MKS Instruments, Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

MKS Instruments, Inc. is a global technology company that provides instruments, systems, subsystems, and process controls to manufacturers in the semiconductor, electronics and packaging, life and health sciences, and advanced manufacturing sectors.

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.

MKS Instruments, Inc. operates in diverse and technically complex industries, making it challenging for an average investor to understand its operations fully.

Business Overview

  • Revenue Distribution: MKSI operates through three reportable segments:
    • Vacuum and Analysis Solutions (V&S): This segment is the core of the company, designing and manufacturing instruments and systems used in semiconductor processing, vacuum technologies, and analytical applications.
    • Photonics Solutions Division (PSD): This segment develops laser systems, motion control solutions, and other similar technologies used for various purposes.
    • Materials Solutions Division (MSD): This segment focuses on manufacturing specialized chemicals and materials used in several processes, including advanced materials applications and packaging.
  • Industry Trends: The industries MKS serves are characterized by rapid technological changes, high capital expenditures, and demand driven by continuous innovation. In Semiconductor Market, as the world continues to digitalize, chip production needs to grow, meaning continuous demand for the tools and systems offered by MKS. In electronics and packaging, demand is also growing for more advanced production methods and advanced packaging solutions. Finally, life and health science industry requires continuous innovation in drugs, bio-materials, medical instrumentation and equipment manufacturing. This sector is also heavily influenced by regulatory requirements.

  • As a result of market trends, the company’s business is characterized by its cyclical nature, as the demand for its products is tied to the cycles of expansion and contraction within the industries it serves.

  • Margins: In the most recent quarter, the gross profit margin for the company was around 44%. The income margin was 15.3% while net income was approximately 9%. A significant portion of expenses for the company is selling, general, and administrative, which is the reason for the lower net margins.

  • Competitive Landscape: The competitive landscape is diverse, with large, established players alongside emerging and specialized competitors. This makes it difficult to determine a sustained advantage over competitors because technology development is a key parameter. There are a few key companies in each sector, often the ones that are most technologically advanced. It is important to note that MKS faces competition from its competitors, even though it has some niche advantages in their industries.

  • What Makes MKS Different: MKS has a long history of leadership and expertise in technologies used in these industries. Their strategic focus is on product development and innovation and expanding in new markets. They do have a reputation for innovative design solutions and customer intimacy. They also have a global network, which provides flexibility and rapid response to its clients’ needs.

  • In the most recent quarterly earnings call, MKS highlighted that it is expanding to other industrial sectors by using its products and core strengths and building partnerships to grow revenue in various industries.

  • Other relevant aspects:

    • MKS instruments focus on developing a full range of capabilities within its products. The company is committed to ensuring high quality for all of its products by adhering to certain standards during manufacturing and through strict quality controls.
    • Management focuses on R&D spend to develop new products and improve their existing ones. They plan to invest over $1 billion in R&D over the coming years to maintain and expand their portfolio.
    • MKS also focuses on integrating any newly acquired business with its own operations, and this was highlighted in their last earnings call. Management says that this allows them to synergize and use their resources effectively.

Financial Analysis

  • Revenue: The company’s revenues are volatile and subject to industry trends, therefore historical yearly revenues can fluctuate quite a bit. The most recent report has a decline in the YOY growth, although the revenue for the entire 2022 was 24% more than 2021’s numbers. The most recent quarterly revenues were around $1.09B, which was 24% more than the same quarter last year. This YoY increase is due to a number of factors, including acquisition of Atotech.
  • Earnings: Although the reported earnings were more volatile than the revenues, we see a similar trend of net loss in 2021, and an increase to around 177 million in 2022. The most recent quarterly earnings were $61 million, a 27% decline from last quarter’s $83 million.
  • Profitability: In the latest quarter, the gross profit margin was roughly 44%, while the net income margin was 5.6%. On a full-year basis the gross profit margins are around 46%, while the net income margins are around 8.8%. The company has been working to improve the profit margins, but those improvements are being held back by higher costs from recent acquisitions and higher spending on R&D.
  • Free Cash Flow: MKS is a cash-generating company. In the first three quarters of 2022, the company generated over $140M in free cash flow. That was substantially lower than the same period the year before because of the higher debt due to recent acquisitions. In previous years, the company had higher cash flows. The management is taking steps to improve working capital, which should lead to higher free cash flows in the future.
  • The company usually distributes more of its cash in acquisitions and partnerships to accelerate growth in new and existing markets.
  • Balance Sheet Health: The company has a manageable balance sheet. It has $498M in current assets while having $932M in total current liabilities. The debt to assets ratio, as at the latest report, is around 0.495 which is a bit high and shows the impact of the acquisition. They have a good equity and the ratio of debt to equity is around 0.79, which is in line with the company’s capital structure targets.
  • The company has a revolving loan facility of $750 million to manage cash flow volatility, which can be beneficial but will be heavily scrutinized during down-cycles in the industry. They are working to pay-off debt, and the recent decline in margins will hamper this.

Moat Assessment: 2/5

  • MKS has some structural competitive advantages that could be categorized under intangible assets and switching costs.
    • Their patents and innovation capabilities in their niche are a source of sustainable revenue.
    • Their strong relationships and tight integration into their customers’ systems also create switching costs for their customers.
  • These are not enough to maintain a strong moat as they can be replicated. Also, due to rapid tech changes the longevity of these patents and relationships can be limited. The company is not as dominant as some other companies that we consider to have a wider moat. Also, it can be very costly to maintain a competitive advantage. It is easier to compete than maintain dominance.
  • Although MKS has shown a consistent ability to innovate in their market, they have not proven that they can maintain those innovations for an elongated period of time.
  • Although, they operate in a difficult and technologically challenging industry, which can act as a barrier to entry, I believe their competitive advantages are too easy for their competitors to replicate which leads to a limited moat. * Also, competition from large and established players limits their ability to create and maintain economic moats.
  • Rating: Narrow Moat. The company has a limited ability to sustain higher than average returns on capital due to the above reasons.

Risks to the Moat and Business Resilience

  • Technological Obsolescence and Disruption: Given their focus in tech, their business could be quickly affected by shifts in technology or adoption of new tech in the industries they operate. Competitors might offer similar products at lower prices, which can affect pricing power.
  • Industry Cyclicality: As mentioned earlier, the industry is cyclical in nature. Therefore, even companies with good moats can get affected. Downturn in demand for semiconductor manufacturing can cause substantial damage to company profits.
  • Acquisition Integration Risks: A lot of the company’s growth, and therefore its future, is dependent on it successfully integrating its acquisitions to reach the expected cost synergies and revenue growth. Failing on this, and integration cost itself, could pose a risk to the company’s overall profitability.
  • In the last quarterly earnings call, the management stated that they are focusing on integrating new acquisitions and working to reduce operational costs.
  • Concentration of customers: A significant portion of the company revenue comes from top customers. The loss of any of these customers can cause substantial damage to revenue and profitability.
  • Supply chain risks: MKS is also facing supply-chain risks that may affect the ability to deliver products. The company is working on securing contracts and sourcing the raw materials that they need.
  • Geopolitical risks: International operations are affected by fluctuations in foreign exchange rates, trade restrictions, and geopolitical problems. Since MKS has manufacturing facilities all over the world, a political risk in one country can have broader effects.
  • High R&D Spend: MKS needs to spend aggressively on R&D to maintain its innovation moat. However, these spending are not guaranteed to create value, and they can have a negative effect on profitability if not targeted carefully.

Understandability: 3/5

  • MKS operates in relatively complex and specialized technology industries, with a wide variety of end applications.
  • While the revenue drivers are understandable, the technical details of products and the complexity of value creation require significant industry expertise. The multiple business segments and a very complex revenue model make this difficult to follow by an ordinary investor. However, I would say that it is not impossible to understand, with some effort. I am also not an expert on high precision manufacturing of parts used in tech, nor semiconductor equipment. Therefore, my ability to analyze this may be limited, and my judgment is affected by that.

Balance Sheet Health: 4/5

  • The balance sheet of the company is in relatively good health. It has around 0.8 debt to equity which isn’t too high. The equity position is good. The most important liability is their long-term debt, most of which stems from the Atotech acquisition. They are trying to deleverage and reduce the debt with free cash flow generation, but if the profitability dips, they might be at high risk. Their cash is a good part of the assets, which means they are stable, and capable to maintain liquidity even during tough economic times.
    • The credit rating is a little lower, but still within investment-grade range.