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Summary

  • KLAC is poised to benefit from strong double-digit sales growth for semiconductor equipment this year.
  • KLAC's latest quarter book-to-bill was at 1.22, while the North American semiconductor equipment industry book-to-bill ratio rose to 1.09 in June.
  • KLAC has compelling valuation metrics and very strong earnings growth prospects.
  • KLAC returns cash to its shareholders by stock buybacks and increasing dividend payments.

KLA-Tencor Corporation's (NASDAQ:KLAC) has outperformed the market in the last years, but in my opinion, KLAC's stock still has plenty of room to move up. KLA-Tencor will benefit from a rebound in semiconductor manufacturing equipment spending in 2014. SEMI.ORG sees strong double-digit sales growth for the semiconductor equipment industry this year. KLA-Tencor has compelling valuation metrics and very strong earnings growth prospects. In addition, KLA-Tencor returns cash to its shareholders by stock buyback and increasing dividend payments.

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 everyday devices like smart televisions, 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 July 21, 2014 SEMI.ORG announced that the North American semiconductor equipment industry posted June 2014 book-to-bill ratio of 1.09. On that occasion, Denny McGuirk, president and CEO of SEMI, said:

Semiconductor equipment bookings are at the highest level since May 2012. The strength of the June bookings (three-month average) substantiate the outlook for strong double-digit sales growth this year.

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

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's valuation metrics are very good. The trailing P/E is at 20.46, and the Enterprise Value/EBITDA ratio is low at 11.07. According to Yahoo Finance, KLAC's next financial year forward P/E is low at 14.73 and the average annual earnings growth estimates for the next five years is very high at 19.60% - these give a very low PEG ratio of 0.75. The PEG Ratio - price/earnings to growth ratio is a widely used indicator of a stock's potential value. It is favored by many investors over the P/E ratio because it also accounts for growth. A lower PEG means that the stock is more undervalued.

Many analysts of the semiconductor 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).

KLAC PS Ratio (<a href=

KLAC PS Ratio (NYSE:TTM) data by YCharts

Dividend and Share Repurchase

KLA-Tencor has been paying uninterrupted dividends since April 2005. The forward annual dividend yield is at 2.51%, and the payout ratio is at 49.4%. The annual rate of dividend growth over the past three years was very high at 38.7% and over the past five years was also very high at 21.7%.

On July 08, KLA-Tencor announced that its Board of Directors has authorized significant increases to the company's program to return cash to stockholders. As part of the program, the Board has approved an increase in the level of the company's quarterly dividend from $0.45 to $0.50 per share. This increase is expected to take effect beginning with KLA-Tencor's quarterly dividend to be declared in August 2014. This represents an 11 percent increase compared to the prior quarterly dividend and is the sixth dividend increase since KLA-Tencor first instituted its dividend in April 2005.

Additionally, the Board has approved an increase in the company's share repurchase program for up to 13 million additional shares of the company's common stock. This is in addition to the company's prior repurchase authorizations, under which approximately 2 million shares remained available for repurchase as of June 30, 2014.

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Source: Annual Analyst Briefing At SEMICON West 2014

Latest Quarter Results

On July 24, 2014, KLA-Tencor reported its fiscal 2014 fourth quarter financial results, which missed EPS expectations by $0.06 (7.0%) and was in-line on revenues.

The company reported revenues of $734.3 million, down 11.7% sequentially, and up 2.0% from the year-ago quarter. GAAP net income was $129 million, and GAAP earnings per diluted share were $0.77, down 36.4% sequentially and down 3.7% from the year-ago quarter.

New orders were at $898 million which gives book-to-bill ratio of 1.22.

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Source: KLA-Tencor Q4 Fiscal 2014 Conference Call

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

KLA-Tencor's fourth quarter results culminate a year of strong operating and financial performance for the company, as well as solid execution of our strategic objectives. Our market leadership was highlighted by the second-highest net bookings result in the company's history in fiscal year 2014, including record bookings for our Wafer Inspection products. This demonstrates our customer focus and market leadership, as well as the critical role KLA-Tencor plays in helping our customers address the higher cost and complexity associated with competing at the leading edge.

On the company's conference call with analysts, KLA management forecast Q1 revenue of $590 million to $650 million, and EPS of 34 cents to 54 cents, assuming bookings of $600 million to $800 million, and a gross profit margin of 54% to 55%.

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.

Source: Yahoo Finance, finviz.com

KLA-Tencor has the lowest EV/EBITDA ratio and the highest dividend yield among the stocks in the group. However, ASML has higher annual earnings growth estimates.

Most of KLA-Tencor's Margins and Return on Capital parameters have been better than its industry median, its sector median and the S&P 500 median, as shown in the tables below.

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Source: Portfolio123

Technical Analysis

The charts below give some technical analysis information.

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Chart: finviz.com

The KLAC stock price is 2.85% below its 20-day simple moving average, 3.19% above its 50-day simple moving average and 10.16% above its 200-day simple moving average. That indicates a short-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 0.66 and descending, 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 61.78 which do not indicate oversold or overbought conditions.

Ranking

According to Portfolio123's "Balanced4" powerful ranking system, KLAC's stock is ranked second among all S&P 500 stocks yielding more than 2%. Only Lockheed Martin (NYSE:LMT) is ranked higher (see my article about LMT). The "Balanced4" ranking system is quite complex, and it is taking into account many factors like EPS consistency, technical analysis, valuation, profitability ratios and dividend information, as shown in the Portfolio123's chart below.

Back-testing over 15 years has proved that this ranking system is very useful.

Analyst Opinion

Analysts' opinion is divided, but most analysts recommend the stock. Among the 20 analysts covering the stock, two rate it as a Strong Buy, nine rate it as a Buy, seven rate it as a Hold, and two analysts rate it as an Underperform.

TipRanks is a website that ranks experts (analysts and bloggers) according to their performance. According to TipRanks, among the analysts covering KLAC stock there are eleven analysts who have the four or five star rating, eight of them recommend the stock, and three analysts have a Hold rating on the stock.

Major Developments

After reporting a weaker than expected September quarter outlook on July 24, KLAC stock declined almost 5% in late trading to $69.50. However, KLAC's stock gained most of its loss in the next trading day, to close at $71.60, just 1.95% down from its previous price. Since the beginning of the year KLAC's stock has gained 11.1% while the S&P 500 index has increased 7.0%, and the Nasdaq Composite Index has risen 6.5%. Moreover, since the start of 2013 KLAC's stock has gained 49.9% while the S&P 500 index has increased 38.7%, and the Nasdaq Composite Index has risen 47.4%.

SEMI.ORG sees strong double-digit sales growth for the semiconductor equipment industry this year. In fact, the North American semiconductor equipment industry book-to-bill ratio rose to 1.09 in June. Meanwhile, KLA-Tencor's latest quarter book-to-bill was even higher at 1.22. KLAC's new orders in the fourth quarter were $898 million, up 27.9% sequentially, 25.9% year over year and better than the guided 625-825 million. The strength in the last quarter was related to foundry demand in the sub-20nm category and in demand for DRAM. KLA-Tencor is gaining market share in process control equipments, as shown in the chart below.

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Source: Annual Analyst Briefing At SEMICON West 2014

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 a rebound in semiconductor manufacturing equipment spending in 2014. The company has compelling valuation metrics and strong earnings growth prospects; its PEG ratio is very low at 0.75. Furthermore, KLAC's stock is ranked second among all S&P 500 stocks yielding more than 2%, according to Portfolio123's "Balanced4" powerful ranking system. In addition, KLA-Tencor returns cash to its shareholders by stock buyback and increasing dividend payments.

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.

Source: KLA-Tencor: Buying Opportunity In A Good Yielding Stock