KLA: Highest Profitability In Semiconductor Equipment Sub-Industry

May 10, 2022 5:39 PM ETKLA Corporation (KLAC)9 Likes
Khaveen Investments profile picture
Khaveen Investments
5.11K Followers

Summary

  • As the market leader with over 50% market share, we determined its advantage with its wide portfolio breadth and forecasted its revenue growth at 6.1% beyond 2022.
  • Also, we believe its stable installed base growth could support its services revenue growth outlook and forecasted its revenue growth in line with its products revenue growth.
  • Lastly, we also expect its strong market position to continue supporting its profitability with a forecasted gross margin and net margin of 61.6% and 32.6% respectively by 2026.

3d rendering robotic arms with silicon wafers for semiconductor manufacturing

PhonlamaiPhoto/iStock via Getty Images

In our previous coverage on KLA (NASDAQ:KLAC) vs Applied Materials (AMAT), we determined KLA's relatively more specialized business model in process control equipment serving customers in logic and memory segments. Moreover, we believed Applied Materials had an advantage over KLA in terms of its broader portfolio but KLA's high R&D spending could provide it with an advantage to enhance its portfolio and market positioning in process control equipment. Lastly, with its superior profit margins higher than the industry average, we believe this indicates KLA's business strength over other equipment manufacturers.

In this analysis, we analyzed the company's strengths in the semiconductor equipment process control market based on its market share and compared its product portfolio against competitors to forecast its revenue growth. Further, we looked into its services business segment and analyzed its installed base and share of total revenue growth to forecast its services revenue growth. Finally, we examined and compared its profitability against competitors and forecasted its margins going forward.

Market Dominance in Semiconductor Process Control

KLA specializes in semiconductor process control equipment which inspects and measures components and wafers along the semiconductor manufacturing process. This market represents 10.6% of the $71.1 billion total semiconductor equipment market at $7.52 billion in 2020. KLA dominates with the highest market share at over 50% based on Gartner.

To determine whether KLA has a competitive advantage over competitors such as Applied Materials, Hitachi, ASML and Onto, we analyzed the companies based on the range of process control equipment offered by each company and various types of equipment.

Company

KLA

Applied Materials

Hitachi

ASML (ASML)

Onto (ONTO)

Film measuring

Filmetrics

-

EA6000VX

-

MetaPULSE

Wafer Measuring

PWG5

-

-

YieldStar1385

NSX 330 System

CD Measuring

SpectraShape

VeritySEM

CD-SEM

YieldStar 1375F

IVS Series

Defect Inspection - Patterned Wafer

Puma Series

Voyager Series

UVision

HMI e-beam

Dragonfly G3

Defect Inspection - Unpatterned Wafer

Surfscan

-

LS Series

-

NovusEdge

Resistivity Measuring

OmniMap RS-200

-

-

-

Element system

General Purpose

Tencor P Series

Filmetrics R Series

iMicro

-

CR6300

-

Photomask inspection & repair

Inspection: Teron

Repair: RDC

Inspection: AERA

Repair: MR8000

-

-

Wafer Level Advanced Packaging

Kronos™ 1190

FOWLP

-

-

JetStep

Source: KLA, CSET,Applied Material, Hitachi, ASML, Onto

Based on our findings, KLA has the largest breadth of products among the selected competitors ranging from film & wafer measuring, defect inspections to general-purpose applications. This places KLA's breadth of portfolio ahead of Applied Materials, Hitachi, ASML and Onto.

Company

R&D as % of Revenue (10Y Average)

KLA Corp

15.85%

Applied Materials

13.88%

Lam Research (LRCX)

13.89%

ASML

13.09%

Tokyo Electron (OTCPK:TOELF)

15.85%

Average

14.51%

Source: SeekingAlpha, Khaveen Investments

Additionally, the company's average R&D spending as a % of revenue in the past 10 years is higher than its competitors' average. We expect that its broad process control equipment portfolio indicates its competitive advantage and market leadership. Thus, we projected its Product segment revenues to grow in 2022 based on its prorated Q1 to Q3 results Beyond that, we based its growth on the process control equipment market growth CAGR of 6.1% through 2028 by Data Bridge Market Research.

Product Segment Revenue Projections ($ mln)

2019

2020

2021

2022F

2023F

2024F

20225F

2026F

Product

3392

4,329

5,240

7,101

7,535

7,994

8,482

8,999

Growth %

7.3%

27.6%

21.0%

35.5%

6.1%

6.10%

6.10%

6.10%

Source: KLA, Data Bridge Market Research, Khaveen Investments

Overall, we highlighted KLA's dominance in the process control equipment market with a stable market share of over 50% in the past 10 years from Gartner data. We compiled together various types of process control equipment to compare the breadth of each company's portfolio and found KLA to have the widest portfolio breadth as its competitive advantage.

Continued Service Growth with Long-standing Customer Relationships

Besides selling process control equipment, the company provides customer support and maintenance services to customers based on its annual report which accounts for a quarter of its revenues. We believe this segment to be highly stable for the company due to its long-standing customer relationships. Its top key customers are TSMC and Samsung accounting for over 10% of its total revenues. The company has had a very long-standing relationship with TSMC and Samsung for at least more than 20 years.

Chart, bar chart Description automatically generated

KLA

In addition to its long-standing customer relationships, the company has had stable growth in its install base of equipment. In the chart above, the company's install base of process control equipment has continued to grow to over 20,000 by 2020.

KLA revenue share by product and service

KLA, Khaveen Investments

Furthermore, its service revenue accounts for around 25% of its total revenues and grew at an average CAGR of 11.3% in the past 10 years. In the past 10 years, its share of service revenues as a % of total revenues has also remained stable with an average of 23.49%. Overall, we believe this highlights its stable revenue growth in line with its Product segment.

To project the revenue growth of its Service segment, we based it on a 3-year average share of Service revenues to Product revenues of 33.6%. With our derived Product revenue forecasts applied with this assumption, we obtained the Service revenue projections through 2026 growing at a stable rate.

KLA Revenue by Product and Service ($ bln)

2019

2020

2021

2022F

2023F

2024F

20225F

2026F

Product ('a')

3,392

4,329

5,240

7,101

7,535

7,994

8,482

8,999

Growth %

7.3%

27.6%

21.0%

35.5%

6.1%

6.10%

6.10%

6.10%

Share of Service Revenues of Product Revenues ('b')

34.7%

34.1%

32.0%

33.6%

33.6%

33.6%

33.6%

33.6%

Service ('c')

1,177

1,478

1,678

2,388

2,533

2,688

2,852

3,026

Growth %

34.4%

25.6%

13.5%

42.3%

6.1%

6.1%

6.1%

6.1%

Total

4,569

5,807

6,918

9,489

10,068

10,682

11,333

12,025

Growth %

13.2%

27.1%

19.1%

37.2%

6.1%

6.1%

6.1%

6.1%

*C = A x B

Source: KLA, Khaveen Investments

All in all, supported by its long-standing relationships with key customers over multiple decades such as with TSMC and Samsung, we expect the company's install base growth indicates growth potential for its service segment with long product life cycles requiring maintenance and support services which KLA provides.

Best Margins Among Major Semiconductor Equipment Competitors

With a monopoly over the process control market, the company has some of the highest gross and net profit margins in the total semicon equipment market. In terms of gross margins, it has a 5-year average of 60.74% and above the industry average of 47.93%. Similarly, its net margins have an average of 25.31% which is slightly above the industry average of 22.37%. Moreover, the company's FCF margin is also the highest among competitors.

Company

Gross Margins (5Y Average)

Net Margin (5Y Average)

FCF Margin (5Y Average)

KLA Corp

60.74%

25.31%

20.78%

Applied Materials

44.99%

21.05%

14.01%

Lam Research

45.93%

23.21%

15.35%

ASML

46.73%

24.43%

12.97%

Tokyo Electron

41.25%

17.87%

10.36%

Average

47.93%

22.37%

14.69%

Source: SeekingAlpha, Khaveen Investments

In terms of gross and net margins, KLA leads its competitors followed by ASML. The main difference between the two is that KLA's equipment spans the entire manufacturing process from substrate manufacturing to wafer production and packaging. As the company dominates the market, the bargaining power of buyers is relatively lower than competitors. On the other hand, ASML monopolizes the EUV lithography equipment market, but it is mainly used by foundries and IDMs in the lithography process thus a higher bargaining power of buyers which may explain its lower margins than KLA. Other competitors like Applied Materials, Lam Research and Tokyo Electron compete more aggressively with each other producing deposition and etching equipment.

As mentioned in the first point, the company has the highest R&D spending as a % of revenue among competitors. Despite spending the highest R&D among competitors, the company's net and FCF margins are still the highest among competitors. We view KLA's strong established market positioning as a very high barrier to entry which makes it difficult for competitors to challenge KLA. Based on our forecast of its margins, we expect its gross and net margins to remain fairly stable reaching 61.6% and 32.6% respectively by 2026.

KLA margins

KLA, Khaveen Investments

All in all, KLA stands out among the major semicon equipment manufacturers with its superior profitability margins. We believe this is attributable to its dominating market position in the process control equipment market with over 50% market share and a broad portfolio which decreases its power over buyers. Its superior gross margins enable it to allocate spending to R&D activities as one of the highest in the industry yet still maintaining superior net margins and solidifying its competitive advantage with product development.

Risk: Low Total Semicon Equipment Market Share

While KLA has cornered the process control market with a dominating market share of over 50% in the past 10 years, its lack of presence in other different equipment types could be a concern for growth. In terms of market of the total semiconductor equipment market, it is in the fifth position behind market leaders ASML, Applied Materials, Lam Research and Tokyo Electron despite a strong market position in process control equipment. This is attributed to the relatively small size of the process control equipment market which only accounts for 10.6% of the $71.1 bln semiconductor equipment market as highlighted earlier. As the company remains committed to this segment of the market, its market share gain in the semicon equipment market is limited until it expands to other types of equipment.

market share

Statista, The Information Network

Valuation

The company has had an average FCF margin of 20.03% for the past 5 years. KLA acquired Orbotech in 2019 for $ 3.4bln. Similar to its net margins, its FCF margins are also among the highest in the industry.

kla cash flow

KLA, Khaveen Investments

We valued the company based on a DCF valuation as it has positive FCF margins with its terminal value based on the average semiconductor equipment competitors' EV/EBITDA of 17.02x.

industry average EV/EBITDA

SeekingAlpha, Khaveen Investments

Based on a discount rate of 10.4% (company's WACC), our model shows its shares are undervalued by 16%

KLA valuation

Khaveen Investments

Verdict

To conclude, we determined the company's process control strong market positioning with its dominating market share and broadest equipment portfolio as its competitive advantage and forecasted its product segment revenue growth based on the market forecast CAGR of 6.1%. In addition, we believe that with its rising installed base, its services business segment's outlook is supported as seen by its stable growth in the past 10 years and we forecasted its total revenue growth at 6.1% beyond 2022. In terms of profitability, we believe its strong market positioning could support its superior margins against competitors and expect its gross and net margins to remain fairly stable reaching 61.6% and 32.6% respectively by 2026. Overall, we rate the company as a Buy with a price target of $382.67.

This article was written by

Khaveen Investments profile picture
5.11K Followers
Khaveen Investments is a Global Macro Quantamental Hedge Fund managing a tactical asset-allocated portfolio of globally diversified investments. We have interests in 100+ investments across multiple asset classes, countries, sectors and industries. Our investment approach takes both a top-down and bottom-up approach encompassing macro-economic, fundamental, quantitative and technical analysis. We serve accredited investors throughout the globe, which include HNW individuals, SMEs, associations, and institutions. Our investment managers have decades of investment experience between them, with research expertise in emerging technologies such as Artificial Intelligence, Cloud Computing, 5G, Autonomous & ElectricVehicles, FinTech, Augmented & Virtual Reality and the Internet of Things.www.khaveen.com
Follow

Disclosure: I/we have a beneficial long position in the shares of KLAC either through stock ownership, options, or other derivatives. 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.

Additional disclosure: No information in this publication is intended as investment, tax, accounting, or legal advice, or as an offer/solicitation to sell or buy. Material provided in this publication is for educational purposes only, and was prepared from sources and data believed to be reliable, but we do not guarantee its accuracy or completeness.

Recommended For You

Comments

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.