Why Lam Research is a Good Buy at Current Levels

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Mar 23, 2015

Lam Research (LRCX, Financial) is a global supplier of innovative wafer fabrication equipment and services to the semiconductor industry. The company design, manufacture, market, refurbish and service semiconductor processing systems that are used in the fabrication of integrated circuits. Lam Research's market-leading products are designed to help its customers build smaller, faster, and more power-efficient devices that are used in a variety of electronic products, including cell phones, tablets, computers, storage devices, and networking equipment. The company's products include Plasma Etch, Thin Film Deposition, single Wafer Clean and Photoresist Strip.

The company’s customer base includes leading semiconductor memory, foundry, and integrated device manufacturers that make products such as DRAM, NAND memory, and logic devices. In fiscal years 2014, 2013, and 2012, three customers, Samsung Electronics Company, Ltd. (SSNLF, Financial), SK Hynix Inc. (HXSCL, Financial) and Taiwan Semiconductor Manufacturing Company, Ltd. (TSM, Financial), each individually represented greater than 10% of the company's total revenues.

The company spends considerable amount on Research and Development. The company's R&D expenses during fiscal years 2014, 2013, and 2012 were $716.5 million, $683.7 million, and $444.6 million, respectively. The majority of R&D spending over the past three years has been targeted at deposition, etch, single-wafer clean, and other semiconductor manufacturing products.

The company's primary competitors include Tokyo Electron (TOELY, Financial), Applied Materials (AMAT, Financial), Dainippon Screen Manufacturing Co., Semes, ASM International (ASMI, Financial) and Wonik IPS.

Financial overview

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The company has seen good growth in its topline from FY2012 to FY2014. In addition to organic growth and market share gains, the company's results also benefited from its acquisition of Novellus Systems, Inc (NVLS, Financial). The company's EPS decreased from FY2012 to FY2013 due to one time integration cost of Novellus. However, it again increased meaningfully from FY2013 to FY2014. For the twelve months ended December 2014, the company's EPS was $4.02.

Investment argument

Lam Research reported strong December quarter results where it showed strength across all metrics. The company's revenue came at $1.232 billion, which were up 7% from the prior quarter, making it the sixth consecutive quarter with revenues above the $1 billion mark. Within the quarter, the company grew backlog by greater than 20%. for the full year, the company's revenue growth rate outperformed the industry by a factor of two with its profit expansion at more than twice the pace of its revenue growth.

In 2014, the company made meaningful progress against its market share targets, introducing new products and services to participate in the market expansion opportunities of various technology inflections, including multi-patterning, FinFET, 3D NAND and advanced Packaging. The company delivered 20 new products and offerings to its customers, the most notable being Vector ALD oxide deposition system and the flex FX dielectric etch system. Both these products are experiencing unprecedented momentum.

Going forward, in 2015, the company's focus is to execute well on the opportunities it has already won, gain market share with a focus on atomic level control in deposition and etch process, prioritize employee organization and business system development to enable scaling and deliver profitability required to fund growth.

The company also has significant market expansion opportunity in WFE markets going forward. Prior to acquisition of Novellus, the company competed for 19% of WFE market with its standalone etch and clean product portfolio. Subsequent to the addition of the deposition portfolio post merger, the company competed for 25% of WFE at the date of Lam-Novellus merger closing. On the three year anniversary of announcing that deal (June 2015), the company will have a product portfolio that will compete for approximately 28.5% of WFE while by 2017 this number will increase to more than 30%. So, there is a meaningful market share gain opportunity which combined with market share gains, can provide a meaningful upside for the company going forward.

In addition to good growth prospects, management's willingness to return capital to the shareholders also makes Lam Research a good buy. Last year, the company established a $1 billion capital return program which included the institution of Lam Research's first-ever quarterly dividend program. The company generated $942 million in operating income for the year and returned approximately $486 million to its shareholders through dividend and share repurchases. In recognition to the company's strong financial performance, it was recently added to the NASDAQ 100 index.

Lam Research is trading at a P/E of 19.70 which is a discount to its peers like Applied Materials which has a P/E of 25.70 and ASML Holding (ASML, Financial), which has a PE of 35.10. The company's top line is expected to grow 11.40% in the current year and 7.80% next year. Analyst opinion is overwhelmingly positive about the company and out of 21 analysts covering the company 19 have buy ratings. I believe the company is a good buy given its strong growth prospects and relative undervaluation.