Lam Research: Undervalued Semiconductor Manufacturer
Summary
- Lam Research is one of the largest players in semiconductor industry. It manufactures various semiconductor equipment for customers from all over the world.
- The company has shown outstanding financial performance compared to its peers past periods, and it is expected to continue. High profitability and growth rates might become key growth drivers.
- At the same time, the relative valuation model shows a decent undervaluation. The company has upside potential and can be considered as a good investment.
Investment Thesis
The production of semiconductors has recently been under the close attention of investors. Lam Research (NASDAQ:LRCX) which is one of the companies in this industry, has already shown a very strong result for the first quarter of 2021 (not to mention a strong growth of more than 140% since March 2020). However, the company still has potential. It shows excellent results compared to its peers, and the comparable valuation model shows a decent undervaluation.
Nowadays the demand for semiconductor equipment is obvious. Semiconductors are used in almost all sectors of the economy. The industry is moving towards gradual automation, which uses products made by such companies. Many familiar products are becoming more technologically advanced, in particular, the emergence of self-driving cars. As well, technology companies that have consistently shown the demand for semiconductors continue their ongoing growth. The fact that the semiconductor industry will be in great demand over the next decades is evident. Thus, the company will obviously gain some earnings growth.
Even now, we can observe a certain shortage of products, and manufacturing companies are increasing their production capacity. In addition, the US government supports the production of semiconductors.
About Lam Research
Lam Research is an American manufacturer of semiconductor equipment. The main activity is the development, production, and sale of semiconductors for the creation of integrated circuits.
The main sources of revenue are:
- Memory - 68%
- Foundry - 26%
- Logic/integrated device manufacturing - 6%
Their shares vary, and a significant shift towards memory production could be seen in 2020.
The main consumers of the products are other technology companies engaged in the production of chips, microcircuits, and other similar products. The company's key customers are located in Asian markets, but sales are worldwide. Therefore, the largest of them are companies such as Samsung (OTCPK:SSNLF), TSMC (TSM), and Micron (MU). The following table shows a breakdown of sales (as well as its dynamics for the same period) by region for 1st 2020 and 1st 2029 ended 29 December.
| County | Dec 2020 | Dec 2019 | Change of Sales by Region |
| China | 35% | 29% | 159% |
| Korea | 21% | 18% | 154% |
| Taiwan | 17% | 26% | 86% |
| Southeast Asia | 11% | 7% | 198% |
| Japan | 10% | 8% | 165% |
| United States | 4% | 9% | 61% |
| Europe | 3% | 3% | 160% |
| Total | 100% | 100% | 134% |
Source: created by the author using LRCX's financial reports
The key market for the company is the production of memory. This industry is actively developing, largely due to the rapid growth in demand for cloud services. In addition, there are other areas, such as components for 5G, autonomous cars, and portable devices.
Financials
Lam Research has very strong financial records. This can be stated about all aspects of its activities: growth rates, profitability, and debt burden. In addition, it looks very good compared to its competitors.
The company has shown impressive growth in recent years, with the exception of 2019. The company's fiscal year ends in June, so the annual figures do not include the last couple of quarters. Subsequently, they recovered, and in the quarterly reports, you can see very strong sales growth in the second half of 2020.
| Earnings Growth | Jun.16 | Jun.17 | Jun.18 | Jun.19 | Jun.20 |
| Revenue | 11.90% | 36.10% | 38.20% | -12.90% | 4.10% |
| Operating Profit | 22.40% | 78.00% | 68.10% | -23.30% | 8.50% |
| Net profit | 39.43% | 40.22% | -7.95% | 2.75% | 31.64% |
Source: created by the author using LRCX's financial reports
The picture for the blocks is more complete. In 2019, we saw a gradual decline in revenue and other profit indicators, but in 2020, this trend has returned to growth. I assume that the company has returned to stable indicators of revenue growth of net profit by 10-20% and 20-30% respectively for the next couple of years.
| Earnings Growth | Mar.19 | Jun.19 | Sep.19 | Dec.19 | Mar.20 | Jun.20 | Sep.20 | Dec.20 |
| Revenue | -15.70% | -24.50% | -7.10% | 2.40% | 2.60% | 18.20% | 46.70% | 33.80% |
| Operating Profit | -31.70% | -35.60% | -9.20% | -0.60% | 22.70% | 22.50% | 78.80% | 47.10% |
| Net profit | -3.77% | -1.02% | -14.03% | 10.46% | 11.71% | 21.21% | 18.20% | 5.56% |
Source: created by the author using LRCX's financial reports
Peers Comparison: One Of The Best Companies in The Industry
I selected several companies from the semiconductor and semiconductor equipment industry. These are Applied Materials (AMAT), ASML Holding (ASML), KLA Corporation (KLAC), Teradyne (TER), Entegris (ENTG), IPG Photonics Corporation (IPGP), Universal Display Corporation (OLED). All of them have a market capitalization of over $10 bn and mostly produce parts for chips or other technological goods.
The table below presents the comparison of key financial ratios between mentioned companies. Indicators have been calculated based on LTM financials.
Source: created by the author using data from tikr.com
We can note the strong financial results of Lam Research over the past 12 months. The company manages to maintain profitability indicators above the industry average. It is worth noting the highest return on assets in the industry. In addition, the company can be called financially healthy: the remaining net debt and high liquidity indicators hint at extremely low risk of bankruptcy.
As for the evaluation, the company is decently undervalued relative to its competitors. Comparative multipliers are significantly lower than the industry average. Only a few companies have lower forward indicators, in particular Applied Materials and KLA. However, only KLA's financial performance is at the level of Lam Research. The difference is that LRCX has had a higher rate of revenue growth over the past periods than KLAC.
Source: created by the author using data from tikr.com
Lam Research's current comparative multipliers are significantly better than most of its peers. It is worth noting the PEG indicator. For such companies with high growth rates, it can be very revealing. Among the selected companies, Lam Research has the lowest PEG, which is also very close to the range of undervalued companies, ~1.2-1.4 (theoretically, a fairly valued company has PEG=1, but this is extremely rare).
Source: created by the author
Relative to the average indicators, the company is very seriously undervalued, but this does not guarantee such high upside potential. For forward indicators, the underestimation is ~52%, for current indicators ~48%. As I mentioned above, such strong growth to market levels is almost impossible. The fact is that some "expensive" competitors have higher growth rates and other products. In modern conditions, companies with a small capitalization have a large number of opportunities to quickly increase sales.
Key Risks
The demand for semiconductors in 2020 was enormous, therefore many companies faced scarcity. Companies have responded by increasing production capacity, so the industry is expected to grow steadily. However, Lam Research has several aspects that can lead to risks for the company.
- The company's revenue is mainly generated by sales in Asia. The strengthening of the dollar may lead to a slight decrease in earnings in the reporting.
- US-Chinese relations are experiencing another crisis. The Chinese market is key for the company, so the tension between the countries and the sanctions can lead to the loss of important customers.
- High competition in the industry. The key competitor is Applied Materials. Companies compete for the same competitors.
- The overheating of the US technology sector. Despite the low rating of Lam Research, in the event of a decline in the entire sector, the company's shares will also go down. But each decline in the share price opens up promising entry points.
The Bottom Line
Overall, Lam Research is a good investment opportunity. The semiconductor industry is growing rapidly. The company has shown outstanding financial results during past periods, and it is expected to continue its good performance. The relative valuation model shows decent undervaluation. The mentioned risks look quite unlikely or insignificant for me.
However, right now, the stock price is at the historical maximum, and investors should be very careful. Any negativity from the market can cause the share price to decline. Wall Street has no clear opinion on the stock, noting a maximum valuation of $800. Nevertheless, in an overheated market, the objective target price looks like $750 per share, which means a growth potential of 13% on the horizon of six months.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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Comments (17)
I'd be careful at these levels. Lots of good news priced in and this business has been known, and still is, a very cyclical one. if your timing is off, you could sit for a year losing money. Stock has recently run from 500. 670ish has been resistance of late. careful here.
