Thematic evaluation
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KLA Corp. (KLAC)

September 06, 2024

Compared to: Lam Research Corp. (LRCX) | Applied Materials, Inc. (AMAT) | Technology Select Sector SPDR Fund (XLK)

Our reasoning

KLA Corp. appears moderately undervalued based on its strong financial performance, market leadership position, and growth prospects in advanced packaging and AI markets. The company's valuation multiples are below industry averages despite its superior profitability and cash flow generation. While risks exist, particularly around regulatory changes and geopolitical tensions, these seem to be overweighted in the current valuation.

Key takeaways
  • KLA Corp. is a leading provider of process control and yield management solutions for the semiconductor industry, with a strong financial performance and a solid track record of growth and profitability.
  • The company is well-positioned to benefit from the long-term growth of the semiconductor industry, driven by increasing demand for semiconductors in various applications.
  • KLA's operational efficiency is strong, with a focus on managing working capital and generating free cash flow, which provides ample resources for debt repayment, dividend growth, and investment in organic growth opportunities.
  • The company faces several risks, including macroeconomic volatility, competition, regulatory changes, and geopolitical uncertainty, which investors should carefully consider.
  • KLA's valuation is currently attractive, with a P/E ratio and EV/EBITDA ratio that are below the industry average, making it a compelling investment opportunity for investors seeking exposure to the semiconductor industry.
  • The company's stock price has outperformed the broader technology sector and its peers over various time periods, demonstrating strong performance and resilience to market volatility.
  • KLA's future outlook is positive, with the company expecting to benefit from the long-term growth of the semiconductor industry, driven by increasing demand for semiconductors in various applications.
Undervalued
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Evaluation summary

  1. Company Overview:

    • KLA Corp. is a leading provider of process control and yield management solutions for the semiconductor and related nano-electronics industries. The company operates through three segments: Semiconductor Process Control, Specialty Semiconductor Process, and PCB, Display and Component Inspection.
    • KLA's products and services are essential for the manufacturing of integrated circuits (ICs), wafers, and reticles, enabling customers to measure, detect, analyze, and resolve product defects to manage manufacturing processes and improve product yields.
    • The company's target market is the global semiconductor industry, which is driven by the increasing need for semiconductors in consumer and industrial products, the rapid proliferation of advanced semiconductor devices, and the growing complexity of leading-edge semiconductor manufacturing.
    • We are using the Technology Select Sector SPDR Fund (XLK) as a benchmark for KLAC's price performance and Lam Research Corp. (LRCX) and Applied Materials, Inc. (AMAT) as industry peers for comparative analysis.

  2. Financial Performance:

    • KLA has demonstrated strong financial performance in recent years, with consistent revenue growth and high profitability.
    • Revenue has been increasing, but the growth rate is slowing. The company is seeing strong customer demand and solid execution, with revenue returning to sequential and year-over-year growth, demonstrating an improving industry environment.
    • The company's profitability is strong, with high return on assets, return on equity, and return on invested capital. These ratios are significantly higher than the industry average, indicating that KLA is more efficient at generating profits from its assets and investments. However, these ratios are decreasing, which could be a sign of slowing profitability growth.
    • The company's profitability is being impacted by large goodwill and intangible asset impairment charges related to its PCB and Display businesses.
    • Compared to its peers, KLAC has consistently outperformed LRCX and AMAT in terms of revenue growth, profitability, and risk-adjusted returns.

  3. Operational Efficiency:

    • KLA's operational efficiency is generally strong, with a focus on managing working capital and generating free cash flow.
    • The company's asset utilization efficiency is improving, as evidenced by the decreasing receivables balance. However, the increasing inventory balance suggests potential inefficiencies or supply chain challenges.
    • KLA's cash flows from operations are increasing, driven by strong earnings and potentially improved working capital management. The company's free cash flow margin is increasing, indicating a strong ability to generate cash flow from operations.
    • The company's capital expenditures are decreasing, suggesting a slowdown in investment activity or a shift in investment priorities.
    • The company's dividend growth is sustainable, with a steady increase in dividend payments.
    • KLA's liquidity position is strong, with a current ratio above the industry average, indicating a comfortable ability to meet short-term obligations.
    • The company's long-term solvency appears healthy, with a decreasing long-term debt balance. However, the increasing short-term debt and high total debt to equity ratio warrant monitoring.
    • Compared to its peers, KLAC has demonstrated better operational efficiency, with lower volatility and higher Sharpe ratios, indicating a better risk-adjusted return.

  4. Growth Opportunities:

    • KLA has several growth opportunities, including market expansion, M&A, R&D, and geographic expansion.
    • The company is expanding its market reach by targeting new applications and markets, such as advanced packaging and artificial intelligence.
    • KLA has a history of successful acquisitions, and the company continues to explore M&A opportunities to expand its product portfolio and market reach.
    • The company is investing heavily in R&D to maintain its technology leadership and address industry trends.
    • KLA is expanding its geographic reach by targeting emerging markets, such as China.
    • The company's strategic focus areas include advanced packaging, artificial intelligence, and the development of new technologies to address the increasing complexity of semiconductor manufacturing.
    • KLA's capital allocation strategies are aligned with its growth objectives, with a focus on investing in R&D, M&A, and organic growth opportunities.
    • Management has a track record of successfully executing on its strategic plans, as evidenced by the company's consistent financial performance and market share gains.

  5. Risks and Threats:

    • KLA faces several risks and threats, including macroeconomic volatility, competition, regulatory changes, and geopolitical uncertainty.
    • The company is vulnerable to weakening global economic and financial market conditions, which could impact semiconductor demand and investment.
    • KLA faces competition from other semiconductor equipment suppliers, including its peers LRCX and AMAT.
    • Evolving U.S. export control regulations pose a significant threat, potentially disrupting KLA's ability to serve customers in China without obtaining difficult-to-obtain export licenses.
    • The company is subject to complex and evolving regulatory requirements, including those related to environmental, social, and governance (ESG) issues.

  6. Valuation Analysis:

    • KLA's valuation is currently attractive, with a P/E ratio and EV/EBITDA ratio that are below the industry average.
    • The company's strong financial performance, growth opportunities, and attractive valuation make it a compelling investment opportunity.
    • Compared to its peers, KLAC is trading at a discount to its peers, suggesting that the market may be undervaluing the company's growth potential.

  7. Price Performance:

    • KLAC's stock price has outperformed the broader technology sector (XLK) and its peers (LRCX and AMAT) over various time periods.
    • The company's stock price has been relatively volatile, with a beta value above 1, indicating that it is more sensitive to market movements than the overall market.
    • However, KLAC's Sharpe Ratio has generally been higher than its peers, indicating that it has been able to generate higher returns with lower risk.

  8. Future Outlook:

    • KLA's future outlook is positive, with the company expecting to benefit from the long-term growth of the semiconductor industry.
    • The company expects the business to transition from a period of stabilization to a resumption of growth, which began in the June quarter and is expected to continue through the remainder of 2024 and into 2025.
    • The company expects the WFE market to be in the mid-$90 billion range, with the second half of 2024 stronger than the first half.
    • The company expects gross margins to remain relatively stable around the mid-61% range, with variability quarter-to-quarter typically guarded by product mix fluctuations.
    • The company's future cash flows are expected to be driven by its strong earnings and continued investment in growth initiatives.
    • The company's free cash flow is expected to continue to be strong, providing ample resources for debt repayment, dividend growth, and investment in organic growth opportunities.

  9. Summary:

    • KLA Corp. is a financially strong company with a solid track record of growth and profitability. The company is well-positioned to benefit from the long-term growth of the semiconductor industry.
    • KLA's key strengths include its strong financial performance, operational efficiency, growth opportunities, and attractive valuation.
    • The company's key risks include macroeconomic volatility, competition, regulatory changes, and geopolitical uncertainty.
    • Overall, KLA is a compelling investment opportunity for investors seeking exposure to the semiconductor industry. The company's strong financial performance, growth opportunities, and attractive valuation make it a good candidate for long-term investment.
    • However, investors should be aware of the risks associated with the company, including macroeconomic volatility, competition, and regulatory changes.
Peer fundamentals 
Fundamentals
Insights
  • KLA Corp. is a leading supplier of process control and yield management solutions for the semiconductor and related electronics industries, facing headwinds from the recent macro-driven slowdown in semiconductor demand.
  • The company's financial performance has been significantly impacted by large goodwill and intangible asset impairment charges related to its PCB and Display businesses.
  • KLA continues to invest heavily in R&D to maintain its technology leadership, but faces risks from IP disputes, supply chain disruptions, and an increasingly complex regulatory environment.
  • The company's liquidity and cash flow generation remain strong, but its leveraged capital structure and concentrated customer base expose it to financial and operational risks.
  • Evolving U.S. export control regulations pose a significant threat, potentially disrupting KLA's ability to serve customers in China without obtaining difficult-to-obtain export licenses.
  • The company's profitability is strong, with high return on assets, return on equity, and return on invested capital.
  • The company's liquidity position is strong, with a current ratio above the industry average.
  • The company's long-term solvency appears healthy, with a decreasing long-term debt balance.
  • The company's free cash flow margin is increasing, indicating a strong ability to generate cash flow from operations.
  • The company's revenue growth is slowing, but the company is still profitable.
  • The company is able to control operating expenses, but they are increasing.
  • The company expects the business to transition from a period of stabilization to a resumption of growth, which began in the June quarter and is expected to continue through the remainder of 2024 and into 2025.
  • The company expects the WFE market to be in the mid-$90 billion range, with the second half of 2024 stronger than the first half.
  • The company expects gross margins to remain relatively stable around the mid-61% range, with variability quarter-to-quarter typically guarded by product mix fluctuations.
  • The company's future cash flows are expected to be driven by its strong earnings and continued investment in growth initiatives.
  • The company's free cash flow is expected to continue to be strong, providing ample resources for debt repayment, dividend growth, and investment in organic growth opportunities.
Analysis
  • Revenue - Revenue is increasing, but the growth rate is slowing. - The company is seeing strong customer demand and solid execution, with revenue returning to sequential and year-over-year growth, demonstrating an improving industry environment. - The company's revenue growth is driven by the increasing need for semiconductors in consumer and industrial products, the rapid proliferation of advanced semiconductor devices, and the growing complexity of leading-edge semiconductor manufacturing. - The company's revenue is concentrated in the foundry/logic and memory markets, which are expected to be the key drivers of growth.
    • Profitability
      • The company's profitability is strong, with high return on assets, return on equity, and return on invested capital.
      • These ratios are significantly higher than the industry average, indicating that KLA is more efficient at generating profits from its assets and investments.
      • However, these ratios are decreasing, which could be a sign of slowing profitability growth.
      • The company's profitability is being impacted by large goodwill and intangible asset impairment charges related to its PCB and Display businesses.
    • Liquidity
      • The company's liquidity position is strong, with a significant increase in cash and short-term investments.
      • The current ratio is above the industry average, indicating a comfortable ability to meet short-term obligations.
    • Solvency
      • The company's long-term solvency appears healthy, with a decreasing long-term debt balance.
      • However, the increasing short-term debt and high total debt to equity ratio warrant monitoring.
    • Operational Efficiency
      • The company's asset utilization efficiency is improving, as evidenced by the decreasing receivables balance.
      • However, the increasing inventory balance suggests potential inefficiencies or supply chain challenges.
    • Cash Flow Analysis
      • The company's cash flows from operations are increasing, driven by strong earnings and potentially improved working capital management.
      • The company's free cash flow margin is increasing, indicating a strong ability to generate cash flow from operations.
      • The company's capital expenditures are decreasing, suggesting a slowdown in investment activity or a shift in investment priorities.
      • The company's dividend growth is sustainable, with a steady increase in dividend payments.
    • Risk Factors
      • The company is facing headwinds from the recent macro-driven slowdown in semiconductor demand.
      • The company's financial performance has been significantly impacted by large goodwill and intangible asset impairment charges related to its PCB and Display businesses.
      • The company's liquidity and cash flow generation remain strong, but its leveraged capital structure and concentrated customer base expose it to financial and operational risks.
      • Evolving U.S. export control regulations pose a significant threat, potentially disrupting KLA's ability to serve customers in China without obtaining difficult-to-obtain export licenses.
    • Future Outlook
      • The company expects the business to transition from a period of stabilization to a resumption of growth, which began in the June quarter and is expected to continue through the remainder of 2024 and into 2025.
      • The company expects the WFE market to be in the mid-$90 billion range, with the second half of 2024 stronger than the first half.
      • The company expects gross margins to remain relatively stable around the mid-61% range, with variability quarter-to-quarter typically guarded by product mix fluctuations.
      • The company's future cash flows are expected to be driven by its strong earnings and continued investment in growth initiatives.
      • The company's free cash flow is expected to continue to be strong, providing ample resources for debt repayment, dividend growth, and investment in organic growth opportunities.
Most recent earnings report
Financial statements 
All public filings
Comparative Analysis
Benchmarks (as of 2024-08-09)
Technology Select Sector SPDR Fund (XLK)
  • Performance Comparison:
    • KLAC has consistently outperformed XLK over all the periods analyzed, with particularly strong outperformance in the longer-term periods (1 year, 2 years, and 3 years). This suggests that KLAC has been a strong performer in the semiconductor industry.
    • KLAC's performance has been relatively consistent, with only a few periods of underperformance. This suggests that KLAC is a reliable investment with a strong track record.
  • Risk and Return Analysis:
    • KLAC has provided higher annualized returns than XLK over all the periods analyzed. This indicates that KLAC has been a more profitable investment than the broader technology sector.
    • KLAC has also been more volatile than XLK, with higher annualized volatility. This suggests that KLAC is a riskier investment than the broader technology sector.
    • KLAC's maximum drawdown has been larger than XLK's, indicating that KLAC is more susceptible to significant price declines. This reinforces the notion that KLAC is a riskier investment.
  • Risk-Adjusted Performance:
    • KLAC's Sharpe Ratio has generally been higher than XLK's, indicating that KLAC has been offering a better risk-adjusted return. This suggests that KLAC has been able to generate higher returns for the level of risk taken.
    • KLAC's Beta value has been consistently higher than XLK's, indicating that KLAC is more sensitive to market movements. This suggests that KLAC is a more volatile investment than the broader technology sector.
  • Overall Assessment:
    • KLAC has consistently outperformed the broader technology sector, demonstrating strong growth and profitability. However, it is important to note that KLAC is a riskier investment than the broader technology sector, as evidenced by its higher volatility and larger drawdowns.
    • Investors seeking higher returns should consider KLAC, but they should also be aware of the increased risk associated with the stock.
    • The recent trends in KLAC's volatility and beta suggest that the stock is becoming more sensitive to market movements. Investors should monitor these trends closely and adjust their investment strategies accordingly.
Peers Price History(as of 2024-09-04)
Lam Research Corp. (LRCX)Applied Materials, Inc. (AMAT)
  • Performance Comparison: KLAC has consistently outperformed its peers, LRCX and AMAT, over various time periods, including YTD, 1-week, 1-month, 3-month, 6-month, 1-year, 2-year, and 3-year periods. This suggests that KLAC has been a strong performer in the semiconductor industry and has been able to navigate market volatility effectively.
  • Risk and Return Analysis: KLAC has provided higher annualized returns than its peers, LRCX and AMAT, over the past three years. However, KLAC's annualized volatility has generally been lower than its peers, suggesting that KLAC has been able to generate higher returns with lower risk. KLAC's maximum drawdown of 40.28% in Q4 2022 was lower than the maximum drawdowns experienced by LRCX (56.39%) and AMAT (55.14%) during the same period. This indicates that KLAC has been more resilient to market downturns than its peers.
  • Risk-Adjusted Performance: KLAC's Sharpe Ratio has generally been higher than LRCX and AMAT, particularly in recent quarters, indicating that KLAC has been offering a better risk-adjusted return than its peers. KLAC's beta values have generally been above 1, suggesting that KLAC is more volatile than the overall market. However, KLAC's beta values have been relatively consistent over the past three years, indicating that its sensitivity to market movements has remained stable.
  • Overall Assessment: KLAC has consistently outperformed its peers, LRCX and AMAT, over various time periods, demonstrating strong performance and resilience to market volatility. KLAC's lower volatility and higher Sharpe Ratio suggest that it has been able to generate higher returns with lower risk compared to its peers. While KLAC's beta values indicate a higher risk profile, its consistent performance and resilience to market downturns make it an attractive investment option for investors seeking exposure to the semiconductor industry.
Peers Fundamentals(as of 2024-06-30)
Lam Research Corp. (LRCX)Applied Materials, Inc. (AMAT)

  1. Market Position and Size:

    • KLAC is the second-largest company in the peer group based on market capitalization, with a market cap of 100,161.0 million, slightly larger than Lam Research Corp. (LRCX) at 99,282.4 million, but significantly smaller than Applied Materials, Inc. (AMAT) at 150,355.0 million.
    • KLAC's market cap is closely correlated with its revenue, EBITDA, and net income, reflecting its position as a major player in the semiconductor equipment industry.

  2. Profitability and Efficiency:

    • KLAC exhibits significantly higher profitability than its peers and the industry average, with a Gross Profit Margin of 62.04%, EBITDA Margin of 44.95%, and Net Profit Margin of 32.59%.
    • KLAC's strong profitability is further evidenced by its high Return on Average Assets (ROA), Return on Average Total Equity (ROE), Return on Average Total Capital (ROTC), and Return On Average Invested Capital (ROIC), indicating efficient asset and capital utilization.

  3. Financial Health and Stability:

    • KLAC's financial health is generally strong, with robust cash flow generation and a solid track record of profitability.
    • However, its lower liquidity and high debt levels are potential concerns, particularly in light of its recent deceleration in growth.

  4. Valuation and Market Perception:

    • KLAC's valuation is generally higher than its peers and the industry average, reflecting its strong profitability, growth prospects, and market position.
    • The market values KLAC's sales, earnings, and book value at a premium compared to its peers and the industry, indicating investor confidence in its future prospects.

  5. Cash Flow and Capital Management:

    • KLAC generates a significant amount of free cash flow, indicating its ability to fund future growth and return value to shareholders.
    • Its relatively low capital expenditure compared to its peers suggests a focus on efficient capital allocation.

  6. Growth and Future Prospect:

    • KLAC has shown strong growth in profitability and cash flow generation, outperforming its peers in key metrics like EBITDA, Net Income, Basic Earnings per Share, Free Cash Flow, and Free Cash Flow Margin.
    • However, its growth has been decelerating in the most recent period, which could indicate a slowdown in its market share and competitive position.

  7. Potential for Investment:

    • KLAC presents an attractive investment opportunity due to its strong profitability, robust cash flow generation, and accelerating growth.
    • However, investors should be aware of its lower liquidity and high debt levels, which could increase its financial risk. The recent deceleration in growth is another factor to monitor closely.

  8. Key Risks and Considerations:

    • KLAC's lower liquidity and high debt levels are potential concerns, particularly in light of its recent deceleration in growth.
    • Investors should monitor KLAC's growth trajectory closely to assess the sustainability of its current performance.

  9. Overall Assessment:

    • KLAC is a strong competitor in the semiconductor equipment industry, with a significant market share and a strong financial performance.
    • Its high profitability, strong return on capital, and robust cash flow generation position it favorably within the peer group. However, its lower liquidity and high debt levels are potential concerns. The recent deceleration in growth is another factor to monitor closely.