It’s been a tough year for the semiconductor sector as the post-pandemic drop in PC sales and the end of the 5G smartphone upgrade cycle curbed the market’s appetite for new chips. Nevertheless, many semiconductor stocks have actually rallied since the beginning of the year as investors look toward a cyclical recovery.
One of those stocks is Lam Research (NASDAQ: LRCX), which provides wafer-fabrication equipment and services for the semiconductor industry. Lam’s stock has risen 45% year to date as the benchmark Philadelphia Semiconductor Index advanced just over 30%. So is it too late to hop aboard the bullish bandwagon after that impressive run?
Image source: Getty Images.
Lam was founded 43 years ago and is now one of the world’s largest semiconductor equipment companies. Its equipment is mainly used in front-end wafer processing, where it produces the wiring and active components of semiconductor devices.
As one of the bellwethers of the semiconductor sector, Lam generally follows the industry’s growth cycles. Here’s how its business fared between fiscal 2019 and fiscal 2023 (which ended on June 25).
Metric
FY 2019
FY 2020
FY 2021
FY 2022
FY 2023
Revenue growth
(12.9%)
4.1%
45.6%
17.8%
1.2%
Gross margin
45.1%
45.9%
46.5%
45.7%
44.6%
EPS growth
4%
10.2%
78.1%
21.7%
1.4%
Data source: Lam Research. EPS = earnings per share.
Lam’s decline in fiscal 2019 was caused by sluggish sales of smartphones and a supply glut in memory chips. The COVID-19 pandemic delayed its recovery in fiscal 2020, but its growth accelerated again in fiscal 2021 as those headwinds dissipated.
That growth continued in fiscal 2022, but inflation squeezed its gross margin with higher material, freight, and labor costs. A higher mix of lower-margin customers and products exacerbated that pressure.
In fiscal 2023, Lam’s revenue growth slowed to a crawl as many chipmakers reined in their spending to cope with the market’s sluggish demand for new chips (especially in the memory market). U.S. export controls against Chinese chipmakers also reduced its annual revenue by about $2 billion, which was equivalent to 11% of its reported revenue for the full year. The inflationary headwinds also continued to compress its gross margin.
That cyclical slowdown wasn’t surprising, but Lam continued to buy back its shares to boost its earnings per share (EPS). Over the past five years, it repurchased 14% of its shares. It also pays a forward yield of 1.3%, and it’s raised its payout annually for nearly a decade.
During Lam’s latest conference call, CEO Tim Archer said the company was “not ready” to provide a full-year outlook for fiscal 2024. As for China, which accounted for 26% of Lam’s revenue in fiscal 2023, Archer said some Chinese chipmakers were still purchasing its equipment for technologies that weren’t affected by the export controls — namely older etch, foundry logic, and edge technologies — but admitted he couldn’t “speak to future regulations that may or may not be contemplated.”
For now, analysts expect Lam’s revenue and adjusted EPS to decline 16% and 20%, respectively, in fiscal 2024 as the semiconductor market remains weak. Those growth rates are dismal for a stock that trades at 22 times forward earnings.
For reference, Lam’s industry peer Applied Materials — which is only expected to post single-digit revenue and earnings declines this year — trades at just 17 times forward earnings. ASML, which is still expected to generate double-digit revenue and earnings growth this year, has a forward multiple of 25.
Lam generated some market-beating gains this year, but I think it’s too early to bet on its cyclical recovery. Its revenue growth is sluggish, its margins are slipping, and its valuations are too high relative to its industry peers. For now, investors would be better off sticking with Applied Materials as a value play or ASML as a growth play in the semiconductor sector.
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Leo Sun has positions in ASML. The Motley Fool has positions in and recommends ASML, Applied Materials, and Lam Research. The Motley Fool has a disclosure policy.
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