Lam Research (LRCX 2.65%) stock keeps going up. This may be a bit confounding, given that the company's largest end market, memory chip manufacturing, is in a deep slump due to excess inventory. Investors don't seem to care much. Shares are up nearly 50% so far this year and are re-approaching all-time highs.
Perhaps we can blame the current hype cycle focused on artificial intelligence (AI) and all of its game-changing potential, as well as electric vehicles (EVs) going mainstream. That's fair. But is Lam Research still a buy after the recent surge?
The importance of advanced chips and packaging
Lam Research has made a couple of moves lately highlighting the coming boom in advanced chips used in AI systems and EVs. Last November, it bought a small business called SEMSYSCO off the hands of a private equity company.
SEMSYSCO specializes in advanced chip-packaging equipment, particularly for complex systems used for AI, cloud computing, and other data-intensive applications (like the modern vehicle). Packaging is when a silicon wafer (what you can often see someone in a lab suit holding in a chip fab facility) is diced up into chips, then assembled into a computer.
More recently, Lam announced some new chip manufacturing equipment it cooked up in-house. Dubbed the Coronus DX, this machine is involved in the complicated manufacture of the wafers themselves, before the packaging step.
In the company's words, here's what the Coronus DX does: "As semiconductors continue to scale, manufacturing becomes increasingly complex with hundreds of process steps needed to build nanometer-sized devices on a silicon wafer. In a single step, Coronus DX deposits a proprietary layer of protective film on both sides of the wafer edge that helps prevent defects and damage that can often occur during advanced semiconductor manufacturing."
Why is this important? When it comes time to dice up those wafers into chips, oftentimes the edges are unusable. That's a growing problem with the most advanced chipmaking processes. Basically, Lam has a way to make more of the edge of the wafer usable, decreasing waste and increasing the number of chips that can be sold per wafer (known as the "yield" in industry parlance).
As companies grapple with the rising expense of AI and EVs, better yield from manufacturing can be a great way to boost profit margin early on in the semiconductor-development supply chain.
Lam and friends have deep hooks in this economy
Lam isn't the only company developing advanced equipment for chips that eventually find their way in AI supercomputers and EVs. The cost to develop these chips has soared over the last decade, and that trend isn't going to ease anytime soon.
As the price tag rises, more power has concentrated into Lam and the other top four chip manufacturing equipment companies that form an oligopoly. Whether you're Intel (INTC -9.20%) or Taiwan Semiconductor Manufacturing (TSM 1.26%) or Texas Instruments (TXN 1.27%), it doesn't matter; you're highly reliant on these equipment makers.
Besides Lam, they are as follows (from most revenue to least):
- Applied Materials (AMAT 2.98%): The generalist with the broadest portfolio of chipmaking equipment.
- ASML Holding (ASML 2.04%): The specialist, focused on lithography equipment, including a monopoly on the most advanced type called extreme ultraviolet (EUV) lithography.
- Tokyo Electron (TOEL.Y 1.59%): Another broad portfolio of equipment like Lam and Applied, including coater/developers that deposit chemicals on wafers used in crafting fine features of chips.
- KLA Corp (KLAC 4.95%): The specialist in metrology and process diagnostic and control (PDC), used to ensure that the complex manufacturing processes are working as intended.
Data by YCharts.
Time to be cautious, or just keep buying?
There's a clear path to long-term growth for Lam and its peers as the semiconductor industry goes from just shy of $600 billion in global sales in 2022 to $1 trillion per year by the end of this decade. But there will be bumps in the road, as there are with any manufacturing industry. And 2023 is one of those years.
Lam said its quarter that ends in June will produce about $3.1 billion in revenue and earnings per share (EPS) of $4.75. That's a steep drop from the quarter just six months prior that ended in December 2022, when revenue was nearly $5.3 billion and EPS was $10.77. And yet, the stock is up since then. Have investors lost their minds?
Likely not. A number of months back, Lam shares were cheap -- and a solid argument could be made that they still are. Despite a nasty downturn driven primarily by advanced memory chips (one of Lam's top chip-fab end markets), the company is still highly profitable. Thank strict cost controls management has put in place to help manage the nasty downturn of 2023. And by 2024, Lam is expected to be back in strong growth mode.
Shares currently trade for 17 times trailing-12-month EPS, but 24 times next year's expected EPS. Clearly, Lam has some tough quarters ahead of it. However, again keep in mind it's still highly profitable even during one of the nastiest downturns for the chip market in decades.
And what Lam is choosing to do to bridge the gap between now and when it eventually returns to growth mode is important. The company is returning excess cash to shareholders, especially leaning into its robust free cash flow to do so. Over the last reported 12 months, Lam generated $3.95 billion in free cash flow. It used $2.02 billion to buy back stock, and used much of the rest to pay a dividend (which currently yields 1.1% a year).
So is Lam Research stock a buy? Personally, I'm still in wait-and-see mode for now. I like the discount offered on Applied Materials and KLA Corp a bit more at the moment. But Lam's stellar rebound so far in 2023 isn't out of bounds. Keep this key under-the-radar player in the semiconductor industry on your radar.
