Lucrative Tools
In this edition of the Smart Investor newsletter, we examine one of the world’s largest manufacturers of semiconductor fabrication equipment. But first, let’s delve into the latest Portfolio news and updates.
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Portfolio Updates
❖ Applied Materials (AMAT) reported its fiscal Q3 2024 results on July 15th. The chip giant beat analysts’ quarterly revenue and EPS estimates by a wide margin. However, shares slipped afterwards, as investors were disappointed by FQ4 guidance that was only in line with analysts’ projections. The quarterly results reflected a smaller addition from China to the total revenue mix, apparently one of the factors behind the softer-than-expected FQ4 guidance. However, lower China exposure would positively contribute to the company’s earnings stability in the longer term if it continues. In addition, analysts noted AMAT’s drive to expand its already wide margins by focusing on market share gains in areas related to critical technology inflections.
❖ Google (GOOGL) shares lost some shine recently after a report that the U.S. Justice Department may push for the tech giant break up for its web search monopoly. This came after a federal judge ruled that the company violated antitrust law, becoming a monopolist by turning itself into the world’s default search engine. However, analysts view the negative market reaction as considerably overblown. First, the search giant will lead a lengthy appeal process against the ruling, possibly stretching out into 2026. Even if it loses that legal battle, the breakup of Google is the least possible outcome, according to analysts, with the most likely scenario being the imposition of restrictions on its exclusive default agreements with OEMs and browser owners. In this case, users will be presented with multiple pre-selected options for the default search engine when setting up a new device, which would potentially benefit Google, as its superior search quality will likely remain unmatched for several years at the least.
❖ Dell Technologies (DELL) is expected to post its FQ2 2025 results on August 29th. The company’s shares saw extreme volatility over the past month, falling by over 31% and then surging back by almost the same percentage. At first, investors reeling from widespread tech sell-off were spooked by the announcement of a 10% reduction in its global workforce, as Dell announced a significant restructuring in a bid to modernize operations and focus on AI. However, several top Wall Street analysts positively opined on the company’s near- and long-term prospects, sparking a strong stock rebound. JPMorgan analysts added DELL to an “Analyst Focus List” based on the company’s strong market position and growth opportunities in the AI-server market and other high-growth areas. Morgan Stanley analysts said they expect to see a boost to Dell’s FQ2 and fiscal 2025 revenue and EPS from AI servers, storage demand, and gradual PC market recovery.
❖ Taiwan Semiconductor Manufacturing (TSM) received approval from the European Commission granting it €5 billion ($5.5 billion) in German state aid to support the construction of a semiconductor manufacturing plant in eastern Germany. The facility, which will be built in cooperation with European chip producers, is a part of the European Union’s push to safeguard its supply of semiconductors amid a growing rift with China and its Taiwan ambitions. The U.S., Japan, and other Western countries are also pouring billions of dollars of subsidies to help localize chip production. TSM, the world’s largest chip foundry, opened its first plant in Japan earlier this year and intends to build three advanced plants in Arizona.
❖ Dover (DOV) announced that it has acquired Texas-based Criteria Labs, Inc., a leader in radio frequency device and microelectronic engineering solutions for aerospace and defense applications. Earlier this month, Dover acquired SPS Cryogenics from the Netherlands, which it said will boost the company’s clean-energy solutions capability.
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Portfolio Earnings and Dividend Calendar
❖ The Q2 2024 earnings season is drawing to an end, and there are no Smart Portfolio companies scheduled to release their results in the coming week.
❖ The ex-dividend date for Applied Materials (AMAT) is August 22nd, and for Parker Hannifin (PH) it is August 28th.
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New Buy: Lam Research (LRCX)
Lam Research is a global leader in the design and manufacturing of essential semiconductor fabrication tools with a primary focus on etching, deposition, and cleaning tools used in semiconductor manufacturing. It is the world’s third-largest semiconductor wafer fabrication equipment (WFE) manufacturer, counting all leading chipmakers in the world as its customers. With a market capitalization of $115.2 billion and 2023 revenues of $17.4 billion, it ranks #237 on the Fortune 500 list.
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History of Innovation-Led Growth
Lam was founded in 1980 and has been publicly traded on the NASDAQ since 1984. Since its establishment, the firm has immensely contributed to the extraordinary pace of innovation in the semiconductor industry. Thanks to its research leadership, it has gained vast intangible assets related to equipment design, including almost 20,000 global patents related to innovations in the areas of industrial automation, robotics, machine learning & AI, semi design & manufacturing, testing & measurements, and others. The company spends about $2 billion annually on research and development.
Heavy investment in R&D was the leading factor that contributed to LRCX’s fast growth and rise to prominence. The company’s growth was only marginally aided by acquisitions, as opposed to its large counterparts in the wider Technology sector. Lam has only acquired eight businesses in the past two decades, with the latest of them being the buyout of Texas-based plasma simulation company Esgee Technologies in January 2023.
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The Backbone of the Chip-Based Economy
Lam Research produces and services semiconductor processing equipment used in the fabrication of integrated circuits, specifically in the process steps of etch, deposition, and cleaning, and provides equipment for a broad variety of manufacturing and testing capabilities. Lam is the world’s market share leader in dry etch, which is a critical step in the chipmaking process and holds second place globally in deposition technologies. It serves both logic and memory chipmakers so that nearly every advanced chip in the world today – including the AI chips designed by NVIDIA – is built using Lam technology.
The semiconductor space is rife with monopolies, duopolies, and oligopolies due to the immensely high barriers to entry for competitors and high switching costs for clients. Within the fabrication space, five companies – ASML, Applied Materials, KLA Corp, Tokyo Electron, and Lam Research – hold an oligopoly over most steps of semiconductor OEM manufacturing. Lam’s extensive investment in gaining expertise and manufacturing efficiencies has led to significant cost and scale advantages and innovation leadership, helping widen its economic moat.
In addition, LRCX’s wide and sticky customer base gives it a strong competitive edge. Lam’s largest customers are Samsung Electronics, SK Hynix, Taiwan Semiconductor, Micron, and Intel. The company works in close collaboration with its customers to deliver the products and technologies according to their requirements and to implement solutions and additional capabilities in its new offerings.
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Short-Term Risks, Bright Future
Lam derives about 40% of revenues from etch and deposition equipment for various memory solutions, with the rest coming from products for advanced chip foundries and logic/integrated manufacturing. Memory tends to be a highly volatile end market with extensive price fluctuations, which impact the company’s revenues in the short term. However, the revenue cyclicality is partially compensated for by the fact that over 38% of total annual revenues, including the Memory segment, are derived from servicing previously installed equipment. Moreover, memory demand seems to be stabilizing now, with a significant rebound expected in 2025.
Another revenue volatility factor is LRCX’s exposure to China, which is responsible for over 25% of the company’s annual revenue. Although lower than before, such an elevated exposure creates vulnerabilities related to trade restrictions. In recent quarters, Lam has seen declines in some aspects of memory equipment sales to China due to one of its largest customers being slapped with U.S. sanctions.
However, as long as equipment sales to China are not banned outright, the technological rift between the two nations may actually benefit Lam Research’s sales. As China faces growing hurdles to purchasing advanced semiconductors, it invests in developing its own semiconductor-manufacturing capability and accelerates its purchase of manufacturing equipment. Still, a possible push to further limit equipment sales to China must be noted as the main risk to LRCX’s short-term revenue growth.
In the long term, Lam’s prospects are bright as it is one of the main “picks and shovels” suppliers to the production of semiconductors, which underpin the global economy. The adoption of new technologies such as edge computing, IoT, and AI drives significant changes in the performance and power-efficiency demand of semiconductors. This, in turn, leads to new equipment requirements, increasing demand from gear manufacturers. As technological changes accelerate, Lam Research is slated to continue its robust growth.
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Stellar Finances and Operational Excellence
Lam’s financial health is more than stellar, as it features a negative net debt-to-equity ratio (it has more cash than debt). This is an unusual position in the capital-intensive equipment manufacturing industry.
The company’s capital efficiency and profitability metrics are outstandingly strong. Its ROE, ROA, and ROIC ratios are in the top 5% of its industry. LRCX’s margins are also top-notch, with the gross margin coming in the top 20%, and net profit margin in the top 10%, while its operating and FCF margins make the top 5%.
Lam’s revenues have increased at a CAGR of 12.5% in the past decade, while its earnings-per-share grew by 23.1%. While revenues have been strongly impacted by the industry demand’s cyclicality, the company has maintained a high degree of stability in its annual rate of operating income and margin expansion thanks to its leading market position and operational excellence.
LRCX last released its quarterly results on July 31st, reporting for its FQ4 2024 and providing partial data for the full fiscal year. In the fiscal year 2024, the company reported revenues in line with analysts’ estimates, exceeding them on EPS. The quarterly report featured revenue, EPS, and profitability metrics above guidance midpoints. Earnings-per-share surpassed analysts’ estimates by a wide margin, rising by over 36% year-over-year, while revenues grew by 21%. The company provided an upbeat outlook for FQ1 2025, guiding for a year-over-year growth in EPS of 18% at midpoint.
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Total Return vs. Valuations: A Rare Opportunity
Lam Research is a dividend-paying company; it has paid and increased its payouts annually for the last nine years. While the company’s dividend yield is modest at 0.93%, it has grown at a CAGR of 14.5% and is expected to rise by 5-6% p.a. in the next several years.
Lam also rewards its shareholders through generous buybacks. In May 2024, the company’s Board approved a new $10 billion share repurchase authorization to be executed over an indeterminate period. According to the management, the program is consistent with LRCX’s plan to return 75% to 100% of free cash flow to stockholders in the form of dividends and share buybacks.
At the same time, Lam Research announced a 10-for-1 stock split, expected to be effective after markets close on October 2nd, 2024, for stockholders of record at that time.
LRCX has gained ~29% in the past 12 months. It reached an all-time high on July 10th, after which it tumbled by over 30% on the back of the broad tech sell-off, which was the most pronounced in the semiconductor and AI infrastructure-related areas of the market. Although it has rebounded by over 15% from its recent low on August 7th, the stock still trades at a very reasonable valuation.
Top Wall Street analysts pencil in an upside of over 27% for the stock in the next 12 months, not including dividend payments. However, barring another tech sell-off, LRCX may see even higher returns, supported by buybacks as well as the potential influx of investors before and after the split.
The company’s current PE ratio is now in line with that of the IT sector, while its forward PE features a ~14% discount to the sector’s average. The company is now trading in line with the average U.S. Semiconductor Industry, and even comes in towards the bottom of the valuation scale for comparable peers.
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Investing Takeaway
Lam Research is a highly efficient chip equipment producer with stellar finances and a wide economic moat. Its leading market position and extensive expertise allow it to capitalize on the accelerating demand for equipment required to produce AI-related chips, as well as semiconductors used for other cutting-edge applications. Despite the cyclicality of its industry, Lam is expected to continue churning out rising profits in the long term. We view the past sell-off as an opportunity to gain exposure to this highly valuable stock at a reasonable price.
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New Sell 1: Martin Marietta Materials (MLM)
Martin Marietta Materials is North America’s leading resource-based building materials supplier, providing aggregates and heavy-side building materials to the construction, infrastructure, agricultural, utility, and environmental industries in the United States and internationally.
As one of the leading suppliers of materials for the construction of everything from bridges to data centers, MLM has capitalized on the federal government’s subsidies and funding initiatives, including the Infrastructure Investment and Jobs Act, the Chips and Science Act, the “Investing in America” initiatives, among others.
As a result of its involvement in the flourishing business of building data centers and reshoring factories, Martin Marietta has been at the center of investor attention, leading to a strong run-up in its stock price. The stock came down by a significant percentage from its all-time high recorded in April, and MLM’s valuations don’t appear outstretched compared to its sector. However, the stock has been under a magnifying glass following its surprise revenue and EPS miss in Q2.
Martin Marietta’s earnings are highly volatile on a quarterly basis because of seasonality. The best quarters for building and construction, as well as their suppliers, are usually Q2 and Q3. That’s why the report on a year-over-year decline in EPS has taken analysts and investors by surprise.
The company said that the underperformance was due to weather disruptions, which, together with ongoing restrictive monetary policy, curtailed sales volumes. In addition, the company made an accounting adjustment in the cost of inventories of their recent acquisition, Blue Water Industries, which negatively impacted gross profit.
While COGS adjustment and weather may have been temporary headwinds, the pressures from the high interest rates are expected to linger for some time even if the Fed starts cutting rates in September. Given this outlook, MLM has lowered its full-year 2024 EBITDA guidance. Wall Street analysts, including those from JPMorgan, Citi, Jefferies, Stephens, Loop Capital, and Truist, have been quick to follow with downward price-target revisions.
Martin Marietta Materials is a financially robust company with a strong and expanding business, poised to outpace its competitors over the medium to long term. However, it faces several short-term headwinds that may continue impacting its stock performance in the near future. We plan to revisit this Materials powerhouse when macroeconomic skies clear up, but for now, we find it prudent to sell the stock.
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New Sell 2: Emerson Electric Company (EMR)
Emerson Electric Company is a global technology, software, and engineering powerhouse, providing innovative solutions for customers in industrial, commercial, and residential markets. Emerson’s wide product portfolio includes measurement and analytical instrumentation, industrial valves, fluid control, pneumatic mechanisms, electrical distribution equipment, and much more.
EMR is the undisputed leader of process automation, holding top positions across various end markets. In recent years, the company has been implementing a strategy aimed at refocusing on high-growth business lines. The move towards the high-growth goal seemed to be within reach after two highly successful first and second fiscal quarters, which ended in December and March, which featured high double-digit EPS growth.
However, in FQ3 2024 the company encountered some headwinds, and even as EPS slightly surpassed estimates, revenue missed the mark. JPMorgan’s analysts downgraded Emerson’s stock from “Buy” to “Hold,” flagging several factors overshadowing the company’s progress.
According to JPM, the rebound in sales growth that was predicted by the management earlier this year appears slower to materialize than was anticipated. Analysts also see a backlog normalization leading to potentially lower sales in the Test & Measurement division in the next fiscal year. The company also cited the softness in the MRO (maintenance, repair, and operation) and discrete automation markets as leading factors in FQ3 underperformance and said it expects the weakness in the latter to stretch into FQ4.
Notably, Emerson’s discrete automation and test & measurement sales were hit by an auto production decline stemming from weak consumer demand, a trend which is not expected to reverse in the short term given tight monetary conditions.
Moreover, EMR derives about 30% of revenues from Asia, Middle East & Africa, with China contributing a significant part. Emerson’s management cited weakness in sales to the country, which has hit the company’s Test & Measurement revenues. Given the lack of visibility regarding the Chinese sales outlook in the next quarter, the company may be forced to adjust its guidance for fiscal 2025 lower, which may impact sentiment toward the stock.
Selling this industrial automation powerhouse is not an easy decision given its robust long-term prospects, which are based on its ability to capitalize on the ongoing megatrends such as digitalization, reshoring, and increasing energy efficiency. However, due to the short-term headwinds and the lack of visibility of revenue trends in the coming two to three quarters, we view it as necessary. Still, we may revisit this valuable company in the future.
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Portfolio Stocks Under Review
❖ Applied Industrial Technologies (AIT) announced its FQ4 and full fiscal year results on August 15th. In the quarter, the industrial company surpassed analysts’ revenue and EPS expectations. In FY24, revenue was in line with estimates, while EPS outpaced them. Margins came in historically high as the company maintained operational strength despite a decline in revenues from the previous fiscal year. The reason for putting Applied under review is its weak fiscal 2025 guidance, which projects flat revenues and softer earnings at the mid-point. Although AIT’s peers have seen similar macro headwinds that are expected to continue into the next year, the company’s valuations are somewhat outstretched vis-à-vis its growth outlook, limiting further potential upside. On the other hand, AIT has much less debt than most of its comparable peers, which adds to its ability to perform growth-supporting acquisitions. Moreover, AIT’s supreme cash-generation results increase its potential for additional stock gains supported by buybacks. On the whole, we are positive about the company’s outlook but plan to closely watch the trends concerning investor sentiment, insider trends, and other stock-performance-affecting factors.
❖ Vertex (VRTX) remains under review following its underwhelming Q2 results, which included an EPS miss. The company reported a wider earnings-per-share loss than was expected. Notably, the negative EPS is a one-time event brought on by expenses associated with an acquisition of Alpine Immune Sciences, as well as increased investments to support launches of new therapies. The biopharma giant raised its full-year product revenue guidance, citing growth in sales of its cystic fibrosis (CF) treatment and the soon-to-launch gene therapy Casgevy. The stock fell from its all-time high following Q2 underperformance, though not by a large percentage. However, it quickly bounced back, and its stock price is still elevated compared to history. As a result, some analysts have cut their outlook on the stock, citing limited near-term upside opportunity given its high valuation. On the other hand, Vertex’s stellar finances and cash-producing capabilities, along with its strong portfolio of existing and prospective treatments, provide a strong argument in favor of the company.
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Smart Investor’s Winners Club
*The 30% Winners Club includes stocks from the Smart Investor Portfolio that have risen at least 30% since their purchase dates.
Despite the turbulence in the markets over the last weeks, the list of Winners still holds 16 stocks: GE, AVGO, SMCI, ANET, TSM, EME, ORCL, AMAT, APH, PH, CHKP, HWM, GD, TPL, VRTX, and ITT.
The next in line to enter the lucrative club is REGN with a 27.22% gain since its purchase date. Will it close this minute gap, or will someone else outrun it to the finish line?
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Smart Investor Portfolio
| Portfolio YTD Return |
Portfolio Volatility (Beta) | Portfolio Dividend Yield |
| 20.67% | 1.12 | 0.78% |
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Disclaimer
The information contained in this article represents the views and opinions of the writer only, and not the views or opinions of TipRanks or its affiliates and should be considered for informational purposes only. TipRanks makes no warranties about the completeness, accuracy, or reliability of such information. Nothing in this article should be taken as a recommendation or solicitation to purchase or sell securities. Nothing in the article constitutes legal, professional, investment and/or financial advice and/or takes into account the specific needs and/or requirements of an individual, nor does any information in the article constitute a comprehensive or complete statement of the matters or subject discussed therein. TipRanks and its affiliates disclaim all liability or responsibility with respect to the content of the article, and any action taken upon the information in the article is at your own and sole risk. The link to this article does not constitute an endorsement or recommendation by TipRanks or its affiliates. Past performance is not indicative of future results, prices, or performance.
