Lam Research Corp. (LRCX, Financial) is a leading global supplier of wafer fabrication equipment. This pick and shovel play on the semiconductor industry provides some of the market’s most advanced and popular chipmaking tools, and its market dominance has allowed the company to achieve an incredible track record of return on invested capital (ROIC) compared to weighted average cost of capital (WACC), showing high profitability and value creation for shareholders.
Lam Research has also been a popular buy among gurus in recent quarters, as shown in the chart below:
Those buying shares in recent quarters include Frank Sands (Trades, Portfolio), Philippe Laffont (Trades, Portfolio) and Ron Baron (Trades, Portfolio). As of the end of the third quarter of 2022, Frank Sands (Trades, Portfolio) was the top guru shareholder of the stock with 1.73% of shares outstanding, followed by Ken Fisher (Trades, Portfolio) with 1.66% and Jeremy Grantham (Trades, Portfolio) with 0.55%. In total, the stock appeared in the 13F or mutual fund filings of 14 of the Premium gurus followed by GuruFocus.
The guru trade data comes from 13F filings and mutual fund reports for the quarter in question. Investors should be aware that 13F reports and mutual fund reports do not provide a complete picture of a guru’s holdings. The 13F reports include only a snapshot of long equity positions in U.S.-listed stocks and American depository receipts as of the quarter’s end. They do not include short positions, non-ADR international holdings or other types of securities. The mutual fund data is sourced from the quarterly updates on the website of the fund(s) in question. This usually consists of long equity positions in U.S. and foreign stocks. However, even these limited reports can provide valuable information.
However, the stock price has fallen steeply since highs at the end of 2021. Nowadays, it is trading well below its GF Value of $670.05 at $456.93 per share, its price-earnings ratio of 13.11 is lower than its historical median of 18.98 and it is even trading below the fair value estimate of the Peter Lynch chart for the first time since 2019:
While semiconductor stocks have broadly fallen since the end of 2021 due to the expectation of an industry-wide slowdown, the GuruFocus All-in-One Screener shows only four other high-growth semiconductor stocks that are as cheaply valued as Lam Research as of this writing when using the following criteria (you can find the full screen here):
1) Trading below GF Value
2) Trading below the Peter Lynch earnings line
3) A price-earnings ratio below 15
4) A three-year revenue per share growth rate of at least 20%
5) A three-year earnings per share without non-recurring items growth rate of at least 20%.
Let’s take a closer look at this company and the headwinds it faces to see why Lam Research’s valuation has fallen to such bargain basement levels, and whether or not such a drop is deserved.
Semiconductor slowdown incoming
After a massive semiconductor shortage put a chokehold on many industries in 2020 and 2021 due to Covid-19 shutdowns as well as easy money policies that helped fund a wave of investments in tech startups, 2022 saw the situation transform into a supply glut for certain types of chips.
While supply still remains tight for most specialized chips, such as those used in automobiles and artificial intelligence, memory chips used in PCs and smartphones are being hit hard by the previous pull-forward in demand as their customers have already stocked up more than they need for the time being.
Since Lam Research provides a wide variety of products across the semiconductor fabrication equipment spectrum with a focus on advanced technologies, it will likely remain relatively insulated from the broader industry supply glut. The company says it does expect to see weaker fabrication equipment spending from customers in 2023, but it believes its technology leadership will still give it a way to take advantage of growth opportunities.
U.S.-China tensions strike again – or do they?
Compared to the semiconductor industry slowdown, a more worrying and potentially long-lasting problem for Lam Research is that in October 2022, the U.S. Department of Commerce banned the sale of advanced semiconductors and semiconductor fabrication equipment to China, which is home to the vast majority of the world's wafer fabrication capacity. With this move, the Biden administration aims to supercharge its plan to bring domestic semiconductor production back to the U.S. and reduce economic reliance on China.
As of its most recent earnings report for the quarter that ended in September 2022, the China region made up 30% of Lam Research’s revenue, so this development seems dire for the company at first glance.
There’s no denying that this ban will have a harsh impact on the world’s advanced semiconductor supply in the near-term and medium-term. One could argue that the U.S. government is hard at work handing out money to companies like Intel (INTC, Financial) so that they can produce chips in the U.S., but these new fabrication plants will still take years to build.
However, Bloomberg analysts only cut their revenue guidance for Lam Research by 11% in response to the news. Why not 30%? Part of the reason for this is because not all the equipment that Lam Research sells to China is for advanced semiconductor production, and part of it is because technology tends to find its way around the world despite the best efforts of governments trying to hoard it.
As the saying goes, as long as there’s a buyer for something, a seller will appear. It’s not that difficult for a middle man from another country to buy technology from a U.S. company and sell it to a Chinese company, or vice versa. Thus, the main result of trade bans such as this is just that the middle man gets a job and customers end up having to pay more due to higher production expenses. The only way to get rid of this workaround would be to ban U.S. companies from buying semiconductors from China, though even this would likely just give more middle men a job.
Most importantly for Lam Research, this means that it won’t lose all of its China revenue, and it will also benefit from the new chip factories that are soon to be under production in the U.S.
Company outlook
For its quarter that ended on Dec. 25, 2022, Lam Research has issued guidance for revenue of $5.1 billion, plus or minus $300 million, and net income per diluted share of $9.98, plus or minus $0.75. The company’s fiscal year ends in June. For reference, revenue was $4.2 billion in the year-ago quarter while net income per diluted share came in at $8.44.
In the longer term, analysts from Morningstar (MORN, Financial) are projecting the company’s full-year revenue to be $18.2 billion in fiscal 2023 and $16.1 billion in 2024 before recovering to $19.4 billion in 2025, while earnings per share are expected to be $34.77, $28.77 and $39.37.
These estimates are all highly unreliable due to how far in the future they are projecting into, but they do show a general expectation that Lam Research won’t be hit too hard by the headwinds it faces.
According to the GuruFocus discounted cash flow calculator, even if Lam Research were to only grow its earnings per share by 5.58% per year for the next decade (which is much lower than its past 10-year earnings growth rate of 42%), it still wouldn’t be overvalued at today’s levels.
All things considered, Lam Research seems extremely undervalued due to short-term headwinds that have been blown out of proportion combined with the general stock market downturn and risk-off sentiment. As long as the company can keep growing its earnings in the mid-to-high single digits or more, the stock price should eventually recover.
