July 17th, 2002
KLA May Spell "Upturn"
By ERIC C. FLEMING
Things could soon be going from bad to better for semiconductor equipment makerKLA-Tencor.
Along with the rest of the chip sector, KLA-Tencor has taken a whupping. Its shares have slipped 36% from its 52-week high of 70.58 in March.
The problem, of course, has been lousy demand by chipmakers and their customers.
But things may be slowly turning up. A recent Lehman Brothers survey calls for a 17% decline in 2002 (up from a projected 24% drop in April). Not much to write home about, but spending fell 41% last year.
That faint light at the end of a very dark tunnel may come from the long-awaited recovery and a new wave of equipment upgrades among contract chip manufacturers, according to Lehman analyst Edward White. KLA is the only equipment maker he rates Buy.
KLA will be among the first beneficiaries of that spending, says Dennis McKechnie, manager of the PIMCO Innovation Fund.
The company is the leader in critical equipment, used by chipmakers like Texas Instruments, that scans for defects early in the production process.
KLA had 52% of the chip process control equipment market in 2001, but a whopping 85% of the wafer inspection market, according to market research firm Gartner Dataquest.
"Nobody's got the combined breadth [of products] to take away KLA's leadership any time soon," says Gartner analyst Bob Johnson.
By saving precious time, KLA's equipment helps chip making become profitable faster. In some cases, "KLA-Tencor machines were paying for themselves in eight to ten weeks," says McKechnie.
That gear is even more important now as the industry goes into a big new upgrade cycle.
Chipmakers are switching to bigger wafers (discs from which chips are cut), cooler wiring and smaller chip sizes.
Semico Research, a market research firm, forecasts that about half the chip plants will adopt the 0.18-micron (1/25,000th of an inch) chip size standard by 2004.
And that's just the beginning. Some, like Intel and Texas Instruments, are going to even smaller 0.13-micron and 90-nanometer sizes. Gregory Konezny, analyst at US Bancorp Piper Jaffray, says that smaller chip concerns are planning to upgrade to the 0.13-micron standard, too. He rates KLA-Tencor a Strong Buy.
At A Glance
KLA-Tencor (KLAC)
Stock Price: $44.63
52-Wk High: $70.58
52-Wk Low: $28.61
Market Cap: $8 billion
Earnings Est. (Fiscal 2002): $1.07 per share
Forward P/E: 42x
Projected Long-term
EPS Growth: 25%
Projected EPS Growth
('03/'02): 28%
Sales (2001): $2.1 billion
Div. Yield: n/a
CEO: Kenneth Schroeder
Headquarters: San Jose, Calif.
Sources: Thomson Financial/First Call, kla-tencor.com, FreeEdgar.com
By 2006, Semico expects share of wafers processed at 0.13-micron or smaller to increase more than 25-fold from last year, to almost 30% of all wafers.
In the long run, Gartner projects capital spending on chips to rise 37% by 2007 to $62 billion, from $45 billion last year, with 2002 the turning point.
Anybody see signs of life yet?
Well, actually there are some hints end demand is reviving.
Orders for components of personal computers, which use a lot of chips, have been picking up in Asia (See Barron's, Asian Trader, "Have Seeds of a PC Revival Been Planted in Taiwan?," July 8, 2002).
And in May, bookings for new equipment exceeded billing by a ratio of 1.26, meaning equipment makers got $126 worth of new orders for every $100 of product billed for the month. That key "book-to-bill ratio" was above 1.0 for a third consecutive month, according to trade group Semiconductor Equipment and Materials International.
KLA-Tencor's strong financials also have won it fans.
Unlike Applied Materials and others, KLA has been profitable and "they're still making money," says Robert Bacarella, manager of the Monetta Select Technology Fund.
For the fiscal year that ended June 28, KLA earned 34 cents a share, and is expected to grow earnings by 25% annually for the next several years, according to Thomson Financial/First Call (see At a Glance).
Shawn Price, co-manager of the Navellier Large Cap Growth Fund, says he would buy more shares of KLA-Tencor for its growth in operating margins and its strong cash flow.
Even in a nasty recession, KLA's operating margins have been at least 20% for the past two fiscal years. (KLA-Tencor reports fiscal 2002 results on July 30, when the company is expected to earn $1.07 a share.)
McKechnie thinks operating margins can rise about two percentage points from its 23% consensus estimate for fiscal 2003.
Cash flow from operations grew to $407.9 million last year from $122 million in 1999. KLA-Tencor has no debt to speak of and $580 million, or $3.07 a share, in cash.
Its valuation looks pretty appealing, too.
While KLA's price-to-earnings ratio for fiscal 2002 is at a premium to its long-term projected earnings growth of 25%, its P/E of 32x estimated fiscal 2003 earnings is below the Thomson Financial/Baseline five-year historic median price-to-earnings of 36.5 times forward results.
To be sure, despite some hopeful signs, many chipmakers have been reluctant to spend on new equipment, and analysts continue to cut their ratings and earnings estimates on the stocks. And Applied Materials, Hitachi and others are hungry for KLA's markets, too.
Yet KLA, with its strong market position and a nice cash horde, is as good a way as any to play a new chip upgrade cycle and a recovery that may well have already begun.
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FULL DISCLOSURE:
KLA-Tencor
• Robert Bacarella, manager of the Monetta Select Technology Fund, has about 5% of the portfolio's assets in KLA-Tencor shares, according to Morningstar.com.
• Gregory Konezny, analyst at US Bancorp Piper Jaffray, could not be reached. But US Bancorp Piper Jaffray analysts do own shares of KLA-Tencor, according to a Konezy note last month. The firm has had an investment banking relationship with KLA-Tencor within the last three years, the report says.
• Dennis McKechnie, manager of the PIMCO Innovation Fund, says KLA-Tencor accounts for 2.5% of the portfolio's holdings. The fund's assets total about $300 million, according to Morningstar.com.
• Shawn Price, co-manager of the $250 million Navellier Large Cap Growth Fund, says he holds a 3.4% position in the portfolio. The fund's assets total about $15 million, according to Morningstar.com
• Edward White, analyst with Lehman Brothers, doesn't own shares of KLA-Tencor, according to a Lehman spokesman, and the firm has not had any investment banking ties to KLA-Tencor.
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