Lam Research: Q4 Preview And Go-Forward Prospects (NASDAQ:LRCX)

California-based Lam Research (NASDAQ:LRCX) is a leading semiconductor equipment provider that specializes in the deposition, etch, and cleanings steps of the manufacturing process. The company stays on the leading-edge of its technology niche and, as a result, its products & services are in demand by semiconductor companies across the world that need to build ever smaller, faster, and lower-power chips for a variety of markets. These markets include memory devices (NAND), cell-phones, personal computers, servers, GPUs and EVs – just to name a few. In the process (no pun intended), Lam has established itself as a strong generator of free-cash-flow that has delivered excellent shareholders returns. Indeed, over the past 5-years LRCX has not only outperformed the broad semiconductor industry as a whole as measured by the VanEck Semiconductor ETF (SMH), but has about tripled the returns of the Nasdaq-100 (QQQ):

Today, I will preview what investors can expect from Lam Research’s calendar Q4 2023 earnings report, which is due out on January 24th (this coming Wednesday). I’ll also look at the company’s prospects going forward.

Investment Thesis

If you follow me on Seeking Alpha, and even if you don’t, you no doubt already know the thesis for investing in the semiconductor sector: strong global demand coming from multiple sub-sectors that have long-term secular growth trends. These include markets such as high-speed networking, 5G cell-phones & infrastructure, IoT, data centers, EVs and clean tech, high-performance computing (“HPC”), and of course the latest headline grabber: AI. The point is, the semiconductor sector today is much more diversified and less cyclical than it was in the “dot.com” era 25 years ago, when it was still largely dependent on demand from the PC and automotive markets for the majority of revenue. Today, this strong demand for semiconductors across a plethora of tech sub-sectors corresponds to strong demand for semiconductor-equipment from makers like Lam Research, Applied Materials (AMAT), KLA Corp. (KLAC), and ASML Holdings (ASML).

Meantime, the on-shoring of semiconductor production, as well as the expansion of domestic semiconductor capacity as a result of the Biden Administration’s CHIPS & Science Act, provides for a relatively clear line-of-sight for lucrative near- and mid-term market opportunities.

Let’s take a look at LRCX’s recent financial performance and preview the upcoming calendar Q4 2023 report, due this coming Wednesday.

Earnings

In its Q3 report, Lam reported solid sequential revenue growth of 8.6%:

However, revenue was down 31% on a yoy basis. Gross margin in Q3 grew by two full percentage points sequentially, while operating margin increased by 2.8 percentage points to 29.4%. As a result, per share EPS grew by 11.6% to $6.66/share sequentially.

On the Q3 conference call, Lam reported a continued strong backlog of EUR$35 billion (US$38 billion). The company also expects calendar Q4 gross margin to come in at a range of 50-51%, which at the midpoint would be +3 full percentage points on a sequential basis – a nice tailwind.

Recent consensus earnings estimates for the calendar Q4 report due next week, per Yahoo Finance, are shown below:

As you can see, LRCX is a well followed company (20 analysts) and the consensus EPS estimate for Q4 is $7.10/share (which would be +6.6% on a sequential). However, as you can see from the low- and high-estimates, there is a relatively high-level of uncertainty in the consensus estimate. That is likely a reflection of the high degree of uncertainty management discussed on the previously referenced conference call:

While lithography tool utilization are still running at levels lower than normal relative to last quarter, tool utilization in Logic continues to show signs of improvement, while Memory has yet to turn. We concur with our customers that still expect to see an inflection point, indicating the start of a recovery by the end of the year, although the shape and slope of the recovery remains uncertain.

Despite these comments, note that there is significantly more upside potential (i.e. the high estimate is $7.63/share) as compared to the downside. Indeed, over the past 90 days, the Q4 consensus earnings estimate for LRCX has risen by $0.42/share.

Looking Forward

On last October Q3 conference call, Peter Wennink – Lam Research President & CEO – said the following:

Looking further ahead to 2025, we expect a significant growth year since more than 50% of our EUV and DUV shipments will go to new fab projects. On top of this, we expect existing fabs will be adding capacity, driven by continued recovery cycle.

Lam management did raise its guidance for full-year 2023 wafer-fab equipment (“WFE”) from $70 billion to $80 billion. While that is still down from $90+ billion in 2022, investors should assume that LRCX captured some part of that incremental $10 billion expansion market as the year closed.

One of Lam’s biggest customers is Intel (INTC). Intel is implementing aggressive growth plans in an attempt to catch (and perhaps pass …) Taiwan Semiconductor (TSM) and put the “#1 semiconductor company” crown back on its head. Over the mid-term, this should be a positive catalyst for LRCX.

On a longer-term basis, LRCX is perfectly positioned to benefit from the long-term secular growth of the semiconductor sector, which in my opinion is such a strategic industry that I advise all investors to allocate some capital and establish and hold a long-term core position in the sector (see: SMH: You Need Exposure To The Vibrant & Lucrative Semiconductor Sector).

Risks

Lam ended Q3 with cash & cash equivalents of $5.1 billion and long-term debt of $5 billion, so the company has a very strong balance sheet and is basically net-debt free.

Lam’s high-end equipment sales are primarily exposed to the memory segment: NAND, 3-D stacking, and extreme ultra-violet (“EUV”) lithography. That being the case, the company likely won’t return to previous robust growth rates until the recovery in the memory sub-sector begins in earnest. Investors should listen closely to the Q4 conference call for any commentary management may offer in that regard.

According to the Q3 earnings report referenced earlier, Lam’s regional sales were as follows:

Click to enlarge

However, 48% of revenue from China is not as big a negative as many investors might assume. I say that because, despite the U.S. semiconductor equipment trade restrictions on China, the majority of LRCX’s equipment sold to China is for mature nodes (i.e. not leading edge processes) and therefore fall outside of the U.S. trade restrictions. The majority of LRCX’s high-end equipment is going to Korea, Japan, Taiwan, and the U.S.

Lam has a very strong customer service business (i.e. think systems maintenance) that is a revenue buoy that mitigates risk during times of slowing systems orders (just as it has over the past year or so). Indeed, in Q3, customer support related revenue was $1.43 billion (41% of total). This is a high-margin and oft overlooked segment that is an important piece of the investment thesis in Lam Research. That’s because as the number of Lam’s systems that are in-service increases over time, the more the customer-service segment grows. For those investors familiar with SaaS-based business models, you can almost think of Lam’s customer-service revenue as a source of ARR (“annual recurring revenue”).

Summary & Conclusion

Lam is one of my favorite semiconductor equipment companies, and the stock is +83% since my Nov. 2022 Seeking Alpha buy-rated article (see: Lam Research: Undervalued By A Long Shot).

However, Lam’s stock price popped to the upside during the 2023 year-end tech sector rally and YTD on the recent AI-driven catalyst, which was given an additional turbo-boost this week when Taiwan Semiconductor’s (TSM) released a strong Q4 report that beat on both the top- and bottom-lines. However, it was TSM’s Q4 conference call guidance that FY24 revenue would grow in the low- to mid-20% range this year that really lit a fire under the sector. This is demonstrated by a 3-month total returns chart of LRCX, the triple Q’s, and the SMH Semiconductor ETF:

Indeed, at pixel time, Lam stock ($826.71) had already significantly surpassed New Street Research’s PT of $790, which was reiterated only a month ago.

LRCX currently trades with a TTM and forward P/E=28x. The annual dividend is $8/share, which equates to a current yield of only ~1%. The company increased its dividend by 16% in September. However, in the September quarter, Lam spent $830 million on share repurchases and only $230 million on dividends. That being the case, and while dividend growth has been excellent, the primary investment thesis in Lam Research is capital appreciation, not income.

Bottom line: I like Lam Research, its products, its growth prospects, its strong free-cash-flow profile, and the company’s underrated customer service business. However, I am getting a bit nervous about the recent big rally in the semiconductor sector. There may be a better entry point into LRCX in the relatively near future. That said, I would not sell the stock if I already owned it – I rate LRCX a HOLD.

Meantime, the SMH ETF may be a better and diversified way to play the semiconductor thesis at this time. SMH has strong exposure to Nvidia (NVDA), TSMC, and Broadcom (AVGO) – and LRCX is the #7 holding in SMH with a 4.4% weight. That said, and while SMH may be a better diversified investment opportunity, it too has rallied sharply of late. That being the case, I continue to advise investors to scale-into a full-position in SMH slowly (or “dollar-cost-average” if you prefer …), perhaps over a period of months, in order to take advantage of market volatility and make sure you don’t go “all in” at the peak. Heck, it took me a couple years to establish my personal full-position in SMH (and I still nibble at it from time-to-time).

I’ll end with a 5-year total returns comparison of LRCX versus the SMH ETF:

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.