KLA Corporation

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

KLA Corporation is a leading global supplier of process control and yield management systems for the semiconductor manufacturing industry.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

KLA Corporation (KLAC), headquartered in Milpitas, California, is a major player in the semiconductor manufacturing equipment industry. They are focused on designing, manufacturing, and marketing process control and yield management systems that are essential to the production of semiconductors.

Semiconductor manufacturing is a complex and precise process, with each stage requiring sophisticated equipment. KLA’s products perform critical in-line testing, process control, and defect detection in all stages of the semiconductor manufacturing flow.

Revenue Distribution

KLA’s revenue is derived from three main segments:

  1. Semiconductor Process Control (SPCO): This segment generates the majority of KLA’s revenue and includes equipment for pattern overlay, inspection, metrology, defect review, and data analysis.

  2. PCB, Display and Component Inspection (PCDI): This segment focuses on products for testing and inspection of printed circuit boards, flat panel displays, and other components.

  3. Services: KLA also generates revenue from services associated with their equipment, including maintenance, support, and upgrades.

While KLA’s largest revenue comes from the SPCO segment, their diverse product portfolio offers them revenue sources from different parts of the semiconductor manufacturing ecosystem. Also, their business model includes a recurring revenue stream through their services.

The semiconductor industry is characterized by:

  • High Cyclicality: The demand is greatly impacted by macroeconomic changes, and also by the ever-changing nature of consumer electronics which leads to periods of rapid expansion, and periods of oversupply.

  • Rapid Technological Advancements: Constant innovation requires continuous investments in research, and development and newer technology upgrades, and production processes.

  • Globalization and Competition: The industry is becoming increasingly complex, and more global, leading to greater competition.

Competitive Landscape

KLA operates in an oligopolistic market, with a few large players dominating the semiconductor equipment landscape. These competitors include companies like Applied Materials, ASML, and Lam Research. These competitors, as well as other companies that provide specific technology solutions like Cadence and Synopsys, make for a rather fiercely competitive environment. However, KLA has cultivated a specialized niche, specifically in process control and yield management which gives them an advantage over the general competition.

KLA’s edge in the competitive landscape lies in their focused approach on metrology and inspection systems, which provides mission-critical inputs in manufacturing flows, thereby giving them access to strong customers who depend on quality and reliability metrics.

What Makes KLA Different?

KLA differentiates itself with its:

  • Advanced Technology: Their focus on developing innovative solutions for process control allows them to have a unique selling position.

  • Strong Customer Relationships: They work closely with their customers, who include a large portion of the semiconductor industry’s manufacturers, for long periods of time, creating high switching costs.

  • Dominance in a Niche Market: Rather than focusing on general semiconductor manufacturing equipment, they focus on the niche areas of metrology, inspection, and process control; thereby achieving high market share.

Financial Analysis

KLA’s financials show a reasonably healthy balance sheet and strong profitability, however a few things are notable:

Profitability and Margins

  • KLA has maintained good margins over the past years, with a gross margin around 60% and above, and net income over 25%. This shows KLA’s pricing power and their operating efficiency.

  • However, it has been noted that their margins and overall profitability can take a hit in times of decreased demand from their customers.

  • The company is also very reliant on exports and a good chunk of their revenues and profits comes from regions such as China and Korea, as such, a slowdown in those regions could affect their profitability.

  • KLA is highly capital intensive, requiring constant research and development efforts and significant spending on manufacturing capacity.

Balance Sheet Health: 4/5

KLA has a rather strong balance sheet, it is not debt free, however, the debt it has seems manageable, and a good percentage of it is long-term.

  • The company also has a cash position of $3B.

  • The current ratio, a measure of short-term financial health, is 3.0, this shows a comfortable cushion in the company’s financial health.

The cash flow statements show that while KLA is making a lot of income, the company is spending a good percentage of it on R&D and CAPEX, which is understandable for a company in a market that relies on continued innovation. They are also using a good proportion of the free cash flow on share repurchases, indicating their long term confidence in the business.

Recent Concerns and Challenges

KLA, like many semiconductor companies, is susceptible to macroeconomic changes and the inherent cyclicality of their industry. The current economic slowdown and the reduced demand for many of their products has been putting pressure on the company.

  • The company has given a forecast of lower growth rate due to an “overall softness in the industry”, but expects things to turnaround in the long term.

  • The management expects capital spending for 2024 to be lower than 2023, indicating lower demand in the short term.

  • The company expects supply chain disruptions to ease in 2024, but the timing is somewhat uncertain.

  • As companies start pulling back on their chip productions, it will have a direct effect on the demand for KLA’s products, and hence hurt their revenues.

  • They are also focusing on cost management during this downturn period, and have already started to reduce their overhead costs, which will also negatively affect revenues in the short term.

  • Their largest revenue and demand is coming from China, and therefore political tensions between US-China might become a risk for KLA.

KLA’s susceptibility to industry cyclicality, and high reliance on exports are areas of concern for the investor to consider. While they have been resilient over past downturns, how they react in the long term to these will be worth looking into.

Moat Analysis: 3/5

KLA’s moat can be classified as a narrow moat. The company’s strong position in the metrology and inspection niche within the semiconductor equipment sector, coupled with high customer switching costs provides them with a reasonably good degree of sustainable competitive advantage. However, other aspects of their business are highly susceptible to new players, and are not as robust as some other businesses.

  • Intangible Assets: KLA benefits from its established brand and the reputation it has built in the industry. They also have intellectual property protections in place due to constant innovations, and patents over new technologies and production processes. But they are not as strong as pure patent or brand plays.

  • Switching Costs: Their high customer switching costs arising from integration and validation process of their equipment give them a moat. However, once the systems are set up, the customer becomes accustomed to their product line.

  • Cost Advantages: They do not have any significant cost advantages based on economies of scale. The main business driver for KLA is quality, not necessarily cost, and are constantly trying to stay on the forefront of new technologies.

  • Network Economics: Their business is not known for strong network effects.

Understandability: 3/5

While the basic premise of KLA’s business - providing inspection equipment for semiconductors - is relatively easy to understand, there are certain aspects of the company’s business that require a deeper level of financial and accounting knowledge. The specific technicalities related to semiconductor manufacturing, financial jargons, and the various types of accounting methods can make it somewhat challenging to understand for non-financial individuals. The complex supply chains and the high volatility of the industry can add further complications.

Therefore, KLA will get a rating of 3 on understandability.

Conclusion

KLA Corporation is a leading company in the semiconductor manufacturing equipment sector. They have a wide product portfolio, strong balance sheet, and they operate in an industry that is expected to grow significantly in the future. While their dependence on certain regions for revenue, and the highly cyclical nature of the industry are significant risks, their core business and competitive advantages make them a solid company to follow for the foreseeable future.