One of the biggest trends in technology over the coming year will be the widespread embrace of 20 nanometer chip design and production.
A number of semi equipment stocks across design, such as Cadence (CDNS), equipment, including Applied Materials (AMAT) and lithography, such as A S M L (ASML) are likely to benefit. Another stock set to move higher on the increased spending is process equipment play KLA-Tencor (KLAC).
The company is a major player in process equipment deployed in foundries to discover irregularities and errors in production. This is critical to foundries given their focus on yield and their customers' focus on quality.
Higher semiconductor capex is bullish for process equipment sales.
In the most recent quarter, bookings, revenue and earnings per share all came in at the high end of the company's guidance. New orders for KLA's equipment increased 50% from the September quarter to $760 million, driven by foundry and logic customers.
In calendar 2012, KLA generated $3.1 billion in revenue and $4.23 in non-GAAP earnings per share. In FY Q2, sales of $673 million increased 5% from a year ago. That's not too shabby for an industry facing double digit drops in semi equipment spending during 2012.
The major reason KLA is growing faster than the industry is rapid consumer adoption of mobile devices. This adoption has encouraged OEMs to increase the number of smart phones and tablets, integrating increasingly complex chip structures to increase speed, reduce battery consumption and ultimately win market share.
As a result, about two-thirds of KLA's new orders came from foundries last quarter. And additional sales should be coming this year given major foundries are increasing their capital spending budgets.
Spending growth at foundries is being driven by a need to ratchet up 20 nanometer capacity. As chip maker transition from 28 nanometer designs to 20 nanometer, the number of critical processes is set to increase. This suggests an even greater need for inspection tools, such as those sold by KLA.
Outside of the foundries, about 16% of KLA's December quarter bookings came from logic, a market transitioning from traditional PCs to mobile devices. Another 17% of the quarter's orders were memory, which is arguably more hampered by lackluster PC sales.
Despite the memory headwind, KLA told investors the market for its products stabilized heading into 2013. The company expects overall semi spending will fall 5-10% this year. But order levels projected to build through the year anticipate another year of KLA outpacing the broader market. If so, a stabilized memory market and a return to growth in logic would dovetail nicely with the upcoming foundry growth.
For now, orders continue to grow most in the 20 nanometer space.
Roughly a third of last quarter's orders were related 20 nanometer or below. The percentage should increase throughout 2013 as capacity investments take hold and focus shifts to 16 and 14 nanometer. Those smaller designs are even more complex and should provide tailwinds for measurement tools.
Additionally, early activity in 450 mm tools offers opportunity for growth. The company has already been shipping these tools to equipment makers, particularly bare wafer particle inspection tools.
Importantly, existing tools aren't being retrofitted for 450. Instead, new models are being built with 450 capabilities, which means better pricing and margins. As wafer needs translate into pilot programs, the impact on KLA sales should increase over the coming years, not months.
K L A also has an ongoing niche opportunity in e-beam inspection. The ability to target and determine defects using e-beams means slower throughput than with optical tools, which the company also sells.
As a result, e-beam tools are more ideally suited as a complementary tool to optical. KLA's latest e-beam inspection system is designed to work with optical systems to improve accuracy and speed. Such tools will remain key additions for leading edge fabs.
Overall, the tide appears to be turning for semi equipment stocks as OEM's increasingly integrate the latest, more margin friendly designs. Their strength should continue to fuel design innovation, which remains critical to companies like KLA, who are dependent on capital investment.