04/23/2018

Why we like KLA-Tencor Corp. as an investment opportunity

Overview: KLA-Tencor Corporation, is a leading provider of process control and yield management solution. Their products and offerings help companies manage yield throughout the entire semiconductor fabrication process—from research and development (“R&D”) to final volume production. KLAC’s products, services and expertise are used by their customers to measure, detect, analyze and resolve critical product defects that arise in order to control nanometric level manufacturing processes. The company’s revenue in fiscal 2017 (year ending June 30, 2017) was $3.48 Billion, a 16.6% growth over fiscal 2016. The company had sales of $969 Million in Q1 2018 – representing a 29% growth rate year over year. Over 75% of its revenue base is derived from Asia, 15% from US and 10% from Europe & Israel. The company has 2 distinct revenue streams – products & services. The product revenues are composed of 2 big segments – Wafer Inspection and Patterning. As cost of advanced wafer fabrication facility continue to increase (can cost over $5.00 billion), chipmakers are looking into making sure those wafers achieve higher productivity. KLAC’s products & services help those chipmakers by providing tools to help inspect and solve issues along the manufacturing process. KLAC’s tools locate the source of defects and resolve the underlying process issues enabling their customers to improve control over their manufacturing processes and increase yields leading to higher profitability. As you can see in the revenue breakout trend, wafer inspection is still primary revenue driver but KLAC’s patterning revenue has grown faster as chips become more complex.

Catalyst: The semiconductor equipment has multiple catalysts as their customers are expanding into more products and services. Chipmakers are seeing their products used for more applications now – Artificial Intelligence (AI), Internet of Things (IoT), Automated Driving, etc. As the complexity (smaller geometries and more complex multi-level circuitry) and the demand for semiconductors increase, the semiconductor manufacturers are spending more on building new fabrication facilities and more advanced technologies to make chips denser and smaller. Companies like KLAC benefit from their increased spending as KLAC’s tools are used to help these companies in their process control and yield management to ensure that these new facilities and tools are profitable. Another catalyst is China, the largest consumer of IC’s (integrated circuits) is pushing to become one of the biggest manufacturers of IC’s. The Chinese government wants more chips made by domestic manufacturers. Tsinghua Unigroup secured $22 billion from Chinese government investors to help it build China’s first advanced memory chip factories. As Chinese domestic companies push into investing and developing advanced semiconductors, companies like KLAC will benefit. KLAC also benefits as existing manufacturers spend to stay ahead of the new competition. Modeling analyst expectations of 13% sales growth for FY 2018 and 6% thereafter with EBITDA margins declining from current 39% to 36% by 2022, we get over 20% upside. Most likely the company should exceed the growth expectations in the near term as semiconductor companies are seeing healthy demand and newer nodes (smaller geometries) are introduced later this year. KLAC might also benefit as US based companies such as Intel & Micron could increase capital expenditures as they are allowed immediate deduction for equipment purchases under the new tax law.


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About Dhaval Sanghavi, CFA 2 Articles

Partner at The Applied Finance Group
Focus areas: Global Equity Analysis, Quantitative Research.
Joined AFG in 2003

About Dhaval Sanghavi, CFA 2 Articles

Partner at The Applied Finance Group
Focus areas: Global Equity Analysis, Quantitative Research.
Joined AFG in 2003