Lam Research Corporation
Semiconductor manufacturing is a complex process, but let's try to break it down into something more simple for the purpose of looking at Lam. The etch and clean steps are closely related. Etch refers to removing portions of material layers placed on top of silicon wafers in order to create integrated circuit patterns. The clean step then follows, removing the leftover particles and residues from the etch step. One way to think of it is chiseling a stone tablet. Etch would be the chiseling, while clean would be brushing off the stone pieces and powder left over.
Lam's Exelan and Versys products have a very solid market share in their segments. Lam boasts about 54% market share in the etch equipment sector, and nearly 30% in single wafer clean. The company has continued to gain share in both areas over the past few years. Its main competitors are the large full-line equipment suppliers, notably Applied Materials (AMAT) and Tokyo Electron. While these firms have been focused on taking business in etch and clean, they have failed to make much inroads as of yet, and chip equipment is a business with fairly high switching costs and customer loyalty. Lam's competitive position is strong.
Lam also boasts a very impressive balance sheet, which is paramount for such a cyclical industry. Over $1 billion in cash dwarfs the approximately $21 million in debt. Free cash flow is strong, averaging 15% of revenues over the past 5 years. Normalized return on capital is outstanding at a 70% average 5-year rate. I'm also really impressed with Lam's stability in a volatile industry. Aside from fiscal (June) 2009, in which Lam posted a loss along with everyone else in the sector, operating margins have remained stable between 20-30%.
Finally, growth prospects look good over the next year or so. A solid cyclical rebound off of 2009 is underway. Lam's Q2 showed a 79% year-over-year increase in revenues, and solid quarter-to-quarter growth as well. Expectations for fiscal 2011 show a 53% growth in sales and almost 90% in operating profits. Management estimates that several of its end-markets are set for major growth this year, particularly NAND flash which is needed for smartphones and tablets. Industry analysts predict flat to 10% growth in overall chip equipment spending in 2011.
The primary risk is a easing of chip capacity expansion, which would likely be triggered by a significant slowdown in smart-phone sales and/or a failure of the emerging tablet market to sell up to expectations. Customer concentration is also somewhat of a concern, with Samsung, TSMC (TSM), and Toshiba making up half of sales. Intel (INTC), the world's largest chip-maker, does not do business with Lam.
Clearly, 2011 results will be robust. However, it is only reasonable to assume that year-over-year growth in smartphone shipments will moderate by the end of the year. Equipment spending is an early cycle activity. Following 90% growth for 2011, I model flat results for 2012, followed by a typical cyclical downturn for 2013 before a rebound and better-than-average growth over the long-term. Using those assumptions, and accounting for Lam's historical multiples, I think the stock is worth about $63 a share. That's about 19% above where it trades today.
That is a decent margin of safety, and with Lam's very good business profile, I'm giving the stock a "thumbs up" to interested Magic Formula investors. However, the uncertainty of the business cycle and relatively modest upside keep it out of Top Buy consideration.
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Steve does not own LRCX.
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