KLAC gets an EUV Kicker

KLAC put up a great quarter coming in at revenues of $1.07B and EPS of $2.22. Guidance is for $1.03B to $1.1B with EPS of $2 to $2.32. Both reported and guided were at the high end of the range and above consensus. We had suggested in our preview notes that KLAC would be the least impacted of the big three (AMAT, LRCX & KLAC) semi equipment companies by the current memory volatility.

That has turned out to be the case as KLAC will likely see less than a 10% slow down in shipments and essentially zero impact on revenue and earnings versus the 25% drop in revenues expected by Lam along with an EPS drop below the low end of the range. We still predict that AMAT will fall somewhere between KLAC’s zero revenue impact and Lam’s 25% fall off probably coming in at a 10%-15% drop in revenues.

KLAC is obviously much less exposed to the more volatile memory sector and thus didn’t see as much of the sharp increase or sharp decline and has historically been a more consistent performer. KLAC reported record high shipments, revenues and EPS in the quarter and continues its juggernaut like roll. The company also was more forceful about its view of the December quarter calling for a “sharp snap back” rather than the more nebulous “positive trajectory” offered up by Lam.

We expect memory capex spending to continue to be quickly modulated by pricing and demand trends with either long or short term volatility and cyclicality as the industry keeps one foot on the accelerator and the other on the brakes. Having a very good balance and diversification that KLAC has will provide more consistent longer term performance and likely deserves a higher multiple,as compared to others, for the reduced volatility. We also expect ASML to have a similar performance to KLAC with minimal memory impact given its steadier long term history.

Market positioning remains very strong as the industry needs metrology and yield management tools to get the process fine tuned before they go out and buy the process tools that vary more with demand and output.

An EUV kicker
The transition to EUV is anything but easy. Aside from ASML who is the obvious beneficiary of the transition we think that KLAC could see if not as much benefit but perhaps even more especially in the current early stages of the transition where the problems are the greatest. ASML’s EUV revenue also replaces its DUV revenue so there is a bit of an offset which KLAC does not see.

This compares to dep and etch players who have nothing but downside as the number of overall dep and etch steps will without doubt be lower under EUV processes as compared to DUV processes. We think that KLA is another way to play the EUV transition for those who do not want to put all their eggs in ASML’s basket.

Financials are best in the industry
With industry leading gross and operating margins coupled with ATM machine like cash generation, whats not to like. The financials underscore the pricing power of being the market leader in the process control part fo the industry.

More diversification coming
The pending Orbotech acquisition will bring even more diversification to KLA’s model and further insulate it from volatile single end markets. We think this addition of SAM to an already strong base will further strengthen the story.

China exposure helps KLA
KLA is likely seeing more benefit than others from the growing China market as a lot of money is being spent in China by chip companies trying to come up to speed and perfect processes. Something that is almost impossible to be done without KLA tools. While China has more alternative sources for process tools there are really no alternatives to KLA tools which they have to keep buying in quantity.

The Stock
We continue to favor KLAC over both LRCX and AMAT. Not only are the financials way better but the risk is much lower as demonstrated by KLAC’s performance this quarter which barely registered a blip at KLAC but is causing heartburn elsewhere. The company well deserves a higher multiple for this more consistent performance along with better financials and diversity.

This more consistent performance may not be as flashy on the way up but avoids the near term pain and stock gyrations on the way down. In general we feel a lot safer in KLAC stock right now and probably for a couple of quarters until we get better visibility on memory. The near term factors are most aligned with KLAC right now and their stock should be a better performer.