KLA Corporation - 2024 WFE guidance is below expectations
In this post, we review KLAC's fiscal Q2 results and provide our medium-term financial estimates for the company in order to determine whether they are attractively valued.
KLA Corporation might not be a company that often takes the spotlight and gains much investor attention. Possibly, you have never even heard of it, which is no surprise as the company tends to act on the background. However, it fulfills a crucial role in the semiconductor industry and was the first to provide concrete 2024 guidance on WFE spending.
KLA is a formidable leader in the semiconductor equipment manufacturing sector, particularly in process control. This is how I described the company’s operations in my most recent coverage of it on Seeking Alpha:
“To put it more understandably and without going too much into detail (which most investors won’t care about), it provides a range of products and services to help semiconductor manufacturers monitor and control various aspects of the semiconductor manufacturing process to improve yield and efficiency by giving them tight control of their processes and by identifying issues in time. This means KLA’s products contribute to the precision, quality, and efficiency of semiconductor manufacturing by providing tools for accurate measurement, defect detection, and process control. These capabilities are essential for producing high-performance and reliable semiconductor products, and these are growing in importance.”
However, I am not here now to dive into the company’s operations and products but would rather discuss its Q2 results, which it reported earlier this week (If you are unfamiliar with the company, it might be worth reading my Seeking Alpha article on it. If you can’t access this, let me know in the comments and I will send it to you!)
The quarterly results weren’t well received by investors, as shares fell 5% in the following trading session. However, the issue wasn’t the company’s quarterly performance but the guidance, which sat below expectations.
KLA reported revenue of $2.49 billion, up 4% sequentially, roughly in line with the consensus, but also still down over 16% YoY as the company still faces weak demand. Positively, service revenue was able to at least offset some of the demand weakness as this was up 1% sequentially and 8.6% YoY to $565 million, now accounting for roughly 20% of total revenue.
These service revenues are a great hedge against volatility and offer a recurring high-margin revenue stream, which is growing faster than product revenue as the installed base grows. For reference, management maintains a long-term target of growing service revenues by 12-14% annually through the cycles.
To put the company’s financial performance in slightly more perspective, KLA’s 2024 revenue total was $9.7 billion, which, while down 8% YoY, outperformed the double-digit contraction in the foundry industry.
On the bottom line, the company impressed more in Q4 by reporting an industry-leading gross margin of 62.6% and an operating margin of 40.7%, both up sequentially. This led to a net income of $839 million, representing a net income margin of 33.7%, down 140 bps YoY. While this might seem far from great, considering the over 16% top-line decline, this is actually quite impressive and far ahead of our estimate for a net income margin of 31.9%.
This resulted in an EPS of $6.16, down 16.5% YoY but still beating our estimates by 5.5%. FCF also turned out resilient, down only 8% YoY in Q4 to $545 million, bringing the 2023 total to a record high of $3.2 billion. In terms of cash flows and margins, there really aren’t many alternatives more impressive in the semiconductor equipment industry.
This allowed KLA to end the year with total cash on the balance sheet of $3.3 billion against debt of $5.95 billion, earning it a Fitch rating upgrade to A from A- with a stable outlook. The company has shown excellent cost control over recent quarters and is quick in its actions to maintain a healthy balance sheet in the face of an industry-wide slowdown.
For example, the company has kept costs relatively flat over recent quarters and has significantly lowered the number of share buybacks by over 50% YoY in 2023.
Nevertheless, the company still returned over $500 million to shareholders in Q2, and shares yield a decent 0.9% on a payout ratio of just 23%. Meanwhile, it has consistently grown the dividend by mid-teens, and considering the industry rebound expected in 2025 and the growth potential of KLA, there is no reason for dividend growth to ease, making this an interesting dividend growth pick.
And yet, despite this all and the solid Q4 results, shares fell by 5% in response to the guidance below expectations. KLA now expects a bottom in its revenue in the current quarter, which is driven by customer project delays. However, it is seeing an uptick in scheduled deliveries for the June quarter and expects demand to accelerate over the remainder of 2024.
As a result, management now expects WFE spending to sit in the mid to high $80 billion range, guiding for a mid to high single-digit growth in the WFE industry, which sits somewhat below what investors and analysts hoped for. Earlier projections pointed to double-digit growth and WFE spending in the $90 billion range in 2024, which explains why many semiconductor equipment stocks like AMAT and Lam also lost a couple of percentages.
Clearly, a real rebound in this industry will take slightly longer, mainly due to a recovery in growth for memory staying out. Meanwhile, foundry/logic should see moderate growth in 2024. As a result, projections for leading WFE players might have to be lowered for 2024, with a stronger uptick in 2025.
As a result of these dynamics, KLA now guides for fiscal Q3 revenue of $2.3 billion, plus or minus $125 million, pointing to a 5% YoY drop in revenue before growth should turn positive again in Q4. Despite the expected drop, margins are expected to hold up quite well, with management guiding for a gross margin in the range of 61.5% plus or minus 1 percentage point, which is a wide range due to a shifting product mix.
However, management expects a relatively stable gross margin of around 61% in 2024. For Q1, this translates into an EPS of $5.26, plus or minus $0.60, which is down 4.2% at the midpoint.
Crucially, even as the company’s guidance may have disappointed, the long-term bull case for KLA is still very much alive. The company is poised to benefit from the advances in the semiconductor industry to smaller nodes, which make KLA’s advanced metrology tools even more important in addressing the challenges associated with maintaining high yields and controlling critical dimensions.
This, combined with the push for manufacturing expansion by giants like TSMC, Intel, and Samsung from 2025 onward, should lead to substantial growth for KLA.
We will provide financial estimates as we added some KLA shares to our portfolio in recent months. Based on these Q2 results and the given guidance, we have slightly lowered our revenue estimates but were able to increase our fiscal FY24 EPS guidance, driven by the Q2 beat. This results in the following financial estimates through fiscal FY27.
Based on these estimates, we have shares now trading at just below 27x earnings, which is a very heavy multiple to pay, even after the 5% reduction in share price following earnings. This multiple is an almost 53% premium to its 5-year average and a 7% premium to the sector average.
For now, we award shares a 23x multiple, which seems fair when considering its impressive outlook, resulting in a price target of $732. Therefore, despite our enthusiasm for KLA, shares are priced too rich for our taste at this point. Consequently, we put a hold rating on the shares and look for prices to fall back to the $570 range before buying.
Thank you for reading this post. Please remember that this is no financial or investment advice and is for educational and informative purposes only. We are simply sharing our views, actions, and opinions, which I hope will be insightful!
Please make sure to like, restack, and share this post to increase our reach and support our work. Thank you!
Not subscribed yet? What are you waiting for?!
Disclosure: I/we do have a beneficial long position in the shares of KLAC either through stock ownership, options, or other derivatives. This article expresses my own opinions and we are not receiving any sort of compensation for it.
No recommendation or advice is being given as to whether any investment is suitable for a particular investor. The information provided in this analysis is for educational and informational purposes only. It is not intended as and should not be considered investment advice or a recommendation to buy or sell any security.
Investing in stocks and securities involves risks, and past performance is not indicative of future results. Readers are advised to conduct their own research before making any investment decisions.