Shares of Lam Research (LRCX +3.96%) took a beating after the company released disappointing fiscal 2022 second-quarter results for the three months ending on Dec. 26, 2021.
Lam stock fell 7% following the release of the earnings report on Jan. 26 as the company's performance was affected by supply chain constraints plaguing the semiconductor industry. However, a closer look indicates that Lam's problems should be short-term in nature. Let's look at the reasons why.
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Lam Research's slowdown should be temporary
Lam Research reported Q2 revenue of $4.23 billion, a jump of 22% over the prior-year period. Adjusted earnings increased 41% year over year to $8.53 per share during the quarter. Wall Street, however, was looking for adjusted earnings of $8.52 per share on revenue of $4.41 billion. It is worth noting that Lam's quarterly revenue and earnings were below the midpoint of the guidance that it had issued in October last year.
However, the weaker-than-expected results were caused by factors out of Lam's control. CEO Tim Archer explained this on the company's latest earnings conference call:
Lam's operations and results were impacted by the effects of COVID-19, labor shortages, freight and logistics cost escalation and supply chain constraints.
Archer also said that the rapid spread of the omicron variant of the coronavirus has led to "further disruption to freight and logistics operations as well as exacerbating skilled labor shortages." Additionally, the company faces a substantial shortage of components and parts, which explains why its guidance fell way behind what Wall Street was anticipating.
Lam anticipates $4.25 billion in revenue this quarter at the midpoint of its guidance range, along with adjusted earnings of $7.45 per share. For comparison, Lam earned $7.41 per share on revenue of $3.85 billion in the prior-year period. So while the company's top line could increase 10% year over year at the midpoint, its earnings are on track to decline thanks to the higher costs caused by the supply chain constraints.
Lam points out that it is incurring additional costs to secure the supply of more semiconductor components and fulfill the end-market demand for its machines, which are used in the fabrication of chips. However, the near-term supply chain problems mean that Lam won't be able to match Wall Street's Q3 expectation of $8.72 per share in earnings on $4.49 billion in revenue by a wide margin.
The good part is that Lam management sees the supply chain situation improving in the coming quarters, which should eventually allow the company to meet the robust demand from customers and get its growth back on track.
Don't miss the bigger picture
The problem with Lam Research right now is that it doesn't have the resources to fulfill the tremendous demand for its products. Lam management pointed out on the earnings call that customer demand is exceeding supply, and that has led to five straight quarters of growth in the company's backlog.
Lam's deferred revenue is also an indicator of the robust demand for the company's semiconductor manufacturing equipment. The company's deferred revenue stood at $1.46 billion at the end of last quarter, a massive increase compared to $640 million in the year-ago period. What's more, Lam believes that its deferred revenue could grow another $500 million in the current quarter on account of the supply chain constraints.
Deferred revenue is the money collected in advance by a company for services that will be rendered later. It is recorded as revenue on the income statement once the actual delivery of products or services takes place. The increase in this metric indicates that Lam customers continue to place orders for the company's solutions, and the increasing deferred revenue pipeline points toward strong revenue growth once the orders are fulfilled.
Moreover, Lam is operating in a market that's built for long-term growth. That's because the company "designs, manufactures, markets, refurbishes, and services semiconductor processing equipment used in the fabrication of integrated circuits." Lam's solutions are used by foundry/logic customers as well as memory manufacturers, whose appetite for equipment isn't going to slow down any time soon.
Spending on semiconductor fabrication equipment is expected to hit $100 billion this year following last year's estimate of $90 billion. It wouldn't be surprising to see such high levels of spending continue in the future as well thanks to the higher capital spending by foundries and memory manufacturers. Taiwan Semiconductor Manufacturing, for instance, has a capital spending budget of $40 billion to $44 billion for 2022, up significantly from last year's outlay of $30 billion.
Micron Technology, on the other hand, has a $150 billion spending forecast for the next decade, while Intel recently revealed plans to invest up to $100 billion in a semiconductor complex in Ohio. These investments bode well for Lam Research, as it counts the likes of Intel, Micron, Samsung, SK Hynix, and TSMC among its "most significant customers."
The valuation makes it a compelling buy
Investors should look beyond the near-term problems Lam Research is facing, as the company could regain its mojo thanks to the lucrative semiconductor opportunity it is sitting on. Analysts expect the company's earnings to increase at an annual pace of 16% for the next five years, though it could do better once the supply-related challenges ease.
All of this makes Lam Research an enticing semiconductor stock to buy right now, as it is trading at just 18 times trailing earnings, which makes it cheaper than the S&P 500, which has an earnings multiple of 27.
