Lam Research: Upgrade To Buy, WFE Spend Rebound Timed For 2024 (NASDAQ:LRCX)

We’re upgrading Lam Research (NASDAQ:LRCX) to a buy from a hold. We’ve been neutral on the semi-cap since last quarter due to exposure to the Biden administration ban, but we upgraded Applied Materials (AMAT) after the stock sell-off last week due to higher exposure to Chinese sales but mainly as a reaction to Reuter’s report on the U.S. criminal investigation into AMAT potentially evading ban restrictions through sales to Semiconductor Manufacturing International Corporation (SMIC). We think AMAT stock has now been somewhat de-risked and is better positioned to outperform. We think the worst has been priced into LRCX’s outlook and the peer group (in this case, AMAT), so we extend our bullish sentiment to LRCX. We see industry dynamics and WFE spending improving next year, especially in memory, and expect this to drive outperformance for LRCX.

We previously downgraded LRCX to a hold based on our concerns that shipments to Chinese customers panic buying ahead of demand in fear of the Biden administration ban would be an unsustainable revenue driver amid macro weakness. Now, we’re less concerned about the company’s high exposure to Chinese domestic customers as we expect non-Chinese leading-edge WFE spend to rebound in 2024, boosting LRCX’s top-line growth, which is already growing in a mid-single range sequentially.

We’re not denying the severity of LRCX’s exposure to China, with shipments to Chinese customers growing 100% QoQ this quarter to account for 48% of total sales, up from 26% last quarter. We think panic buying will continue to impact financial performance over the next quarter and support management’s guidance for 6% QoQ growth to $3.7B. Still, when this wave of higher shipments to Chinese customers disappears due to the ban expansion, then LRCX will be better positioned to now leverage the rebound in WFE spending in 2024.

It’s a lot about memory

We’re specifically optimistic about WFE for the memory rebounding next year; we’re already seeing signs of bit shipment improvement in DRAM and NAND. Western Digital (WDC) results this quarter confirm the narrative of a recovering memory/storage market in 2024; WDC’s Flash bit shipments increased 26% QoQ and 49% Y/Y. We think the better bit shipment will be followed by an improved pricing dynamic for memory next year. Memory chipmakers have purposefully limited their output this year to move along the industry inventory correction, which we now believe is complete. We’re more constructive on the memory market rebounding due to the PC rebound in particular next year; we estimate the 2024 PC TAM to be around 5–8% Y/Y growth. We believe the memory content growth per device in 2024 will be more than enough to absorb all the current industry overcapacity. While we have limited visibility on the smartphone TAM rebound next, we expect an improved end demand in 2024; currently, we’re expecting the 2024 smartphone TAM to be flat to modestly up but see no near-term catalysts for an upward revision for the industry’s biggest players, including Apple (AAPL).

Additionally, we think the macro headwinds have been priced into the stock for the most part, as outperformance over the past six months versus over the past three months has moderated. Over the past six months, LRCX is up 25%, outperforming by 15% versus over the past three months, outperforming by 5%.

The following graph outlines LRCX stock against the S&P 500 over the past six months.

The following graph outlines LRCX stock against the S&P 500 over the past three months. We think the stock provides a more favorable risk-reward profile for the stock into next year due to the priced in China exposure and WFE spending uptick driven by the industry transition to more complex solutions for etch and deposition in both DRAM and logic/foundry ends.

Valuation

The stock is undervalued, in our opinion. On a P/E basis, the stock is trading at 22.8x C2023 EPS $30.68 compared to the peer group average of 27.8x. The stock is trading at 5.7x EV/C2023 Sales versus the peer group average of 5.9x. We see more upside for the stock as WFE spending rebounds in 2024 after a muted 2023. We recommend investors begin exploring entry points into the stock at current levels.

The following chart outlines LRCX’s valuation against the peer group.

Word on Wall Street

Wall Street shares our bullish sentiment on the stock. Of the 28 analysts covering the stock, 19 are buy-rated, and the remaining are hold-rated. The stock is currently priced at $700. We think Wall Street’s sentiment on the semi-cap names is well placed for the longer-term outlook as increased complexity in etch and deposition for the next generations of 3D NAND and DRAM, as well as leading-edge logic, will drive LRCX’s top-line growth, in our opinion.

The following outlines sell-side ratings for LRCX.

What to do with the stock

We upgraded AMAT yesterday, and now LRCX follows; we think the stock is now better positioned to outperform through 2024 due to the uptick in leading-edge WFE spending for memory and foundry/logic recovers. Additionally, we think LRCX will experience a substantial uptick due to its positioning in the memory market as we see DRAM and NAND start to rebound into 2024. We recommend investors begin exploring entry points at current levels.