Share prices of chip fabrication equipment (CFE) company KLA Corp. (KLAC +3.26%) have held up remarkably well during the semiconductor industry slump. In fact, they've held up versus the market, period. Share prices have fallen just 3% since the beginning of 2022, compared to a 12.5% stumble for the S&P 500 and 22.1% drop for the Nasdaq Composite indexes over the same time period.
Recently, some CFE company investors (like those that own ASML Holding) have had some fears over U.S. export controls to China reigniting. However, KLA could be largely exempt from these challenges. In fact, with the whole industry in flux in 2023, KLA actually looks like a compelling value here. Is the stock a buy?
KLA has resilient demand, rain or shine
Looking beyond just the last year, this little company harboring a small niche of the chip industry has been a fantastic long-term market-beating investment. As I explained last September, part of KLA's resilience comes from the fact that much of the CFE it develops isn't considered cutting-edge. That's the realm of companies like ASML. But though not the most advanced stuff out there, KLA's machines are expensive to develop, giving it a natural barrier protecting it from would-be competitors.
NASDAQ: KLAC
Key Data Points
KLA's equipment is centered on things like silicon wafer inspection, chip patterning inspection, and other process control machines and services. Thus, since they are involved with inspection and quality control rather than actual production, many of KLA's machines were exempted from the U.S. (and now possibly a U.S.-Japan-The Netherlands coalition) export bans on the most advanced chip and chipmaking equipment. As explained on the recent earnings call by KLA CFO Bren Higgins:
I think if you look at some of the peer companies and some of the export control dynamics as a percent of the total, I think they're impacting some of our peers, perhaps at a little greater degree than KLA. So I think for all those factors, we feel pretty good about our position as we think about just our performance relative to the overall market despite the strength of what we saw in 2022.
Additionally, while some chipmakers (particularly memory chipmakers like Micron Technology are paring back their spending on expensive equipment in 2023 to deal with the downturn, KLA sees its equipment holding up well. Why? For one, it still has a big backlog of orders to fill. Another reason could be that inspection and process control equipment (both of which help improve manufacturing yield, which improves profit margins) are still likely a priority during a time in which businesses are working hard to boost profitability during a bear market.
But what about KLA's financials?
For the quarter ended December 2022 (KLA's second quarter of fiscal 2023), revenue increased 26% year over year to $2.98 billion. Earnings per share (EPS) rocketed 46% higher to $6.81, or up 32% year over year on an adjusted basis -- just as you'd expect from a good manufacturing business. Higher sales mean better utilization of existing operations, so additional revenue adds up to higher profit. KLA also repurchases lots of stock with any free cash flow remaining after paying its dividend, which also boosts EPS.
For the next quarter (corresponding to the first quarter of calendar year 2023), KLA expects revenue of $2.2 billion to $2.5 billion and EPS in a range of $4.06 to $5.46. That's a wide gap between the low and high end of guidance, but there's ample variability out there due to the cadence of customer spending habits. Nevertheless, KLA is anticipating year-over-year revenue growth of about 3% at the midpoint of guidance and EPS growth of as much as 13%.
Management also reiterated its long-term target of growing free cash flow at an average clip of 15% a year. While this might rank as a "boring" semiconductor industry stock, there's nothing boring about that kind of profit growth target.
Is KLA stock a buy?
Given KLA's rosy outlook in spite of economic and chip industry difficulties, as well as geopolitical troubles between the U.S. and China, this stock ranks solidly in buy territory for me. Shares trade for 17 times trailing-12-month earnings per share, and 20 times trailing-12-month free cash flow.
That may seem pricey for a company expecting sluggish revenue growth in the coming quarters. However, I expect KLA will heat up again as the chip industry bottoms and then rebounds. That's expected to occur sometime midway through the calendar year 2023. And in the meantime, KLA management said it will exercise some prudence with expenses, which is showing up in guidance for solid earnings growth that could exceed sales growth next quarter.
For investors looking for a stable bet on the semiconductor space during what could be a very volatile year, give KLA Corp. a serious look right now. It could be in a far better position than its peers to weather geopolitical intrigue between the U.S. and China, as well as a chip industry downturn. This may not be the fastest-growing semiconductor stock, but that's OK. KLA's business model has demonstrated its ability to beat the market over the long term, and it could be poised to continue delivering for years to come.
