Looking to put new money to work today? It's not an easy task to find great values. The COVID-19 pandemic is wreaking havoc on many businesses related to travel and leisure, or anything that really depends on leaving the house. In addition, mass furloughs could lead to a recessionary mindset and decreased spending.
Yet stocks have already rallied strongly from the March lows, as massive government stimulus measures and a decrease in new COVID-19 hospitalizations have brought lots of optimism to the market. And if a certain company makes products or services that benefit from either the digitization of business or the stay-at-home economy, its stock is likely higher than when the year started!
So, are there any stocks left that still cater to these next-generation technologies, yet haven't yet fully recovered from the March plunge? These days, I've been looking at memory stocks, some semiconductor stocks, and semiconductor equipment stocks. Among them, my top pick for June is semicap equipment supplier Lam Research (LRCX -0.25%).
Image source: Lam Research analyst day presentation.
Lam Research's recent performance
Like many technology stocks, Lam Research has bounced back significantly from its March lows, but its stock is still over 20% below its all-time highs set back in February, about double the decline of the overall market.
Lam's bounce-back back was recently halted by the reemergence of U.S.-China tensions. The U.S. government recently proposed new rules that could limit sales of semiconductor manufacturing equipment to certain non-U.S. foundries which supply Chinese tech company Huawei with advanced chips.
The news immediately sent shares of Lam, as well as those of other equipment suppliers lower. However, the U.S. seems to be directly targeting only Huawei's military equipment and perhaps 5G base stations. As long as those restrictions only apply narrowly, it appears as though China chip sales may only be slightly affected. If the restrictions lead to a ban on all kinds of chips to all Chinese companies, even consumer-facing ones, that would be another thing. However, I think it's a stretch to think the U.S. would go that far at this point.
While Lam Research does get 32% of sales from China, only about half of those customers are Chinese companies, with the remainder being other companies with manufacturing operations within China. And of that half -- call it 15% of Lam's sales -- only a small fraction of those could potentially be affected, as Lam counts NAND, DRAM, and lagging-edge foundries within China as customers. Yet even if foreign non-Chinese foundries such as Taiwan Semiconductor Manufacturing (TSM 1.60%) are restricted from selling chips to Huawei, some of that market should be filled in by other vendors, as Huawei cedes market share to other companies inside and outside of China.
Lam's strength looks intact
China issues aside, Lam's strong competitive advantages seem intact, its growth prospects remain strong, and its valuation is still quite reasonable. That's why the recent China-related tensions may have opened up an opportunity.
Over the years, many semicap equipment companies have consolidated, leaving critical and technologically difficult steps in advanced semiconductor manufacturing with only one or two key vendors that compete -- Lam being one of them. Lam' equipment is especially important for making leading-edge semiconductor chips for things like 5G and artificial intelligence processing, and also stacking NAND flash memory modules. NAND is a high-growth category that should be a critical data storage technology in the decade ahead.
Lam is winning even in a narrow competitive field
In addition, Lam has been especially good in outgrowing the industry, increasing revenue by a 16% average growth rate between 2013 and 2019, versus the semicap equipment industry's still-strong growth of 8%. So, Lam has been growing market share for the past six years. However, in the company's recent analyst day presentation, management believes it can continue to take four to eight more percentage points of market share in etch and deposition equipment by 2023.
Image source: Lam Research analyst day presentation.
The strong competitive position and execution has made Lam immensely profitable, with a return on invested capital at or near 50% for each other last four years -- and that includes two years of "up-cycle" and two years of "down-cycle" in equipment sales, showing that the company can remain profitable even when overall semiconductor spending has been soft.
Lam's resilience has been for a couple reasons. Importantly, Lam's services business has grown along with its installed base, and is an annuity-like stream that isn't as affected by cycles as equipment purchases. Not only is Lam's installed base growing, but its "revenue per chamber" is growing as well, as the company has added more and more value-add services over the years. Last quarter, Lam's services revenue amounted to 34.2% of overall sales, putting a nice floor on results even as equipment sales were held back by stay-at-home orders.
Image source: Lam investor day presentation.
Second, as the world becomes more digitized, the demand for high-powered chips and memory is increasing by leaps and bounds. In fact, silicon chips have more than doubled their proportion of world gross domestic over the last 20 years, and the trend continues to be up, even if it is uneven from year to year. Going forward, in order to make more and more advanced logic and memory chips, the amount of process steps per chip is increasing, leading to a long-term growth trajectory for Lam's mission-critical products and services, no matter what the broader economy is doing.
And while the economy is in a dip right now, all of the semiconductor-hungry digital trends services should get a boost as a result of COVID-19, as more and more businesses allow teleworking, hospitals turn to tele-medicine, and schools and colleges turn to more remote education.
Valuation remains reasonable
Unlike many tech stocks that are levered to many of these big tech trends, Lam still actually trades at a relatively reasonable valuation for such a strong company, at just over 19 times trailing earnings but just 14.8 times forward earnings. Lam also pays a dividend that yields 1.72%, which isn't too shabby, considering Lam intends to grow that dividend every year.
That's a very reasonable price for a company with a robust services business, long-term growth trends, and a solid balance sheet, with more cash than debt. In a market that has quickly become fairly valued (or even better), Lam stands out to me right now as a high-quality dividend growth stock that hasn't yet recovered all the way, opening up an opportunity for Foolish long-term investors.
