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Lam Research: Strong Execution, Secular Tailwinds and Still Cheaply Valued

The market is not fully pricing in the long-term opportunity for the chip equipment maker.

Lam Research  (LRCX) - Get Lam Research Corporation Report has delivered an impressive performance in 2019, up more than 110% compared with the S&P 500, which is up approximately 28% in the same time frame. But what matters for today’s investors is not the past, but that looking ahead, Lam continues to have a very favorable environment. 

Given its strong cash flows, capital returns and cheaply valued stock, Lam’s stock makes for a terrific investment opportunity. Here’s why:

Lam Research's Strong Outlook

Lam is a supplier of innovative wafer fabrication equipment to the semiconductor industry. Two-thirds of its revenue is derived from memory markets, led by non-volatile memory (NAND) and DRAM memory.

Thus, if memory markets do well, Lam will also do well. Lam’s President and CEO Tim Archer, declared that he notes improvements in the memory market, driven by NAND. 

These comments have recently been echoed by Micron  (MU) - Get Micron Technology Inc. Report during its recent earnings call, with Micron calling the bottom of the cycle for the memory market.

Looking ahead to the second half of calendar 2020, both of these companies are declaring that the memory market should stabilize and start to grow.

Looking further ahead, positive catalysts are expected from both the server and smartphone industries. While a server CPU upgrade cycle is eagerly awaited by many, what is likely to be an even bigger event for Lam’s memory revenue is the highly anticipated launch of 5G models from the major smartphone vendors. 5G is anticipated to drive content growth for the overall smartphone sector, with Lam Research being a primary beneficiary.

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Strong Returns on Invested Capital; Significant Repurchases

Given Lam’s strong and healthy industry outlook, it could be argued that Lam’s balance sheet carries more than enough cash and equivalents, given its net cash position of $1 billion. And seeing that Lam is expected to finish calendar 2019 with its second-highest level of free cash flow, some shareholders would like to see Lam being more aggressive with its share repurchases.

For its part, Lam’s CFO Doug Bettinger declared that Lam is committed to returning to shareholders at least 50% of its free cash flow via dividends and buybacks and that Lam still has $3 billion authorized by the board for share repurchases -- approximately 7% of its market cap. 

Moreover, Bettinger argued that looking back over the past five years, Lam has in actuality returned more than 50% of its free cash flow to shareholders.

In fairness, one aspect is indisputable, which is that notwithstanding the memory market’s inherent cyclicality, Lam Research has grown its revenues with a three-year and five-year compounded annual growth rate in the mid-to-high teens. This reinforces that Lam has been remarkably prudent with its capital allocation in delivering sustainable and growing cash flows.

Valuation – Large Margin Of Safety

Compared with one of its peers, such as Applied Materials  (AMAT) - Get Applied Materials Inc. Report, what stands out about Lam Research is the tight control Lam has over its expenses throughout the cycle. Investors crave predictability and sustainable growth, and on this front, Lam Research shines.

However, from a shareholders' perspective, even though 2019 has seen its shares rally significantly, investors are only being asked to pay less than 16x its cash flows from operations, which is in no way pricing in Lam's rosy outlooks and strong capital allocation strategy. Patient buy-and-hold investors are likely to be well-rewarded in 2020, too.

The Bottom Line

Lam Research is a cash-generating machine backed by a strong balance sheet. Also, this well-managed company has an impressive capital allocation imperative. However, its valuation surprisingly is still not fully pricing in its long-term opportunity. Readers would do well to consider Lam Research’s stock as part of a well-diversified portfolio. 

Lam Research is a holding in Jim Cramer’s Action Alerts PLUS Charitable Trust Portfolio. Want to be alerted before Cramer buys or sells LRCX? Learn more now.