Lam Research: A Favorite In The Semis – Initiating With A Buy (NASDAQ:LRCX)

Investment Thesis

Lam Research (NASDAQ:LRCX) is set to announce earnings at the end of the month. In my opinion, Lam is going to beat estimates this quarter and trade higher in response. Lam is a semi-cap company with substantial exposure to the memory market, making it liquid gold for 2024 as the DRAM and NAND recover. The stock already outperformed the S&P 500 in the first quarter of the year, up 30% between January and March, while the S&P 500 is up ~10%. I expect Lam to continue to outperform as the industry’s wafer fabrication equipment spend, or WFE increases, to keep up with the appetite for advanced tech to keep up with the AI boom.

Lam’s Value Proposition

Lam is a semi company that operates in the semi capital equipment peer group, also known as the semi-cap, to design and build products for semiconductor manufacturing, specializing in etching and deposition (which make up over 20% of the semi-cap market each, respectively). In my opinion, investors should look at Lam through the prism of the memory rebound for 2024. As shown in the image below, during Lam’s December quarter, memory accounted for 48% of the company’s total sales, while foundry made up 38%, and logic/other made up 14%.

The semi-cap market has three main growth drivers: foundries, memory manufacturers, and IDMs or Integrated Device Manufacturers; historically, there’s been a correlation between increased capex spending from any of these three and Lam’s top-line growth. The chart below from Lam’s 10Q from late January highlights the percentages of equipment and upgrade revenue to each of the primary markets Lam serves. While I understand that end market demand from PCs and smartphones is lacking thus far in 2024 and could weigh on capex spend, I think there are some green shoots in the industry that’ll support outperformance, particularly memory. Micron’s (MU) results last quarter (that drove the stock higher by 55% during Q1) confirmed a positive upward trend for DRAM and NAND pricing and end demand. And I think Lam is another way to play on the memory rebound and the broader semi-rally.

In their 4Q23 earnings call, management noted that “memory WFE was down nearly 40% year-on-year, led by cuts in NAND spending of more than 75%,” and President and CEO of Lam, Timothy Archer’s forward-looking sentiment was “we expect a modest recovery in memory spending to drive a stronger exit to the year.”

In my opinion, management is conservative in its outlook. Granted, the business environment “remains muted,” as Archer noted on the call, but I think the Street’s expectations for Lam have already adjusted to this reality. Hence, in my opinion, Lam is now much better positioned to outperform as AI pushes the industry to spend on advanced process nodes and memory investments. For CY2023, WFE was in the low $80Bs; for CY2024, it is estimated to be in the mid to high $80Bs range due to 1. DRAM growth supported by HBM, 2. NAND growth by tech upgrades, and 3. Replenishing leading-edge investments. Lam’s management confirms my positive outlook for the year, estimating the WFE market to grow from $82B to $85-$89B in CY2024, mainly due to better memory spend.

Justified Valuation

For Lam’s value proposition in 2024, I believe the stock is cheap based on a relative methodology of valuing stocks within the peer group. The stock’s Price/Earnings ratio is 31, while the peer group average ratio is 35.4. Lam’s EV/Sales ratio for CY2024 is a bit higher than the peer group average ratio at 8, while the average ratio is 6. In my opinion, the higher EV/Sales ratio is justified, given Lam’s position in the memory market for 1H24.

If you shift focus to Lam’s stock performance over the past six months against the S&P 500 and its semi-cap peer group, which mainly includes ASML (ASML) and Applied Materials (AMAT), you’ll notice that Lam has 1. Outperformed the S&P 500 by 36% and 2. The semi-cap trio has outperformed the S&P 500 and shows a consistent upward trend that again confirms my positive outlook despite the muted end demand environment.

What Could Go Wrong?

Lam is not without risk; in my opinion, the biggest risk is the unsustainable high percentage of sales coming from China. In Q4, China made up 40% of Lam’s total revenue; the specific details of Lam’s revenue by geography breakdown are outlined below in the image from the company’s 10Q. The percentage details are as follows: China 40%, Korea 19%, Japan 14%, Taiwan 13%, US 5%, Europe 5%, and SEA 5%. I don’t think the exposure to China will disappear or fade in 1H24, but I do believe Lam is at higher risk due to the increased percentage of revenue coming from China compared to a year ago quarter, during which China accounted for 24% of its total revenue. I think this may be an issue in the mid term for Lam, but I don’t see it being a reason for concern into next quarter, as management expects its China sales to be stable in March and only trend lower afterward.

What’s Next?

In my opinion, Lam presents a unique risk-reward scenario in the first half of the year, up 32% in Q1 alone. The risk of high exposure or concentration of sales to China is not one Lam faces alone. In fact, reviewing the last two earning calls from ASML and Applied, a similar trend of heightened sales to China starting in 2H23 can be seen; last quarter China, related shipments accounted for ~39% of ASML’s total sales and 46% of the quarter prior, while AMAT reported strength from China spending. I focus on Lam, in particular, due to its heightened exposure to the memory market compared to the other semi-cap players in my coverage. In my opinion, Lam’s uniqueness springs from the current macro backdrop of a muted demand environment across the board, except green shoots from memory and AI-related demand. The memory recovery we’re seeing play out with Micron and Western Digital (WDC), among others, makes me believe that Lam is better positioned than ASML and Applied for more upside in 2024.

I see an upward trend in Q2 due to the memory rebound pushing healthier WFE spend from the semi-industry. Lam will report its 3QFY24 results later this month, on the 24th of April. What I’ll be watching for and what I recommend investors also keep an eye on is, firstly, the growth of system sales into the DRAM and NAND markets, with emphasis on the former due to AI tailwinds to gauge the demand environment for memory recovery. Secondly, shipments to China as a percentage of total sales will help us understand how the risk of higher sales to China will play out in the second half of the year.

The company now expects revenue to be ~$3.7B for the next quarter, more or less in line with consensus at $3.70B. I think guidance for next quarter is conservative, especially after management’s comments in the Morgan Stanley Technology, Media & Telecom Conference held in early March. I see more room for upside and initiate Lam with a buy in the $950 price range.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.