KLA-Tencor: An Attractive Dividend Stock

Jan.15.14 | About: KLA-Tencor Corporation (KLAC)

I consider KLA-Tencor Corporation's (NASDAQ:KLAC) stock as a rare combination of value and growth dividend stock. The stock has risen 30.5% since the beginning of 2013; this compared to 27.6% rise of the S&P 500 index, and 36.2% rise of the Nasdaq Composite Index at the same period, and it still has plenty of room to go up. Furthermore, the rich dividend (current yield at 2.89%) represents a nice income. In this article, I will show why, in my opinion, KLA-Tencor stock is a remarkably promising long term investment.

The Company

KLA-Tencor Corporation is the world's leading supplier of process control and yield management solutions for the semiconductor and related nanoelectronics industries. Its products are also used in a number of other high technology industries, including the light emitting diode ("LED") and data storage industries, as well as photovoltaic industries and general materials research.

Products

KLA-Tencor's portfolio of products focused on the demands of wafer manufacturers includes inspection, metrology and data management systems. Specialized inspection tools assess surface quality and detect, count and bin defects during the wafer manufacturing process and as a critical part of outgoing inspection. Wafer geometry tools ensure that the wafer is extremely flat and uniform in thickness, with precisely controlled surface topography. Specifications for wafer defectivity, geometry and surface quality are tightening as the dimensions of transistors become so small that the geometry of the substrate can substantially affect transistor performance.

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Source: Annual Analyst Briefing At SEMICON West 2013

The Industry

Semiconductor and semiconductor equipment manufacturers have historically been highly cyclical, with periods of strong growth and high margins, which have caused companies to raise capital investment, and in effect have caused excess supply followed by periods of weakness. The economic data and companies' comments are all saying essentially the same thing, which is that the semiconductor equipment industry has already passed through the bottom of the current cycle. New internet applications will extend the compute environment to every day devices like smart television, wearable, cars, light bulbs and more. This development will increase the demand for semiconductor test equipment.

Book-to-Bill Ratio

One very important parameter when analyzing a semiconductor company is the book-to-bill ratio, which is the ratio between new orders to actual sells. A ratio of above one implies that more orders were received than filled, indicating strong demand, while a ratio below one implies weaker demand. On December 19, 2013 the SEMI.ORG announced that the North American semiconductor equipment industry posted November 2013 book-to-bill Ratio of 1.11. On that occasion, Denny McGuirk, president and CEO of SEMI said:

The continuing rise in equipment bookings clearly points to year-end order activity that is substantially stronger compared to one year ago. This trend supports the current outlook showing a rebound in equipment spending for 2014.

The table below presents the North American semiconductor equipment industry's billings, bookings and the book-to-bill Ratio since the beginning of 2012.

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Source: SEMI.ORG

The charts below present the North American semiconductor equipment industry's billings, bookings and the book-to-bill ratio since 1991.

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The charts below present the North American semiconductor equipment industry's billings, bookings and the book-to-bill ratio since 1991.

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Valuation Metrics

The table below presents the valuation metrics of KLA-Tencor, the data were taken from Yahoo Finance and finviz.com.

KLA-Tencor' valuation metrics are quite good; the company has a low debt, the forward P/E is low at 13.23, and the average annual earnings growth estimates for the next five years is high at 16.1%. The PEG ratio, using next financial year forward P/E of 13.23 and the annual earnings growth estimates of 16.1%, is very low at 0.82 (forward P/E divided by growth). The long term PEG ratio is also low at 1.01.

Many analysts of the semiconductors industry give a high importance to the price-to-sales ratio, and consider it a better indicator than the P/E ratio for companies in this industry. Comparing the current price-to-sales ratio to its historical values can give a fair idea if the stock is cheap or too expensive right now. In the case of KLA-Tencor, the actual ratio is not historically too high as shown in the chart below (the small difference in value between the chart and the table is due to delayed updating of the chart).

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Dividend

KLA-Tencor has been paying uninterrupted dividends since April 2005. The forward annual dividend yield is quite high at 2.89%, and the payout ratio is at 54%. The annual rate of dividend growth over the past three years was very high at 33% and over the past five years was also very high at 22.4%.

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Source: Annual Analyst Briefing At SEMICON West 2013

Latest Quarter Results

On October 24, 2013, KLA-Tencor reported its first-quarter fiscal 2014 financial results, which beat EPS expectations by $0.03 and was in-line on revenues.

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New orders were at $790 million which gives book-to-bill ratio of 1.20.

In the report, Rick Wallace, president and CEO of KLA-Tencor commented:

KLA-Tencor delivered solid results for the first quarter of fiscal year 2014, generating revenue and EPS in the upper half of the guided range for the period, and new orders well above the upper end of the range. Our results demonstrate strong operational execution and financial performance as we address our customers' most critical yield challenges at the leading edge. With our market leadership and customer focus, we believe we will benefit from opportunities for continued growth as our customers execute their next-generation technology investments at the leading edge.

At the conference call, the company forecast earnings and revenue for the current quarter that were weaker than expected by Wall Street, saying foundry customers were taking longer to validate and pay for newly delivered chip manufacturing tools. KLA-Tencor expects revenue in a range of $670 million to $730 million. Analysts expected revenue of $760 million for the current quarter, which ends in December. The company estimated orders of $800 million to $950 million in the current quarter, up from $790 million in the September quarter and higher than some analysts had predicted.

Next Quarter Results

KLA-Tencor will report its second quarter fiscal year 2014 results on January 23. KLAC is expected to post a profit of $0.80 a share, a 27% rise from the company's actual earnings for the same quarter a year ago.

Competitors and Group Comparison

According to KLA-Tencor, the worldwide market for process control and yield management systems is highly competitive. In each of its product markets, it faces competition from established and potential competitors, such as Applied Materials, (NASDAQ:AMAT), ASML Holding N.V. (NASDAQ:ASML) and Hitachi High-Technologies Corporation (OTC:HICTF).

A comparison of key fundamental data between KLA-Tencor and its main competitors is shown in the table below.

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Source: Yahoo Finance

KLA-Tencor valuation metrics look better than those of Applied Materials and ASML Holding if we consider the PEG ratio as the most influencing criteria.

Most of KLA-Tencor's margins, return on capital and stock valuation parameters have been better than its industry median, its sector median and the S&P 500 median, as shown in the table below.

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Source: Portfolio123

Technical Analysis

Personally I am using only fundamental analysis for my investment decisions. After many years of experience, and after having tried all kinds of decisions making including technical analysis, I have reached the conclusion that relying on fundamental information is giving me the highest return. Nevertheless, some investors are successfully using technical analysis to find the proper moment to start an investment (I am not talking about traders, my analysis is only for investors). The charts below give some technical analysis information.

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Chart: finviz.com

The KLAC stock price is 0.95% below its 20-day simple moving average, 1.34% below its 50-day simple moving average and 6.91% above its 200-day simple moving average. That indicates a short-term and a mid-term downtrend and a long-term uptrend.

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Chart: TradeStation Group, Inc.

The weekly MACD histogram, a particularly valuable indicator by technicians, is at -0.33, which is a bit bearish (a rising MACD histogram and crossing the zero line from below is considered an extremely bullish signal). The RSI oscillator is at 53.85 which do not indicate oversold or overbought conditions.

Analyst Opinion

Analyst opinion is divided, but most analysts recommend the stock. Among the nineteen analysts covering the stock, two rate it as a strong buy, eleven rate it as a buy, five rate it as a hold, and one analyst rates it as an underperform.

Discussion

In my opinion, KLA-Tencor will outperform the worldwide wafer fab equipment (WFE) in 2014. According to SEMI.ORG, in its publication of December 03, 2013, worldwide sales of new semiconductor manufacturing equipment will increase in 2014 by 23.2% to $39.46 billion.

KLA-Tencor is poised to benefit from rising capital intensity to be driven by the transition to lower nanometer nodes. The rapid growth of consumer demand for mobile devices, including smartphones, tablets and portable PCs, is currently driving the electronics industry and, as a result, the semiconductor industry as well. Alongside this market growth, the industry continues to witness a high rate of change in technology, with the emergence of new techniques and architectures in production today, such as three-dimensional transistors, advanced patterning lithography and semiconductors with critical dimensions at 28 nanometer and below. Since KLA-Tencor's inspection and measurement technologies play a key role in the new manufacturing processes, a significant increase in the demand for its products can be expected.

Conclusion

As the world's leading manufacturer of yield management and process monitoring systems for the semiconductor industry, KLA-Tencor will benefit from the rebound in semiconductor manufacturing equipment spending in 2014. The company has compelling valuation metrics and strong earnings growth prospects, its PEG ratio is low at 1.01. Furthermore, KLA-Tencor has a strong balance sheet and a low debt, its Enterprise Value/EBITDA ratio is very low at 10.72. The book-to-bill ratio, a very important parameter when analyzing a semiconductor company was quite impressive at 1.20 in the last quarter.

KLA-Tencor has been paying uninterrupted dividends since April 2005. The forward annual dividend yield is quite high at 2.89%, and the payout ratio is only 54%. The annual rate of dividend growth over the past three years was exceptionally high at 33% and over the past five years was also unusually high at 22.4%. I consider that besides dividend yield, the consistency and the rate of raising dividend payments are the most crucial factors for dividend-seeking investors, and KLA-Tencor's performance has been impressive in this respect.

All these factors bring me to the conclusion that KLAC stock is a smart long-term investment.

Risk

Since two companies Intel (NASDAQ:INTC) and Taiwan Semiconductor (NYSE:TSM) were responsible for more than 10% of KLA-Tencor's net sales in 2013, a significant decrease in the amount of sales to any of these customers could have a material adverse effect on the financial performance and business prospects of the company. Downturns in the semiconductor industry or slowdowns in the worldwide economy could have a material adverse effect on the company's future business and financial results.

Disclosure: I am long KLAC, AMAT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.