Share prices of top semiconductor manufacturing equipment provider Lam Research (NASDAQ: LRCX) have been off to the races in the last year. Despite a continued year-over-year decline in the company's financials, the stock has now doubled in value since the beginning of 2023. The company's earnings update for the final months of 2023 (released earlier this month) certainly could justify the rocket-like performance.
I'm not one to chase hot stocks, but Lam does look exceptionally well-positioned for the next few years. Here's why I plan on buying more Lam Research stock during the first quarter of 2024.
Lam Research has an expanding presence in chip manufacturing
As I explained last month, Lam Research is part of what I call the "Fab Five" -- ASML and Applied Materials being the two giants, followed by Lam and peer Tokyo Electron, and process control specialist KLA at No. 5. Aside from dozens of smaller specialists, the entire chipmaking industry essentially has to go through these five businesses if they want to manufacture the chips that power most of today's hottest secular growth trends.
Lam Research historically derives much of its revenue from memory chips, but it's been making some big technological moves so it can participate more in logic chipmaking as well. For example, some of Intel's plans hinge on breakthroughs like backside power delivery, which separates the power delivered to a chip from the data channel, which could lead to better performance and smaller computing system packaging breakthroughs down the road. Some of Lam's new equipment technology is a critical piece of this story.
Paired with a bottoming in the memory chip market, which was bludgeoned during the bear market of 2022 and 2023, Lam has been steadily reporting improving results from one quarter to the next. Its report for the second quarter of fiscal 2024 (for Lam, that's the three months ended in December 2023) was solid. Sales were $3.76 billion, a nearly 8% rise quarter over quarter. Better still, earnings per share (EPS) also increased 8% from the prior quarter, and free cash flow (FCF) rose 53% to $1.34 billion.
For the record, that's an FCF profit margin of 36%, and it helped top up the balance sheet again, too. Lam ended the calendar year 2023 with about $500 million in cash and short-term investments more than three months prior, bringing the balance to $5.6 billion, offset by debt just shy of $5 billion.
Lam Research stock now, at this price?!
I can already hear some objections to buying Lam now after its epic rally. Shares trade for nearly 33 times trailing-12-month EPS. That's not at all a value for a cyclical manufacturing business, even if it's tech manufacturing.
However, over the last year, I've been saying the valuation would get worse before it starts to improve. That period of sequential improvement is now on the way. Based on the midpoint of guidance for the third quarter of fiscal 2024 (the first few months of calendar year 2024), Lam management expects EPS to rise 15% year over year to $6.90 -- although the upper range of guidance indicates as much as a 27% year-over-year increase for EPS.
Of note, this is but the beginning of the next semiconductor industry growth cycle, propped up by new high-performance memory and logic chips in support of data center artificial intelligence (AI) and general computing acceleration, automotive and industrial applications, power consumption performance upgrades, and more.
If industry analyst Semi.org is right, this next cycle of growth will last through 2026, carrying semiconductor manufacturers to new heights for total revenue. Along the way, I expect Lam to unlock higher profit margins and plenty of FCF-per-share growth, something the management team has excelled at over the years of ups and downs for the chip market.
Data by YCharts.
This stock has shot to the top of my list of Fab Five stocks to buy. I thus plan on adding more Lam Research stock to my existing position, and I may add throughout 2024 if the company's financial performance plays out as expected.
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Nicholas Rossolillo and his clients have positions in ASML, Applied Materials, KLA, and Lam Research. The Motley Fool has positions in and recommends ASML, Applied Materials, and Lam Research. The Motley Fool recommends Intel and recommends the following options: long January 2023 $57.50 calls on Intel, long January 2025 $45 calls on Intel, and short February 2024 $47 calls on Intel. The Motley Fool has a disclosure policy.
