This KLAC Stock Forecast article was written by Levi Fu – Financial Analyst at I Know First.

Highlights

• KLA’s revenue was $2,360 million according to the FY25 Q3 10-Q report, representing a 5.1% decrease compared to FY25 Q2 due to the extended downcycle of the broader industry.
• Demand from trailing-edge end markets, particularly in China, continues to grow, with additional growth supported by a rebound in advanced memory applications.
• DCF estimates the stock has a value of $845.9, which represents a 3% upside from the current price of 824.84.

Overview

KLA-Tencor Corp. (KLAC) is the world’s top manufacturer of yield management and process monitoring systems for the semiconductor industry, also serving high-brightness LEDs, data storage, and photovoltaics. It operates in three segments: Semiconductor Process Control (inspection, metrology, and data analytics), Specialty Semiconductor Process (vacuum deposition and etch tools for MEMS and RF chips), and PCB, Display, and Component Inspection (tools for PCB, flat panel displays, and advanced packaging). Around 90% of revenue comes from the semiconductor process control segment. KLA’s systems boost yields by detecting and analyzing defects for real-time corrections, essential as IC line widths shrink. These systems are crucial for production at 16 nm and smaller.

Cyclical trend of the semiconductor industry

Similar to most semiconductor peers, KLA has historically been highly cyclical with periods of strong growth followed by surplus supply. As the revenue graph below shows, the cyclic downturn often appears in June (Q4), and the peak appears in December (Q2).

However, as the semiconductor industry matures and strong demand from end-products such as AI and EVs persists, I anticipate that KLA will face reduced cyclicality moving forward. Apart from this, it should be noted that one of the main causes of cyclicality in the semiconductor industry is chip bans. However, the influence of U.S. government actions on China has had a diminishing impact on KLA’s business, with the Chinese market (along with Taiwan) alone accounting for 50% of revenue in FY2024. The continuous high percentage of revenue and increasing revenue numbers from the Chinese market show the company has successfully avoided government sanctions; thus, it is logical to assume one of the biggest causes of cyclicality has moved away.

Financial efficiency analysis

KLA has been successfully improving its financial position over the past 5 years. As shown in the plot below, the operating income of KLA has shown a steady increase from FY 2019 to FY 2023. COGS remain steady at 40% at all times (as a percentage of revenue), securing approximately 60% of gross profit.

The SG&A expenses have decreased significantly as a percentage of revenue from 13.2% in FY 2019 to around 9.4% in FY 2023, indicating improved operational efficiency and cost control measures within the company. R&D expenses decreased from 15.6% in FY 2019 to 12.4% in FY 2023. This is mainly due to the company’s early development of an advanced process control tool for sub-5 nm production.

The total other operating expenses have shown a consistent decline from 28.7% in FY 2019 to 21.4% in FY 2022, drastically increasing operating income.

Differences in performance by KLA business segments

The graph below shows the revenue percentage by business segment in 10-K for the last 3 years. The Semiconductor Process Control segment, as the largest revenue contributor, accounts for 88.8% of total revenue in 2023. We also notice this segment accounts for 82.9%, 86%, and 88.8% of total revenue in 2021, 2022, and 2023, respectively. This shows a steady growth trend in revenue since the market has shifted towards smaller nanometer nodes (e.g., sub-5 nm production) and advanced architectures (e.g., gate-all-around transistors), which ultimately raised the demand for advanced process control tools. Advanced tools such as better inspection systems, metrology systems, and data analytics systems are crucial for semiconductor fabrication manufacturers such as TSM in the production of smaller nanometer nodes to generate higher revenue. Thus, we can expect this ongoing miniaturization trend in semiconductor manufacturing (driven by AI & EV, and key technological developments such as high NA EUV) would continue to contribute to semiconductor process control segment revenue in the following years.

The PCB, Display and Component Inspection segment mainly provides inspection and measurement tools for printed circuit boards, flat panel displays, and other electronic components. We noticed the revenue downstream decreasing from 11.7% in 2021 to 6% in 2023, which was primarily due to the macro headwind and the increased competition in the FPD (flat panel display) business from the Chinese market. According to the released files in KLA’s 8-K document, KLA decided to exit the FPD market by the end of 2024.

The specialty semiconductor process segment includes advanced vacuum deposition and etch process tools used by specialty semiconductor manufacturers. The fluctuation in its revenue share suggests variable demand driven by niche applications such as microelectromechanical systems (MEMS) and RF communication chips. We expect this segment will be steady in the near future.

Industrial & Geopolitical risks

One of the primary risks facing KLA Corporation is the potential for further delays in the construction plans of major customers’ advanced fabrication facilities. Such delays could lead to a slowdown in the deployment of KLA’s process control tools, affecting revenue growth and market expansion in its semiconductor control segment. Additionally, the risk of heightened export controls on China is significant, given that Mainland China accounted for 42% of KLA’s sales in the quarter ended March 31, 2024, compared to 27% in FY 2023. Although KLA could get away with the export ban for now, US government can impose further restrictions on semiconductor exports, limiting KLA’s ability to sell to one of its largest markets. This would not only impact immediate sales but could also disrupt long-term growth plans and strategic positioning in the region.

As noted before, KLA has been moving towards a less cyclical business model, driven by the increasing size and maturity of the semiconductor industry, along with its diverse customers overseas, including China. However, if US government sanctions on China were to become more stringent, to a point where KLA could not circumvent or mitigate the impact, the cyclicity in KLA’s business could intensify. Such sanctions would likely lead to a substantial reduction in sales to one of KLA’s largest markets, exacerbating the cyclical nature of its business. The inability to sell to China would not only result in immediate revenue losses but could also lead to overcapacity and increased competition in other regions as suppliers redirect their products, potentially driving prices down and impacting margins. This scenario could reverse the trend towards reduced cyclicity that KLA has been experiencing, making its financial performance more volatile and dependent on geopolitical developments.

DCF Valuation

The DCF model suggests an equity value per share of $845.9. This represents a 3% upside potential from the current price of $824.8. It is important to note that the accuracy of the DCF model relies on the assumptions we make, particularly:

• The beta of 1.2 is calculated based on the LTM price compared to the S&P 500 of the same time horizon
• The risk-free rate is based on the US treasury’s 10-year spot rate
• The risk premium is calculated using the industrial average
• The tax rate is calculated based on the sector average
• The cost of debt is calculated from 10-Q data
• The terminal growth rate is assumed to be the average industrial growth rate

Most analysts recommend a hold position while still a considerable analysts consider buy position, according to Yahoo Finance. The forecasting price range is spread between $680 and $890 price per share, representing conservative and optimistic case respectively.

Conclusion

I take a hold recommendation on KLA Corporation because the current DCF target price shows only a 3% upside difference from the current price. While KLA is financially and strategically well-positioned, several factors including market and geopolitical risk warrant caution.

It is worth paying attention that the stock-picking AI of I Know First has a high signal on the one-year market trend forecasts, supporting my position for the KLAC stock forecast. The light green for the short-term forecasts is mildly bullish, while the darker green is a strong bullish signal for the one-year forecast.

Past Success with KLAC Stock Forecast

I Know First has been bullish on the KLAC stock forecast in the past. On Mar 17th, 2024 the I Know First algorithm issued a forecast for KLAC stock price and recommended KLAC as one of the best computer stocks to buy. The AI-driven KLAC stock prediction was successful on a 3-month time horizon, resulting in more than 24.12%.

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Please note-for trading decisions use the most recent forecast.