, 2013 the SEMI.ORG announced that the North American semiconductor equipment industry posted November 2013 book-to-bill Ratio of 1.11. On that occasion, Denny McGuirk, president and CEO of SEMI said:
The continuing rise in equipment bookings clearly points to year-end order activity that is substantially stronger compared to one year ago. This trend supports the current outlook showing a rebound in equipment spending for 2014.
The table below presents the North American semiconductor equipment industry's billings, bookings and the book-to-bill ratio since the beginning of 2012.
The charts below present the North American semiconductor equipment industry's billings, bookings and the book-to-bill ratio since 1991.
The table below presents the valuation metrics of Lam Research, the data were taken from Yahoo Finance and finviz.com.
Lam Research's valuation metrics do not seem particularly cheap at first glance, but considering its exceptionally strong earnings growth prospects, its low debt and its low forward P/E, these valuation metrics are compelling. The average annual earnings growth estimates for the next 5 years is at 32.90%, and the forward P/E is at 12.19, these give a PEG ratio of 0.38 (forward P/E divided by growth), which is extremely low, especially for a company with leadership in its field.
Many analysts of the semiconductors industry give a high importance to the price-to-sales ratio, and consider it a better indicator than the P/E ratio for companies in this industry. Comparing the current price-to-sales ratio to its historical values can give a fair idea if the stock is cheap or too expensive right now. In the case of Lam Research, the actual ratio is not historically too high as shown in the chart below (the small difference in value between the chart and the table is due to delayed updating of the chart).
Latest Quarter Results
On October 23, 2013, Lam Research reported its latest quarter financial results, which beat EPS expectations by $0.10 and was in-line on revenues. EPS guidance for the next quarter was above consensus, and revenues outlook was in-line.
Highlights for the September 2013 quarter were as follows:
- Shipments of $987 million, down 9% from the prior quarter
- Revenue of $1,015 million, up 3% from the prior quarter
- GAAP gross margin of 42.5%, GAAP operating margin of 10.4% and GAAP diluted EPS of $0.50
- Non-GAAP gross margin of 45.0%, non-GAAP operating margin of 16.2%, and non-GAAP diluted EPS of $0.81
For the December 2013 quarter, Lam is providing the following guidance on a non-GAAP basis:
- Shipments of approximately $1.125 billion plus or minus $30 million
- Revenue of approximately $1.1 billion plus or minus $30 million
- Gross margin of approximately 46.0% plus or minus 1.0%
- Operating margin as a percent of revenue of approximately 18.5% plus or minus 1.0%
- Earnings per share of approximately $1.02 plus or minus $0.05, assuming a diluted share count of 174 million
Competitors and Group Comparison
A comparison of key fundamental data between Lam Research and its main competitors is shown in the table below.
Source: Yahoo Finance
Lam Research earnings growth prospects are better than its competitors, and its PEG ratio is the lowest.
Most of Lam Research's growth rates, margins, return on capital and stock valuation parameters have been much better than its industry median and the sector median, as shown in the tables below.
Personally I am using only fundamental analysis for my investment decisions. After many years of experience, and after having tried all kinds of decisions making including technical analysis, I have reached the conclusion that relying on fundamental information is giving me the highest return. Nevertheless, some investors are successfully using technical analysis to find the proper moment to start an investment (I am not talking about traders, my analysis is only for investors). The charts below give some technical analysis information.
The LRCX stock price is 0.86% above its 20-day simple moving average, 1.06% above its 50-day simple moving average and 9.33% above its 200-day simple moving average. That indicates a short-term, a mid-term and a long-term uptrend.
Chart: TradeStation Group, Inc.
The weekly MACD histogram, a particularly valuable indicator by technicians, is at -0.16, which is not yet bullish, (a rising MACD histogram and crossing the zero line from below is considered an extremely bullish signal). The RSI oscillator does not indicate oversold or overbought conditions.
Analysts recommend the stock. Among the 18 analysts covering the stock, four rate it as a strong buy, twelve rate it as a buy, and only two analysts rate it as a hold.
In my opinion, Lam Research will outperform the worldwide wafer fab equipment (WFE) in 2014. According to SEMI.ORG, in its publication of December 03, 2013, worldwide sales of new semiconductor manufacturing equipment will increase by 23.2% in 2014. Lam Research is poised to benefit from rising capital intensity due to the 20/16nm and 3D NAND technology transitions. Furthermore, Lam Research is gaining market share in etch and deposition.
I consider the acquisition of Novellus Systems, in an all-stock transaction, which was completed In June 2012, very positive to Lam Research. The two companies offer complementary products with leading market share positions in adjacent markets. There is also significant cost savings through operating expense synergies.
Some analysts consider Lam Research higher exposure to the memory sector than its peers as a disadvantage due to the high volatility of this sector, but I consider it an advantage. The growing popularity of tablets and smartphones will cause a growing demand for memory especially for the 20nm NAND.
As the global leader in etch and single-wafer clean and in thin film deposition, Lam Research will benefit from the rebound in semiconductor manufacturing equipment spending in 2014. The company latest quarter EPS results beat analyst expectations and guidance for the next quarter was above consensus. Lam Research has a strong balance sheet, low debt, and it is repurchasing its own shares. The company has compelling valuation metrics and very strong earnings growth prospects, its PEG ratio is extremely low at 0.38. All these factors bring me to the conclusion that LRCX stock is a good investment right now.
Main risks to the expected capital gain include a downturn in the U.S. economy, and weakness in the consumer electronics market.