Is LRCX a big value opportunity, or a big value trap?

January 11, 2019

Is LRCX a big value opportunity, or a big value trap?

Did you study the California gold rush in your high school history class? I did, and I remember that one of the most interesting things to me about it was the fact that over the seven years that marked the period, the people that made the most money weren’t prospectors; they were the entrepreneurs that flocked to the territory to sell equipment and supplies to those prospectors. As an investor, I’ve found interesting parallels to those entrepreneurs in the industries that supply the major sectors of the American economy.

The semiconductor sector has been one of the biggest underperformers in the market since the last quarter of 2018. The sector is down enough that a lot of the stocks in that sector are now at really interesting valuation levels; but I think that maybe the best opportunities don’t lie with the most recognizable names in the sector; like those savvy businessmen in California, the smart thing to do right now is to pay attention to the stocks that provide products and services to them. That means companies that specialize in fields like fabrication and manufacturing like KLA-Tencor Corporation (KLAC), Applied Materials (AMAT), and LAM Research Corp (LRCX).

After hitting a high price around $235 in March of last year, LRCX started a downward trend that saw the stock drop almost 50% to a 52-week low around $122 late in December. The stock has rallied almost 18% from that low point, but still remains on the very low end of that trend range. Is the stock is building enough positive momentum to reverse its downward trend? Does the stock’s slide over the last nine months mean a smart value investor should look for an opportunity to jump in, or is the stock down almost 50% for deeper, more troubling reasons? You decide.

Fundamental and Value Profile

Lam Research Corporation is a supplier of wafer fabrication equipment and services to the semiconductor industry. The Company designs, manufactures, markets, refurbishes and services semiconductor processing systems that are used in the fabrication of integrated circuits (ICs). It operates through manufacturing and servicing of wafer processing semiconductor manufacturing equipment segment. Its products are designed to enable its customers build a range of devices that are used in a range of electronic products, including cell phones, tablets, computers, storage devices, and networking equipment. Its customer base includes semiconductor memory, foundry, and integrated device manufacturers (IDMs) that make products, such as dynamic random-access memory (DRAM), negative-AND (NAND) memory and logic devices. It offers a portfolio of products that are used in several areas of the semiconductor manufacturing process flow, including thin film deposition, plasma etch and single-wafer clean. LMC’s current market cap is $22.4 billion.

  • Earnings and Sales Growth: Over the last twelve months, earnings declined almost -3% while revenues dropped nearly -6%. In the last quarter the decline is both areas accelerated with earnings dropping by -37% and sales dropping by -25%. LMC operates with a very strong and stable margin profile, with Net Income running at around 22% of Revenues over the last twelve months as well as the last quarter.
  • Free Cash Flow: LMC’s free cash flow is healthy, at a little more than $2.2 billion and translates to a useful Free Cash Flow Yield of 10%.
  • Debt to Equity: LMC has a debt/equity ratio of .34. This is a very conservative number, supported by the cash and liquid assets that, at $3.6 billion are more than twice as high as long-term debt, which was $1.6 billion in the last quarter. Along with their very impressive operating margins, this means that the company has both the ability to service their debt without difficulty, as well as superior liquidity and financial flexibility.
  • Dividend: LMC pays an annual dividend of $4.40 per share, which translates to a yield of about 3% at the stock’s current price.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for LMC is $34.26 and translates to a Price/Book ratio of 4.16 at the stock’s current price. A red flag for the stock is the fact that in the last quarter, the stock’s Book Value declined almost 15%. When you compare it to their historical Price/Book ratio, it also suggests the stock is overvalued by about -24% right now. A counter to that argument is that the stock is current trading a little more than 50% its historical Price/Cash Flow ratio. The difference between the long-term target prices these ratios offer is very wide, which isn’t something I like to see.

Technical Profile

Here’s a look at the stock’s latest technical chart.

  • Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s downward trend from March 2018 to the pivot low, and the 52-week low it reached at the end of the year; it also informs the Fibonacci trend retracement lines shown on the right side of the chart. Despite the stock’s rally so far this year, the stock remains significantly below the resistance shown by the 38.2% retracement line at about $165 per share. The strength of the downward trend does imply the stock is more likely to find resistance somewhere between its current price and that retracement line than it is to keep building bullish momentum. That resistance could be as close as about $151 or $152 per share.
  • Near-term Keys: If you’re looking for a short-term bullish trade, and you’re willing to speculate a bit, you could think about buying the stock or using call options to take advantage of the roughly $18 distance between the stock’s current price at its most likely resistance at around $165 per share. On the other hand, if resistance appears sooner than later, the fact that the stock is more than $20 away from its 52-week low does suggest there could be an interesting opportunity to short the stock or work with put options as soon as the pivot high appears. The wide difference between the valuation ratios I like to use does mean that I would hold off on thinking about a long-term position on the stock until that distance narrows to a more useful level.