Semiconductors offer an attractive way to diversify across technology given that they ultimately supply the sector's end markets. Given my bullish sentiment on technology and the economy, in general, I see strong risk/reward in semiconductors. In this article, I will run you through a DCF model on Lam Research (LRCX) and then triangulate the result against a review of the fundamentals compared to Applied Materials (AMAT) and Intel (INTC). I find these companies meaningfully undervalued.
First, let's start with an assumption about the top-line. Lam finished FY2011 with $3.2B in revenue, which represented a 51.7% gain off of the preceding year. I model 10% per annum growth over the next half decade or so.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods sold eating 55% of revenue versus 11% for SG&A, 13% for R&D, and 3.9% for capex. Taxes are estimated at 15% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model.)
We then need to subtract out net increases in working capital. I estimate this figure hovering around 3.5% of revenue over the explicitly projected time period.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 10% yields a fair value figure of $48.25, implying 28.4% upside.
All of this falls within the context of better-than-recognized momentum:
"The March quarter represented a solid start to the calendar year as Lam shipments, revenue, gross margin, operating margin and EPS results met or exceeded the midpoint of our guidance ranges. Relative to these specifics, shipments for the quarter were approximately $713 million, up 27% from the December quarter and indicative of improving customer demand across all product lines and most notably, in the foundry space".
From a multiples perspective, Lam is also attractive. It trades at a respective 16.8x and 10.7x past and forward earnings versus 8.9x and 9.2x for Applied Materials and 11.1x and 9.7x for Intel.
Consensus estimates forecast Applied's EPS forecast that it will decline by 27% to $0.94 in 2012 and then grow by 19.1% and 11.6% in the following two years. Assuming a multiple of 12x and a conservative 2013 EPS of $1.08, the stock would hit $12.96 for 25.1% upside. The company currently offers a dividend yield of 3.3%, which makes risk/reward very attractive.
Consensus estimates forecast Intel's EPS growing by 4.6% to $2.50 in 2012 and then by 7.6% and 7.8% in the following two years. Assuming a multiple of 13x and a conservative 2013 EPS of $2.61, the stock would hit $33.93, implying 30.1% upside. Intel is a top brand amongst semiconductors and is led by terrific management. With a dividend yield of 3%, risk/reward is yet again highly compelling.
Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer.