KLA My Top Semiconductor Equipment Pick: Comparison To Applied Materials And Lam Research

Summary

• Stock prices of KLA, Applied Materials, and Lam Research reached 52-week highs on the same day last week.
• KLA’s stock grew 3X that of Applied Materials and Lam Research in the past six months.
• KLA topped all major equipment suppliers with a YoY growth of 42.6% in 2021.
• KLA topped Applied Materials and Lam Research with the highest gross profit margins and highest Quant rating.
• This idea was discussed in more depth with members of my private investing community, Semiconductor Deep Dive. Learn More »

According to a Seeking Alpha news blurb on December 27, 2021:

“The semiconductor equipment sector also extended its already outsized run in 2021. The latest gains allowed KLA Corp. (NASDAQ:NASDAQ:KLAC), Lam Research (NASDAQ:LRCX) and Applied Materials (NASDAQ:AMAT) to set fresh 52-week highs.”

Jae Young Ju/iStock via Getty Images

Comparing these three stocks is complicated by the fact that, unbeknownst to many investors and traders, KLAC doesn’t really compete against AMAT and LRCX.

Why do I say this? Because in a WFE (Wafer Front End) equipment market that will reach nearly $82 billion in 2021, just 5.3% of KLAC’s revenue competes against LRCX, and that was only due to KLAC’s 2019 acquisition of Orbotech. Prior to that, KLAC didn’t compete head-to-head against LRCX in etch and PECVD.

Against AMAT, that percentage increases to 7.5% because of competitive PVD products, in addition to etch and PECVD. But KLAC also competes directly against AMAT in mask and wafer inspection sectors of the metrology/inspection market. This direct competition represents just 5.2% of AMAT’s 2021 revenues that are in the metrology/inspection market, according to The Information Network’s report entitled “Applied Materials: Competing Analysis of Served Markets.”

All three companies are considered semiconductor equipment manufacturers yet the overlap between KLAC and competitors is 7.5% and lower. Yet the three stocks all reached 52-week highs on the same day, which I consider astonishing.

Why The Strong Growth for KLAC?

AMAT and LRCX make processing equipment, such as deposition and etch to form layers and then patterns on the wafer. KLAC makes metrology/inspection equipment to monitor these layers and patterns. In other words, they have very different business models.

KLAC systems not only analyze defectivity and metrology issues at critical points in the wafer, reticle, and IC manufacturing processes, but also provide information to customers so they can identify and address the underlying process issues. The ability to locate the source of defects and resolve the underlying process issues enables KLA customers to improve control over their manufacturing processes, increasing their yield of high-performance parts and delivering products to market faster, thus maximizing profits.

Semiconductor manufacturers worldwide constructed 19 new high-volume fabs in 2021 and will build another 10 in 2022 to meet this demand for semiconductor chips. Of these fabs that started construction in 2021 and 2022, 15 are foundry facilities with capacities ranging from 30,000 to 220,000 wafers per month. The memory sector will have begun construction on four fabs over the two-year span. These 29 fabs could produce as many as 2.6 million wafers per month,

Many of these foundry/logic fabs, primarily those of TSMC (TSM), Samsung Electronics (OTCPK:SSNLF), and Intel (INTC) will be outfitted with equipment to make chips at <7nm nodes. The move to 5nm and 3nm nodes with smaller dimensions will be a major tailwind for the metrology/inspection market. KLA’s equipment at smaller process nodes provide information to customers to identify and address the underlying process issues.

In Chart 1, data from AMD show the cost per wafer increases by a factor of 5X for a chip at the 5nm node versus the 45nm node. What this means is that any device killing defects of today's leading ICs are smaller than ever and require rapid resolution for HVM demands. As wafers go through the >1000 process steps that can take three months from bare wafer to packaged chip to complete, a drop in yield will be a bigger loss of revenue as nodes decrease. Thus, a completed chip at 5nm manufactured by TSMC has a production cost 2.8 times that of a 28nm chip manufactured at a foundry such as SMIC (OTCQX:SMICY) in China.

Chart 1

Comparing The Top Wafer Front End Stocks

Based on equipment revenue for Q1-Q3 2021 and estimated revenues for Q4 calculated from a variety of factors including company guidance, customer WFE (wafer front end) spend, and component shortages, Chart 2 shows that KLAC revenues increased 42.6% YoY for CY2021. Growth was the highest of the top seven equipment companies with baseline revenues above $1.5 billion.

Interestingly in Chart 2 is that the “other suppliers” making up 20% of WFE revenues registered a YoY growth of 20.5% compared to the global WFE growth of 35.9% and an average growth of 40.2% for the top seven companies profiled.

Chart 2

Market Dominance

KLA dominates the semiconductor metrology/inspection sector with revenues 4X greater than its nearest competitors. This share has been consistent between 2010 and 2020. Chart 3 illustrates market shares for KLA and its top four competitors, according to The Information Network’s report entitled “Metrology, Inspection, and Process Control in Semiconductor Manufacturing.”

Chart 3

Investor Takeaway

The fact that AMAT, KLAC, and LRCX all reached 52-week and 3-year highs on the same day is surprising when the competition between companies on a revenue basis is small compared to their overall revenues.

Chart 4 shows KLAC stock performance on a 6-month basis, with growth 3X that of AMAT and KLAC.

Chart 4

P/E Ratio is shown in Chart 5, showing differences of just 2.5%.

Chart 5

Diluted EPS is a different story, as shown in Chart 6. In this 5-year period, the % change increase for KLAC is significantly greater than AMAT or LRCX.

Chart 6

Chart 7 shows a significantly larger Gross Profit Margin for KLAC, 25% higher than from AMAT and LRCX.

Chart 7

Seeking Alpha’s Quant Rankings have KLAC at 8 out of 32 semiconductor equipment companies. This compares to AMAT ranked 15 and LRCX ranked 14. KLAC has a Quant Rating of 4.76 compared to 4.12 for AMAT and 4.18 for LRCX.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.

Comments

[Investor324]

Your article made me very bullish but I found a lot of not so nice things about the company. At first its net margin is as high or less high than that one of the other companies, e.g. Lam, Applied Materials and ASML.
The net margin is much more important than the brutto margin but you wrote only about the excellent brutto margin.
Also you say they nearly have no competitors but in the annual report states:
"The worldwide market for technologically advanced process control, process-enabling and yield management solutions used by semiconductor and electronics
manufacturers is highly competitive. In each of our product markets, we have many competitors, including companies such as Applied Materials, Inc., ASML Holding N.V.,
Hitachi High-Technologies Corporation, Onto Innovation, Inc. and Lasertec, Inc., some of which may have greater financial, research, engineering, manufacturing and
marketing resources than we have. "
What do you think of that ?
I'm very interested in what you have to say to these point!

[Robert Castellano]

@SecretHedgfundInvestor No reason for Gross profit margin vs profit margin. Gross was FIRST on the YCharts list. I've plotted profit margin today and of course numberer are lower but KLAC is still 50% greater than AMAT and LRCX.
On competition question, I think it is an English issue, because I NEVER said in this article they have NEARLY NO COMPETITORS. So please RE-READ this article.
By the way, this statement is the SAME in all 10-Ks and Annual Reports. CFOs use the same template from one company to another and stick in the company names separately.

[Investor324]

@Robert Castellano Thank you for the fast response. I have plotted the profit margin at y chart today too and it isn't 50% higher than if the other companies. In the last quarter Lam's Profit Margin was 27% while Kla's was 30%. The average profit margin of Kla in the last 5 years was 26% and Lam's 23%. So where do you have the numbers from?
And in your article you've written also that only 5 % of the revenue compete with Lam and 12% with Applied Materials. I like your analysis very much and I'd like to hear your opinion.

[Robert Castellano]

@SecretHedgfundInvestor Again you have not read my article. Look at Chart 7. It says 5 years - FIVE. So if you look at the past quarter it is NOT FIVE YEARS, it is THREE MONTHS.
FYI according to YCHART, 5 year KLAC margin is 36.57%, AMAT is 25.53%, LRCX is 27.78%
So the increase of KLAC over Lam 31.6% for margins.
For Gross margins the increase of KLAC over Lam is 30.4%.
SO WHAT'S YOUR POINT AND AGENDA IN YOUR COMMENT?

[Doggywag]

I bought KLAC for the dividend growth, because that's my investment style. How lucky I am that the company also just so happens to be a good investment in many other ways, according to this impressively knowledgeable author (people often don't notice that "authority" is an extension of "author"). I would never pretend to understand this microprocessor stuff, although I do get the gist of what KLAC does and that it occupies a niche. I have seen photos of KLAC machines and they look like something from the year 2295.

[Robert Castellano]

@Doggywag Thank you for your compliment.

[Scootrd]

Robert IMHO you are spot on with your thesis. You have gained a new follower.

Ticker Covered KLAC
Author's rating at publication "Buy"
KLAC price at publication $431.14
Change -16.08%
>
As of close this evening - $361.80-18.80 (-4.94%) 4:00 PM 01/27/22
Folks need not overthink this. You cannot buy a toaster nowadays without a chip in it...You cannot manufacture semi's without as one commenter put it "Semi Picks and Shovels".

The short term materials / supply chain headwinds will eventually unwind. With the recent pullback in the semi space the markets are handing patient long term investors an industry wide miss-priced broad based gift. Short term pain, very long term gains.

KLA-Tencor (NASDAQ:KLAC) reported on Thursday second quarter earnings that beat analysts' forecasts and revenue that topped expectations. Earnings per share of $5.59. Revenue rose to $2.35 billion from $1.65 billion in the year-ago quarter. Wall street anticipated EPS of $5.44 on revenue of $2.33B.

Shares lost 5.43% in after-hours trade following the report on weak outlooks for the "March-ending quarter" risk becoming a drumbeat for the chip sector at large given this week’s earnings reports.

>
Tomorrow I will be over weighting my share count in KLAC and FSELX. I am more than willing to accept a little transitory headwinds, for sustained future gains within an industry that has a solid future for decades to come. The best time to buy quality is when Quality goes on sale.

Others mileage may vary
- Scoot

“Purchasing a business at a price that provides reasonable assurance of a generous margin for error is an erudite way of saying to ourselves, ‘Buy low, stupid’”- Frank Martin

Disclosure Long, KLAC, TXN, FSELX

[Doggywag]

@Scootrd These kinds of stocks are enormously volatile. I've become used to the rollercoaster thrills of KLAC (and LRCX, my other chip stock). But those who can't take it should look to MRK, KO, etc.

[Scootrd]

@Doggywag
All have their place in a diversified portfolio. However with the recent slide in Semi's and the increased need for increased capacity for decades to come ... Semi's are a long term investment in Dividend and in Growth.

Opinions vary (This one is mine)
Much success with your investments.

- Scoot

[Comic123]

Any updated thoughts after the prints? Anything that surprised you or you think isn’t being properly understood? Thanks.

[rm33]

@Robert Castellano

Which company will sell to the new Intel plant in Ohio the machines for making chips or testing the chips

klac or amat?

I know that asml will sell to intc.
Thanks

[Robert Castellano]

@rm33 Both. AMAT has a large percentage of sales to foundry/logic (compared to LRCX that has high exposure to NAND memory) and KLAC in metrology/inspection. KLAC dominates the sector and competes against AMAT in only three out of 20 subsectors and KLAC leads AMAT 2:1 in revenues.

[PA]

AMAT looks primed to 200

[pdcdn]

Thank you once again for a clear view analysis . I continue to read y our articles with attention - wish only I paid closer attention on KLAC and some of the MU moves up, though wonder if it will reach the 120 level you advanced a few articles back.

[Robert Castellano]

@pdcdn Thank you. My system is a very uncomplicated one because I deal with a lot of lies, damn lies, and statistics.

What I do is get a ruler and put it on the stock price in the summer of 2020 before the US election and then extrapolate. Most stocks had a bounce when the election results came in, but the euphoria is now gone, so there has been a pullback. Then we had some good news about Covid and all the electronic stuff bought from lockdowns. Now we have the another bump for the most part except Cathie Wood's ARKK.

[Fred Ziffel]

Do you have view on MPWR?

[Robert Castellano]

@Fred Ziffel Sorry no.

[groundpounder]

Thank you for this article. A very comfortable read. I’ve held LAM for a few years and love watching it grow, even going through this semiconductor situation. Your credentials are impressive and impeccable.

[allencar]

KLAC, LRCX, and ASML are technically competitors in the Fab Equipment space but each is dominate in most of their respective product lines; very little real competition. They go up/down together because of the rate of fab construction and the health of the Semi's. The health of the SMH companies affect these companies but they really are not Semi Companies; they make the equipment that allow Semi companies to produce their products.

Picking the "right" one is above me; so I made my own miniature ETF and bought an equal wight of each. At only ~5% of my portfolio I can accept the volatility. It does appear that the combined ride is smoother than the individual rides.

[Technosemi]

@Robert Castellano

I was originally persuaded by your article, but then I found a post on a new, bullish article on KLAC, and that post's link to a more detailed chart gives me some pause. It seems KLAC trades all over the place w/big moves up, followed by big moves down, Check it out for yourself:

finviz.com/...

[Robert Castellano]

@Technosemi What I could do if I a big computer (and big bucks) to data mine - and then just copy and paste.

[stockhawk]

The eps diluted chart(#5), kind of speaks volumes about your point on KLAC, if I understand what you are saying.That’s a huge difference. In a way the market is agreeing with you on valuation it looks like. Do you follow or have an opinion on COHU the California testing equipment company?

[Robert Castellano]

@stockhawk The key takeaway from this article is that the three stocks reached a high on the same date, and if you look at Chart 4, the cycles match, sometimes even amplitudes match. If you plot on a 1-year basis the are nearly identical % changes for the year.
That means that people and institutions buying these stocks know little about semiconductor equipment because (1) they should have the came stock performance because they have minimal overlap and (2) what is good for one stock should not be good for others because they do compete, particularly Lam and Applied. In other words, a "rising tide raises all boats."
That raises an important question. Why buy all three if the performance of all three is the same?
On COHU, even though it is back end testing, all the front end equipment from these companies make chips and they need to be tested. And if all my other assumptions are correct, then COHU is no better than AMAT or KLA or LRCX.
I presented bottom line financials and revenue data, but nevertheless all three performed the same in 2021 on a % change basis.
Food for thought.

[stockhawk]

@Robert Castellano excellent, makes sense completely. The rising tide analogy is so true, and yes point well taken that Lam and Amat minimally overlap with KLA. I was reading up on COHU and thought the rosy scenario was a bit too good to be true at least fundamentally. Appreciate your straightforward research and knowledge.

[Robert Castellano]

@stockhawk And keep an eye on its guidance. IMO not very promising.

[tzeshan]

Purchased KLAC on 5/2/2019 at $115.50. Now the target price by one analyst is $500. This is amazing return.

[Robert Castellano]

@tzeshan I wrote positive articles on KLA on
Dec 14, 2018
Jan 31, 2019,
Feb 13, 2019,
March 19, 2019
before your May 2, 2019 purchase. I hope they were helpful.

[afroquest]

@tzeshan This "amazing" run, up more than 3x in less than 3 years, is it not a cause for concern?

[afroquest]

@Robert Castellano Your articles was what first brought KLAC onto my radar and after a bit more research I eventually bought some. So yes, your articles were very helpful. All the best.

[PA]

What was your total return last year Mr. Castellano?

[Robert Castellano]

@PA Is this a trick question? 0 for 0

[PA]

@Robert Castellano NO ..Im curious

[Robert Castellano]

@PA Me too. 0 for 0 I don't own stocks and I don't rate companies. This way I give unbiased third-party analysis that doesn't sound like a copy and paste job from an earnings call or presentation because I own stock in the company. Then read my articles. Then ask all my readers.

[magenta17]

KLA is a stealth semi. It's quietly under the radar moving UP oh so nicely! Great management, nice divvy! Longz KLAC! :-)

[Jonathanluceandrews]

Thx. You are on a roll.

[The Devil Made Me Do it]

UCTT was up 53.4%. Why exclude them?

[Robert Castellano]

@The Devil Made Me Do it They are NOT an equipment supplier. They supply components to AMAT and LAM.

[ritholtz47]

@Robert Castellano
Hi,
Finally i understood some differences between these semi equipment stocks. Where does TERA stands with these 3?
Thanks