Last week we dove into Applied Materials (AMAT) to determine an estimated target price per share. This week, I want to go through the same valuation process with one of Applied’s competitors in the semiconductor manufacturing equipment space, LAM Research. At the end, I’ll wrap up with a quick take on LAM vs Applied moving forward.
LAM Research Overview
LAM Research was founded 13 years after Applied Materials in 1967 and is headquartered only 12 miles away in Fremont, California. Much like Applied however, LAM has sales, R&D, manufacturing, and service locations spread out across the globe to service a worldwide customer base. Here you can see a breakdown of their revenue by geographic region over the last 5 years.
As of 2019, LAM has separated their revenue into 2 distinct business units: Systems and Customer Support. It appears to me that Systems and Customer Support are comparable to Applied’s Semiconductor Systems and Applied Global Services business units respectively. LAM also provided a breakdown of revenue by market segment including Memory, Foundry, and Logic. Here are the percentage contributions from each of LAM’s business units as well as market segments.
Relative Valuation Analysis
First, I started with the relative valuation analysis before jumping headlong into the discounted cash flow (DCF) valuation. In the comparable company’s portion of the analysis, I used the same companies as I did for Applied last week. I simply subbed Applied in for LAM’s spot on the list:
- Applied Materials (AMAT)
- ASML Holdings (ASML)
- KLA Corp (KLAC)
- Teradyne Inc. (TER)
- Taiwan Semiconductor Manufacturing (TSM)
As of 12/23/2022, LAM is trading at a 9.8x EV/EBITDA multiple and P/E ratio of 11.9x. Both values fall below the median values calculated in the comparable companies’ analysis below.
With our comps table complete, we can proceed to the historical P/E portion of the analysis. Again, I used macrotrends.com for the quarterly historical P/E data and I decided to use the same data range going back to the beginning of 2014. Once all the data is in Excel, we can identify our upside, middle of road, and downside price scenarios. Having all the data points in one place makes it easy to identify any overly conservative or optimistic scenarios. In the summary section below, I’ve calculated a potential upside reward of +$237.13 (+57.5%) and a downside risk of -$36.22 (-8.8%) relative to LAM’s price per share of $412.12 as of 12/23/22.
DCF Model Assumptions
Now it’s time to move onto the discounted cash flow (DCF) valuation portion of the analysis. Just like we did for Applied, I used the past 5-years of financial statements to analyze the historical trends and average. LAM was able to grow top line revenue greater than 10% for 3 out of the past 5 years which added up to a 5-year average of 11.1% and a 6-year compound annual growth rate (CAGR) of 8.1%. Cost of goods sold remained consistent in the 53.5-55% of revenue range for each of the past 5 years. Here’s you can see a breakdown of the 5-year averages for most of the factors used in the DCF evaluation.
LAM is in the same semiconductor industry as Applied, which is predicted to continue its growth trajectory through 2030. Therefore, I decided to use the same 8-year forecast period we used for Applied last week with 2030 as the terminal year. To start the forward-looking forecast assumptions, I identified the line items that I thought would remain consistent throughout the forecast period.
- R&D – 10% of Total Revenue
- SG&A – 6% of Total Revenue
- Interest Rate – 3.5% of Debt
- Tax Rate – 15% of EBT
- Accounts Payable – 40 days
- CapEx – 2.5% of Total Revenue
- Share-based Compensation – 1.5% of Total Revenue
For the remaining line items below, we needed to take some different approaches because there were some inconsistencies from year to year.
- Cost of Goods Sold – I started on the high side of the 5-year range (55%) for 2023 and tapered it back down to the 5-year average (54%) by the end of the forecast period.
- Accounts Receivable – Accounts receivable days spiked up to 91 days in 2022 compared to an average of 70 days over the previous years. Therefore, I started the forecast period at 90 days for 2023 then tapered down each year until I got to 70 days for 2027-2030.
- Inventory – Inventory days also spiked in 2022 to 155 days vs an average of 120 days for 2018-2021. I decided to use 155 days in the first year of the forecast then quickly taper down to 120 days by 2025-2030.
- Deferred Liabilities – Similar to accounts receivable and inventory, contract liabilities days spiked in 2022 to 33 days compared to the 2018-2021 average of around 20 days. Therefore, I forecasted 35 days for 2023 before tapering down to 20 days by 2026.
- Total Revenue – I estimated revenue to fall by 2.5% in 2023 before returning to growth in 2024. From there, the growth rate ramped back up to the 5-year average at just over 11% over the next 4 years before tapering back down to less than 8% in the final year of the forecast.
To determine LAM’s top line revenue growth forecast, I performed a similar segmental analysis that we used for Applied. Unfortunately, we didn’t have as much segmental data for LAM as they didn’t start reporting segmented revenue until 2019. On LAM’s latest conference call in October 2022, they also cited noticeable weakness in the memory markets and are expecting this weakness to affect the next 3-4 quarters. Like Applied however, LAM noted that the foundry and logic markets were showing resilience in the tough market conditions. However, memory accounts for 60% of LAM’s overall revenue and the remaining 40% attributable to the foundry and logic markets. Here’s my table summarizing LAM’s calculated annual revenue growth rate for each of the 8 years in my forecast.
DCF Output
Now it’s time for us to put all the pieces together in the DCF valuation. Through a weighted average cost of capital (WACC) analysis, I determined a free cash flow discount rate of 11.1%. The tax rate assumption is consistent with LAM’s average historical tax rate. The terminal EV/EBITDA multiple I settled on was 13.4x based on LAM’s average historical PE ratio and the median EV/EBITDA calculated in the relative valuation analysis.
With everything together, the DCF analysis resulted in a diluted price per share of $566.94 (+37.6% potential upside compared to LAM’s share price of $412.12 on 12/23/22). Here you can see the full breakdown of my DCF valuation.
Just like we did for Applied Materials last week, I performed a DCF share price sensitivity analysis to see how the price fluctuates under different assumption conditions. Again, I wanted to show share prices under different WACC and EV/EBITDA multiples assumptions. Here’s the full data table output below.
LAM Research Price Target
To determine an estimated price target, I once again put together a “football field” chart as shown below that incorporates our relative and DCF valuation ranges along with LAM’s 52-week high/low and analyst price targets found on Yahoo Finance. I tend to give more weight to the DCF and relative valuation components of the analysis. Therefore, my current price target for LAM Research as of 12/23/22 is $545 (+31.0% potential upside compared to the current price of $412.12). However, this estimated price target is based on an 8-year forecast. My current forecast model estimates a 12% decline in earnings per share. Therefore, I wouldn’t be surprised to see the share price fall over the next 6-12 months as the day-to-day market tends to reflect a more short-term outlook.
LAM Research vs Applied Materials Summary
As of 12/23/2022, both Applied Materials and LAM Research appear to be trading at a discount and both have potential for strong upside returns. However, I believe Applied is in a better position to weather the impending economic slowdown that is predicted over the next year. Numerous companies in the semiconductor industry have cited significant weakness in the memory end markets with the foundry and logic markets showing much more resilience. LAM is more exposed to the memory end market (60% memory vs 40% foundry/logic) compared to Applied (60% foundry/logic vs 40% memory).
In addition, one of the largest players in the memory segment of the market, Micron, reported their latest quarterly earnings on 12/21/22 and disappointed on both the top and bottom lines. Micron lowered their forward guidance projections due to a significant slowdown in memory chips. Micron also announced that they are planning to reduce their workforce by 10%. Whereas Applied’s largest customer, Taiwan Semiconductor, is currently in the middle of constructing their new $10 billion manufacturing facility in Phoenix, Arizona. In addition, Taiwan Semiconductor recently announced that they plan to follow up with another $10 billion investment in their Arizona facility over the next few years. Therefore, I would have to give the edge Applied Materials as the better buy at this time.
Applied Materials Update: Applied’s share price has fallen over the past week to $97.13 as of 12/23/2022. Our target price of $135 per share for Applied now reflects a potential upside of 39.0%.
Please join me over the next couple of weeks as we to jump over to the opposite end of the semiconductor supply chain with evaluations on AMD and Nvidia.
Disclaimer: These valuations are based on my personal assumptions, calculations, and assessment. I am not a financial advisor, nor should my assessment be considered an investment recommendation.
