Lam Research (LRCX, Financial) witnessed a fantastic year as evident from its full-year results. Gartner’s recent cut in its capital spending forecast for semiconductor equipment manufacturers clouds Lam Research's future prospects. The company appears resilient as it’s backed by the memory industry, not to mention its exposure to Asia Pacific.
Lam Research had an impressive year, resulting in revenue and EPS beat. The company posted revenue of $8.01 billion, up 36.1% on a year-over-year basis. Fourth-quarter revenue came around $2.34 billion compared to the consensus of $2.31 billion. Full-year GAAP EPS was $9.24, translating into a notable 77% year-over-year increase. The fourth-quarter result was no different as EPS, $3.11, came in ahead of the analyst consensus of $3.03.
For the next quarter, Lam Research is guiding for revenue between $2.35 billion and $2.55 billion and EPS from $3.13 to $3.37. Consensus estimates have revenue at $2.18 billion and EPS at $2.76.
Revenue insights
Double-digit revenue growth was possible as semiconductor players invested in fabrication equipment. Memory players are moving toward nonvolatile memory (NVM). FinFET was the key boosting factor for Lam Research’s top line.
As foundry players continue to invest in advanced process nodes, Lam Research is benefiting from this trend. Revenue share from foundry customers increased from 23% in fiscal year 2016 to 27% in fiscal year 2017.
Most of the revenue comes from memory as the company caters to the manufacturing needs of Micron Technology (MU, Financial) and SK Hynix Inc. (XKRX:000660). Increasing foundry revenue can be attributed to Lam Research’s exposure to Samsung (SSNLF, Financial) and Taiwan Semiconductor Manufacturing Co. (TSM, Financial). Shrinking process node technologies continue to benefit Lam Research.
From a geographical perspective, the company generated most of its revenue from Korea followed by Taiwan and China. The U.S. made up only 8% of the company’s total revenue during the fiscal year ended in June.
Lam Research depends heavily on the capital expenditure habits of memory and foundry players. Therefore, changes in semiconductor investment trends can materially affect the company's business prospects. Things look good amid changing memory technology and improving process technology.
Gartner predicts industry slowdown
Gartner notes that semiconductor capital expenditure is expected to decline 0.5% and 7.3% in 2018 and 2019 before registering 2% growth in 2020. Double-digit growth in 2016 and 2017 might be the reason for the upcoming slowdown. Gartner radically changed its previous forecast of 5.3% and 6.4% growth in 2017 and 2018.
Source: Gartner (January)
Gartner’s previous forecast was that the wafer fabrication equipment market will stay put during 2018 before growing 8.4% in 2019. Wafer-level packaging and equipment spending was expected to witness double-digit growth during the next couple of years. But Gartner doesn’t see any growth in the WFE market during the next few years. Some other research firms tend to differ, though.
Others tend to disagree
TechNavio is optimistic; the research firm forecasts a CAGR of 7% for the production equipment market until 2021. The research firm cites the rise of automotive electronics as the primary contributor toward that growth. Moreover, a report from MarketsandMarkets predicts the semiconductor manufacturing equipment market will reach $62.56 billion by 2023, a CAGR of 6.86%. Asia Pacific is expected to be the fastest-growing market, the report points out.
Note that the forecast from TechNavio and MarketsandMarkets includes 2017, which is a high double-digit growth year in Gartner estimates. 2017 growth seems to be the driving factor of growth forecasts presented by TechNavio and MarketsandMarkets. Gartner might be right about the slowdown for 2018 and 2019 after all.
How does this affect Lam Research?
For Lam Research, there is another factor at play, the memory industry. Samsung, TSMC, SK Hynix and Micron are among the top companies in terms of capital expenditure in the semiconductor industry. With a 31% increase, the DRAM/SRAM segment is expected to display the largest percentage increase in capital expenditures of the major products types listed this year, cited IC Insights in its May Update to the 2017 McCleanReport.
Semi.org forecasts the front-end fab equipment market to grow 8% in 2018, reaching $50 billion. Memory, including DRAM and NAND, will support this growth.
Semiconductor CAPEX is indeed fueling the growth of wafer manufacturing equipment companies, especially memory-oriented companies. Slowdown in growth is expected amid heavy CAPEX investments in the recent past.
Lam Research is poised to benefit as four of the top five capital expenditure intensive companies belong to Lam’s client list. Lam Research’s exposure to the memory market also bodes well for the company. The company generates more than 60% of its revenue from the memory market.
Overall, slowdown in growth isn’t expected to hit Lam Research much because of its heavy presence in the memory market and Asia Pacific. Note that Asia Pacific is set to remain the highest-growing market in WFE going forward.
Valuation insights
Valuation based on economic value added approach reveals upside for Lam Research. Analysts expect earnings to grow 27% in 2018 followed by a 6% increase in 2019. High earnings growth in 2018 is plausible as Lam Research’s 2018 reporting year includes the second half of the calendar year 2017. As Gartner expects 19% growth during 2017, high earnings growth for Lam Research is possible. Note that Gartner’s 2016 forecast for Fab equipment stood at 11.4% yet Lam Research managed to post more than 30% top-line growth during 2017. The point is that analysts’ EPS consensus is a good proxy for Lam Research’s earnings growth. See the valuation below:
| Projections | Â | Â | 2018 | 2019 | 2020 | 2021 | 2022 | Perpetuity |
| Â | Â | Notes | Â | Â | Â | Â | Â | Dollars in million |
| Net Income | Â | Â | 2065.38 | 2206.75 | 2272.95 | 2341.14 | 2411.38 | 2483.72 |
| Â | Cost of capital | r*capital invested | 362.05 | 467.86 | 576.34 | 681.65 | 784.17 | 884.27 |
| Dividends | Â | Â | 292.50 | 292.50 | 292.50 | 292.50 | 292.50 | 292.50 |
| Adjusted Net Income | Â | Â | 1703.33 | 1738.89 | 1696.61 | 1659.49 | 1627.20 | 1599.44 |
| Discount factor | Â | Â | 1.00 | 0.93 | 0.87 | 0.80 | 0.75 | 11.52 |
| Economic Value Added | Â | Â | 1703.33 | 1617.57 | 1468.14 | 1335.83 | 1218.45 | 18425.58 |
| Period | Â | Â | 0 | 1 | 2 | 3 | 4 | 5 |
| Â | Â | Â | Â | Market value added | 25769 | Â | ||
| Â | Â | Â | Â | Invested Capital | 5120 | Â | ||
| Â | Â | Â | Â | Value of the equity | 30889 | Â | ||
| Perpetual Growth in Residual Earnings | 0.8% | Price Target | 190.1 | Â | ||||
Focus Equity Estimates
Valuation reveals an upside of around 15% based on double-digit earnings growth in 2018 before falling to 6% in 2019.
Final thoughts
Lam Research might not be able to replicate the growth of 2017 going forward. Nevertheless, there are several positives including growth in the DRAM and NAND market along with the healthy Asia Pacific market. Lam is set to witness growth amid its exposure to memory and APAC despite a predicted slowdown in wafer manufacturing equipment expenditure going forward. Shrinking process nodes and new memory architectures will continue to fuel Lam Research’s growth. Valuation also paints a favorable picture.
Risk
If Lam Research fails to meet analysts’ EPS expectations, EVA valuation won't result in a $190 price target.
Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.
