Lam Research: Benefiting From HBM-Driven DRAM; Initiate With ‘Strong Buy’

Lam Research (NASDAQ:LRCX) is a global supplier of wafer fabrication equipment and services for the semiconductor industry. The company exclusively supplies TSV (Through-Silicon Via) etching equipment to High Bandwidth Memory (HBM) suppliers. Currently, I think the market hasn’t fully appreciated the growth potential of HBM-Driven DRAM. I initiate with a ‘Strong Buy’ rating with a one-year price target of $1,045.

HBM-Driven DRAM Growth

HBM has been wildly used in GPUs, providing high bandwidth memory for AI-related computing. Samsung Electronics (OTCPK:SSNLF) and SK Hynix are the two main suppliers for HBM products. In Q4 FY23, Samsung Electronics delivered record-high HBM sales, increasing by >40% quarter-on-quarter and approximately 3.5x year-on-year. Additionally, the company is expanding their manufacturing capacities for their next-generation HBM4 products, according to their earnings call.

According to TrendForce, SK Hynix decided to allocate KRW 10 trillion (USD 7.6 billion) towards CAPEX in 2024, marking an increase of 43%-67% year-over-year. The substantial expansion in manufacturing capacity is primarily motivated by rising demand for HBM products.

Lam Research is the only provider of TSV (Through-Silicon Via) etching equipment, an important device before stacking during HBM manufacturing process. According to the recent conference call, their management forecasted the related HBM revenue opportunity would reach $1 billion within a 7-year timeframe.

I think Lam Research will experience a strong growth in their TSV equipment for HBM over the next few years. Samsung Electronics predicts that their HBM production will increase 2.5x in 2024 and another 2x in 2025, according to their recent earnings call. Gartner forecasts that HBM demand will grow 8x, from 123 million GBs in 2022 to 972 million GBs in 2027 driven by AI-related workloads. The strong HBM demand would incentivize suppliers to increase manufacturing capacities, leading to more demands for Lam Research’s products. Lam Research doesn’t disclose the current size of their HBM related DRAM business. Assuming they have around $150 million in revenue, it could grow to $1.8 billion if using Gartner’s industry growth as a reference.

Recent Result and FY24 Outlook

Lam Research released their Q2 FY24 earnings on January 24^th with 7.9% growth in revenue and 7.7% increase in adjusted operating profits quarter-over- quarter. Their Q2 FY24 result was slightly above the mid-point of their initial guidance. My biggest takeaway is that they have achieved 50% market share in deposition and edge solutions required for advanced 3D stacking of HBM, and they hold 100% market share in through-silicon via formation etch system. This is an important indicator of their growth potential along with the rapid demand growth in HBM.

Lam Research is scheduled to release Q3 result on April 24^th. I consider the following factors for their future growth:

– Semiconductor Wafer Fab Equipment (WFE) market growth: Global Growth Insights predicts that the WFE market will grow at a CAGR of 5.49% from 2012 to 2029, and the driving factors include technology advancements in 5G, IoT, data center and AI machine learnings. As WFE is tied to the capital expenditure cycles in the semiconductor industry, the demand and growth of WFE should be highly cyclical, in my view.

-Foundry represents around 38% of their system revenue. According to McKinsey, major semiconductor players have announced U.S. based fab construction projects, and the total value of these projects will be around $223 billion to $260 billion through 2030.

For instance, Intel (INTC) announced their ‘IDM 2.0’ strategy with initial investment of $20 billion to build two new fabs in Arizona. As reported by the media, TSMC (TSM) will invest more than $65 billion to construct 3 semiconductor fabs in Arizona.

These new fabs in U.S. could boost the demand for Wafer Fab Equipment, potentially driving Lam Research’s business growth in their Foundry segment, in my view.

-HBM related growth: As discussed earlier, Lam Research has been well positioned for the HBM growth in the near future. Assuming $200-$300 million of incremental revenue, HBM could contribute 1%-2% to the total revenue growth.

Let’s put everything together: industry growth 5.5%; additional 2-3% growth from new fabs; 1-2% of HBM related growth. The total revenue growth is estimated to be 8-10% in the near future, according to my calculations.

Valuation

As discussed, I assume a 9% of revenue growth throughout the cycle. Over the past five years, the company has repurchased a total of $13.7 billion of its own stock, and they have $2.1 billion of remaining in repurchase authorization as of Q2 FY24. Therefore, I estimate the total number of shares outstanding will decrease by 3% year-over-year.

On the expenses side, their R&D costs have been around 10% of total revenue over the past few years, and as indicated over the earning’s call, their R&D expenses won’t move down in the near future as the company continues to invest in new technologies.

Their gross margin expansion is primarily driven by innovative new products and favorable customer mix. Their management is quite confident in maintaining a level of 48% in the near term. In my view, the inflation is easing, the global supply chain is recovering to pre-covid levels, and the labor shortage is improving. These are positive factors for their gross margin expansion in the near term.

I estimate the company will grow their operating expenses by 8% year-over-year, driven by 10bps gross margin expansion and 20bps leverage from SG&A expenses.

I estimate the free cash flow from equity by adjusting the net income with depreciation/amortization, net change in working capital and net borrowings.

The cost of equity is calculated to be 16.5% for Lam Research with the following assumptions: risk-free rate 4.32% (US 10Y Treasury Yield); equity risk premium 7%; beta 1.75.

Discounting all the future FCFE at the discount of 16.5%, the one-year price target is calculated to be $1,045 per share.

Key Risks

China: The market accounts for 26% of total revenue. The escalating geopolitical tensions between U.S. and China may potentially impact the trade relations between the two countries. Lam Research is required to obtain export licenses to supply their products to certain Chinese customers, such as SMIC, YMTC and ChangXin Memory Technologies. Given Lam Research’s large exposure in China, investors should closely monitor any developments related to tariffs and export restrictions.

High Inventory Level: During the global pandemic, Lam Research experienced a significant increase in inventory levels due to global supply chain disruptions. Inventory levels surged from $1.9 billion in FY20 to $4.8 billion in FY23. In recent quarters, Lam Research has initiated efforts to reduce their inventory levels, leading to some growth in the working capital. Keep in mind that Lam Research is a highly cyclical business, and their revenue growth and change in working capital could be quite volatile, subject to the semiconductor capex cycles. Investors seeking stable earnings growth should not consider Lam Research as a suitable long-term investment, in my opinion.

Conclusion

The Wafer Fab Equipment industry is a structural growth market driven by rising demand for chips. In my view, Lam Research could benefit from the growing demand for HBM products in the near future, and their offerings are well-positioned to capitalize on the rapid industry expansion. I initiate with a ‘Strong Buy’ rating with a one-year price target of $1,045.