Dividend investors aren't prone to chasing hot trends. Rather, good dividend investors know money is made by being content with great companies that churn out cash in good times and bad while also having a knack for increasing their cash generation over time.
These attributes tend to rule out the ongoing trend to invest in electric vehicle (EV) manufacturers. But that doesn't mean dividend stock investors should completely write off EVs. An increasing amount of consumer money is being spent on EVs, and manufacturers are shelling out cash (often more than they actually earn) to meet that demand. Someone out there is raking in those chips.
Let me introduce you to KLA Corp. (KLAC 2.50%), a longtime player (and shareholder-friendly stock) in the semiconductor fab equipment industry.
EVs are making it rain, but for who?
KLA's equipment specialty is process diagnostics and control (PDC) and metrology (a fancy-pants word for measuring and inspecting stuff). Sounds boring, right? It is, except that measuring and controlling the manufacturing process of silicon wafers -- which eventually get cut up into "chips" for computing systems -- is crazy complex. The finest features on chips these days are as small as a few nanometers, meaning KLA's equipment can read measurements down to the microscopic, and atomic, scale.
And KLA is a dominant force in this part of chip manufacturing, making it part of the oligopoly that is the chip fab equipment industry. The other four major players here are ASML Holding, Applied Materials, Lam Research, and Tokyo Electron.
KLA's equipment was hot in 2022, as chipmakers around the world ramped up production for the nascent EV industry. Why? PDC and metrology equipment is especially critical when a new chip line starts to ramp up production, and the fab fine-tunes operations to maximize their "yield" (getting the most profit from a manufacturing process as possible).
This led to an epic run for KLA in the last couple of years, with revenue, free cash flow, and earnings per share surging thanks to demand from industrial markets like EVs, as well as new advanced chips for data centers. Meanwhile, EV manufacturers and other companies seemingly more closely tied to the EV boom haven't done nearly as well during this same span of time.
Data by YCharts.
Will KLA's performance continue?
As good of a run as it's been, the boom times are taking a pause (at least temporarily). Fab equipment spending is expected to dip this year. Part of this is due to chipmakers pausing their purchases on expensive equipment to manage an economic slowdown in 2023.
But there's another factor at play: A record number of new fabs and fab expansion projects (worth upwards of $300 billion to build) broke ground in the U.S. in 2022 and are continuing to break ground into 2023. These big construction projects take years to complete, so many companies are gearing up to spend big again with KLA and its peers in the next few years. And what are many of these new fab projects for? Among other things, meeting soaring demand for chips from the auto industry.
Legislation like the U.S. CHIPS Act, the European Chips Act, and similar government subsidy programs in South Korea, Japan, Taiwan, and beyond spurred interest in ramping up chip manufacturing. It will take time, but a massive wave of new fab equipment is brewing.
For KLA, this equated to a 20% sequential decrease in revenue in the first quarter of calendar year 2023 to $2.43 billion (although sales were still up 6% from the year prior). For the next quarter which will end in June 2023, revenue is expected to dip again sequentially to a range of $2.13 billion to $2.38 billion. Thanks to its exposure to secular growth trends like EVs, KLA is nevertheless outperforming many of its chip fab equipment peers.
And like any great dividend stock, this pause in revenue growth hasn't been disastrous for KLA. Far from it, in fact. Not only is KLA still highly profitable in this downturn (net profit margin of 29%, free-cash-flow profit margin of 38% last quarter), but free cash flow actually continued to chug higher. KLA returned most of it to shareholders via its dividend ($181 million, which currently yields 1.4% a year) and share buybacks ($478 million, or if you're looking for an annualized dividend yield equivalent, worth 3.6% of the current market cap).
Over the next few years, KLA's revenue and profitability are poised to charge higher thanks to big changes in the semiconductor industry to support needs coming from industries like EVs, electrification of the power grid, and industrial automation. And with a long history of growth alongside secular trends like this, and handsomely rewarding shareholders along the way, KLA is a great dividend stock from the semiconductor industry. Shares trade for 16 times trailing-12-month earnings, or 17 times free cash flow, which looks like a great long-term value right now.
