The semiconductor industry has been dominating headlines since mid-2021 due to the chip shortage that has crippled some of America's largest industries. The chip drought has impacted everything from vehicle production to PCs, but how are the companies that provide semiconductor manufacturing services doing? Lam Research (NASDAQ:LRCX) is one of such companies, and for some time, they have significantly benefited from the increased demand and pricing power but there are signs that Lam is starting to see its fair share of supply chain disruptions and the company has been tight-lipped about its ability to pass those costs on to customers.
So what does Lam Research do?
The first thing you may be wondering about is what exactly does Lam Research do? Lam Research provides wafer fabrication equipment and services to the semiconductor industry. In short, they sell chips, chip manufacturing equipment, and chip-making services. The company operates in three main segments DRAM chips, NAND chips, and foundry logic (making chips for companies based on the designs provided) .
Source: GETTY IMAGES
As you can imagine, Lam Research is nowhere near as popular as some of the major names in the industry like Nvidia and Micron. Still, because of the support role it plays in the semiconductor industry and the solid gross margins, investors should pay attention here.
Since the pandemic, global digital transformation trends have accelerated, and Lam Research has benefited significantly. The company is coming off of record revenue and record EPS in the calendar year 2021 . This performance saw record revenue in all three of their main segments, and they even had record revenue in their customer support business unit . Total revenue stood at 16.5 billion dollars, and EPS stood at 32.46 dollars per share, representing a 59% increase over the calendar year 2020, and capping a steady trend over the last 5 years.
Source: Lam Research
Lam maintains its heavy exposure to the Asian markets with more than 50% of revenue being derived from the region. In the past, this was a risk factor for investors but it seems as though US-China relations have reached a new normal and this should help investors breathe a bit more easily.
Source: Lam Research
Another encouraging sign is the diverse revenue mix from Lam. All of its segments are performing well but no one segment is an elephant which ties in well with the broad-based elevated demand the industry is currently experiencing.
Supply chain concerns
Supply chain concerns initially created an imbalance that drove up pricing power among the major players in the semiconductor space, and with a gross margin of 46.8%, it's hard to argue that Lam has not felt the tailwinds, but there are warning signs on the horizon. Towards the end of 2021, Lam started to feel more significant effects of supply chain constraints, with one of their major suppliers coming out with their inability to fulfill all of Lam's orders . We've seen similar cases throughout the industry with major players like Micron (discussed here), but Lam's leadership team in the Q4 2021 earnings release, called out the expectation that supply chain constraints will likely play a more prominent role in the first half of the calendar year 2022 . As a result, investors should expect this to impact gross margins modestly. I would say anywhere from a 1 to 3% reduction in gross margin would be an acceptable range for supply chain disruptions when considering the unprecedented constraints companies face. According to the leadership team, the supply chain issues should resolve during the back half of the calendar year 2022, which bodes well for revenue and margins towards the end of the calendar year should demand persist. The supply chain issue isn't exactly a new challenge for semiconductor companies, but Lam Research has not been sitting on its hands. The company has improved capacity in its domestic factories and has invested heavily in its Malaysian facility. The leadership team has targeted 3 billion dollars in revenue from that facility alone . With demand expected to remain elevated for an extended period, these investments will likely turn out to be prudent moves, and shareholders should benefit.
Strong tailwinds despite a hawkish Fed
The Fed has indicated that they will likely be hiking rates multiple times this year which will pump the brakes temporarily on growth stocks like Lam Research but a good business in a low rate environment will likely be a good business in a high rate environment and even if multiples are compressed temporarily there is a lot to look forward to for long term investors . The stock has been in turmoil lately due to the rate hike talk and tensions in Ukraine but I would argue that this could turn out to be a great buying opportunity. Beyond resolving supply chain constraints, Lam Research has several long-term tailwinds that could make it a generational purchase. The metaverse, AI, cloud, increasing device complexity, 5G, and improved adoption of complex devices globally are long-term drivers for Lam's success. Lam is particularly excited about the role AI and immersive gaming will play in the Metaverse. As immersive gaming and AI become more engrained in society the demand for memory will increase .
The takeaway
In closing, Lam Research is a semiconductor supplier that will support the global digital transformation. Moreover, Lam has an excellent track record of returning free cash to shareholders. In Q4 2021, they returned an astonishing 94% to shareholders in the form of repurchases and dividends, which isn't something you often hear from a large semiconductor company. Of course, a hawkish Fed will put the brakes on growth plays like Lam Research temporarily. Still, long-term oriented investors, we'll likely find the recent turbulence as an excellent buying opportunity.
