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Bull of the Day: Lam Research (LRCX)

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I last wrote about Lam Research (LRCX - Free Report) as Bull of the Day in late January after another terrific earnings report. But shares sold off after the beat-and-raise quarter on fears about demand for their wafer fabrication equipment (WFE) from big memory chip makers like Micron (MU - Free Report) . Here's what I wrote back then... 

Always Looking for the Semi Cycle Top
 
The negative market reaction in Lam shares immediately following earnings is a bit of a puzzle. Until, that is, you think about the traditional fear in this industry: Technology investors are still prone to seeing a very cyclical industry with brief periods of boom followed by busts.

But this isn't the 1990s and we aren't talking about desktop computers driving demand.

This is the age of mobile, datacenters, automotive innovations, robotics and automation, and artificial intelligence. These areas are not slowing down and should provide investors enough visibility that they might think twice and give my Technology Super Cycle thesis the benefit of the doubt.

(The link above is to my special report for Zacks Confidential from December. Just scroll down to the 3rd report from 12/11/17)

But one of the big fears for Lam is that memory chip supply will saturate demand in 2019. Since supplying equipment to make DRAM and 3D NAND flash is about two-thirds of Lam's business, investors are probably somewhat justified in wondering if this is "as good as it gets" and the big double-digit growth rates we are accustomed to will drop hard and fast in the next year.

(end of my January 25 article excerpts)

For these reasons, I was an eager buyer of Lam shares into the February correction, even scooping some under $163. And other smart investor joined me on the stock's March rally to new all-time highs above $220.

But the volatility and doubt returned to the semiconductor industry and shares whipped back and forth across the $200 mark into and after the company's Q3 earnings report (FY18 ending in June).

Another Big Beat and Raise

On April 17, Lam Research reported Q3 EPS of $4.79, $0.43 better than the Zacks consensus estimate of $4.36, for a 10% beat. Revenue for the quarter came in at $2.89 billion, on shipments of $3.13 billion, versus the consensus estimate of $2.86 billion.

The company gave solid guidance for Q4 with revenues in a range of $2.95-$3.25 billion, versus the consensus of $2.93 billion. They saw Q4 non-GAAP EPS of $4.80-$5.20 versus the consensus of $4.67.

But there a fly in the ointment that caused investors once again to sell shares. This time it was concern about company guidance for lower shipments of $3 billion in the current June quarter, vs the record quarter they just delivered.

Within two days, LRCX shares dropped back 10% from $210 pre-earnings to $190. But several investment banks and their analysts saw this as a typical overreaction.

Evercore ISI analyst CJ Muse reiterated his Outperform rating and $300 price target, noting that beyond the beat and raise, gross margins came in at 46.8%, better than the consensus of 46.0%. And the June quarter GMs were guided to 47.5% at the midpoint, above consensus of 46.5%.

Goldman Sachs analyst Toshiya Hari said to buy Lam Research on any weakness given his positive view on semiconductor industry capex, Lam's strong competitive position in Etch and Deposition equipment. Hari reiterated his $252 price target on shares.

Stifel analyst Patrick Ho recommended investors use the post-earnings pullback in LRCX shares as an opportunity to buy. He acknowledged the shipment outlook and commentary that may have emboldened bears who think we are at the peak of the cycle, particularly on the memory front. However, he remains "steadfast" in the view that the market is not at or near an overcapacity situation and consequently raised his price target on the company to $295.

Needham analyst Edwin Mok reiterated his Buy rating on Lam after the company after the company reported a solid F3Q18, provided June quarter guidance above consensus, but also offered disappointing shipment guidance that will likely pressure the stock.

The analyst conceded "While we underestimated the magnitude of a NAND moderation, we believe the overall fundamental picture for WFE and for LRCX specifically remains healthy. Despite the lowered CY2H18 shipments outlook, its solid momentum continues to support this narrative of out-performance. We expect the shares to see some near-term volatility, but see any pullback as long-term buying opportunity". Mok reiterated his price target of $270.

JPMorgan analyst Harlan Sur raised his price target on LRCX to $275 from $260 saying that despite investor fears of peak spending in the first half of this year, the stock's setup is favorable for continued robust spending into next year. He maintains his view that memory makers remain disciplined in adding capacity. The analyst continues to see "significant upside" from current levels in shares of Lam and keeps an Overweight rating on the name.

At Deutsche Bank, analyst Sidney Ho raised his price target on LRCX to $260 from $250. He explained that the lack of an increase in full year WFE estimates and the forecast for its shipments to decline half-over-half in the second half likely disappointed higher buy-side expectations. The analyst believes, however, that the company's second half of 2018 has been de-risked. Ho reiterated his Buy rating on Lam Research.

The Technology Super Cycle

Even the company CEO felt compelled to clarify what investors thought they heard on the conference call. Speaking later on CNBC, Lam Research CEO Martin Anstice said the company's guidance implies 'solid' year-over-year growth. Anstice said overall secular and cyclical demand trends are strong, which is "getting lost in translation" amid the "ebbs and flows" of short-term trends.

In January, CEO Anstice said that "semiconductor innovation is contributing increased value in a data-driven economy and we believe that trend is quite fundamental, exciting and sustainable."
 
This sounds exactly like the outlook of my December 11 special report for Zacks Confidential, The Technology Super Cycle, where I recommended LRCX shares under $185 and NVIDIA (NVDA - Free Report) under $195.

Value in Chips?
 
The recent 2018 Barron's Roundtable had as one of its stock-pickers Scott Black, founder of Delphi Management and an old-school value guy. Here's what he said about why you own the Lam...

"It is a powerhouse in semiconductor capital equipment, and its products are used primarily in front-end wafer processing, which is becoming a $50 billion business. Lam has a 56%-57% market share in wafer etch, and about a 40% share in vapor deposition. It wants to gain another four percentage points in both through 2019."
 
Black also addressed Lam's cash position noting the company has $22 a share in net cash with over 70% (approximately $2.8 billion) trapped overseas. "Exclude that and the stock sells for 11.6 times earnings. It is a giveaway. The average company sells for 19 times earnings, and LAM isn't an average company."
 
Black describes Lam as having the "wind at its back" across multiple industries experiencing strong demand, from memory and flash to the cloud and IoT. And he thinks these growth areas provide positive earnings visibility going out two years.

Taiwan Semi Gives a "Bad Apple" Read-Through

Two days after Lam's report, Taiwan Semiconductor (TSM) hosted its scheduled Q1 earnings conference call and gave 2Q revenue guidance significantly below consensus expectations. At the midpoint of the $7.9 billion guide, the company expects to come in 9% lower than the $8.7B consensus.
 
The short-fall is driven by continued demand weakness from a "very high-end smartphone" customer -- and all signs point to Apple (AAPL - Free Report) . TSM now expects 2018 revenue to grow +10% year-over-year in USD, down from its prior expectation of +10-15% y/y, driven by the continued weakness in mobile applications as well as uncertainty in cryptocurrency demand.
 
This news not only impacted AAPL but also the whole Semi complex -- the SOX dropped 4.3% on 4/19 -- and, in particular, WFE players like LRCX and Applied Materials (AMAT - Free Report) who supply equipment to TSM.

Rising Estimates and Price Targets

Other investment banks to raise their LRCX price target were...

Credit Suisse: PT to $278
B. Riley & Co: PT to $285
KeyCorp: PT to $283

But it's the magnitude and agreement of analyst EPS estimate revisions that make a stock like LRCX a Zacks #1 Rank, quarter after quarter.

And after all the noise, analysts kept their word and raised earnings estimates in the past 2 weeks causing FY2018 EPS to move from $16.76 to $17.54, representing over 75% growth.

Revenues are now projected for FY2018 to cross $11 billion, for 38% growth.

The problem is that few are sticking their necks out very far on next year's profit haul, with the FY2019 consensus only rising from $16.50 to $17.50, for essentially flat annual growth. And this is probably what has investors most concerned.

While the analysts wait for better visibility on the semi industry, say from the quarterly report of peer AMAT in a few weeks, I will continue to be the shares are undervalued given its solid double-digit growth in a still-strong technology cycle.

Disclosure: I own shares of LRCX, MU, and NVDA for the Zacks TAZR Trader portfolio.

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