Lam Research (LRCX -3.27%) has been on a tear since the start of 2023, more than doubling in value in that span of time and setting fresh all-time-highs. And all of this comes in the middle of a downturn for Lam's segment of the semiconductor market. What gives?
Lam, along with its chip manufacturing equipment peers like ASML Holding and Applied Materials, is benefiting from nations across the globe funneling incentives toward domestic semiconductor production. In addition to this, artificial intelligence (AI) systems like those from Nvidia are putting heftier performance demands on chips. Lam is a key provider of the advanced equipment needed to make these AI systems.
Investors have begun to catch on to the opportunity and have thus driven Lam stock higher. But as an under-followed AI development company, Lam could still have a lot to gain in the coming years. Here's why.
Help wanted: memory and logic chips
Lam recently reported financial results for its March 2024 quarter, and on the surface, it didn't appear all that good. Revenue was down 2% year-over-year to $3.79 billion, though earnings per share (EPS) did rally 22% from depressed profit margins during the bear market that was still plaguing Lam the year prior.
Data by YCharts.
While the current quarter that will end in June is again expected to be muted for sales, investors are eyeing the next uptick in chipmaking equipment purchases that could kick in starting the second half of 2024. And for Lam, it's not just the start of a new growth cycle that will bring relief to its recently flagging financial results. Its customers -- especially big chip fabs like Taiwan Semiconductor Manufacturing, Intel, Samsung and Micron Technology -- are scrambling to meet demands from AI systems.
What that means is new cutting-edge, more expensive, and higher-profit-margin equipment sales for Lam. For example, new AI systems make liberal use of HBM (high-bandwidth memory) chips to keep plenty of data feeding the powerful GPUs (like what Nvidia specializes in). Lam is a leader in providing the machines that create through-silicon vias (TSVs) that enable the memory chip stacking for HBM devices.
And on the logic chip side of the equation (like the GPUs themselves in an AI system), Lam has been developing new equipment that makes lithography machines from ASML more efficient. It has also been working on backside power delivery, a technique that Intel (and later, other chip fabs) plans on pioneering in upcoming chip manufacturing processes that aim to increase the power-to-performance of high-end chips.
These new machines are expected to potentially drive Lam's total sales several billion dollars per-year higher than during the last peak sales cycle (see chart above). Sometime in 2026, the consensus among Wall Street analysts is that Lam surpasses $20 billion in annualized sales, which jibes with industry estimates that the most advanced chip fab equipment will reach fresh sales records that year. Industry researcher Semi.org predicts advanced fab equipment spending could reach nearly $120 billion in 2026, up drastically from the previous peak of about $90 billion in 2022.
Lam's secret advantage in the AI race
Besides just potential sales growth, though, the real advantage to owning shares of a company like Lam is the even bigger run-up in EPS during growth cycles like this one. Over the last decade in particular, Lam has been steadily increasing its profit margins, and repurchasing lots of stock (which boosts future EPS) along the way.
Data by YCharts.
If Lam continues to execute well on this strategy during this current round of AI development, it could be a fantastic investment. Shares trade for about 33 times trailing 12-month EPS, or 26 times trailing 12-month free cash flow, figures that could get steadily more attractive as Lam's profitability recovers from the bear market as expected throughout the rest of 2024 and beyond.
For these reasons, I started accumulating shares of Lam Research late in 2023, and plan on buying some more this spring. Long-term, investors need to be aware of the cyclicality of a manufacturing business like this one. At some point, after the fresh growth cycle that might get rolling later this year is finished, there is going to be another slump in revenue. Nevertheless, Lam has proven itself as a longtime market-beating investment for those willing to ride out the rollercoaster ride.
