KLA Corporation Stock: A Good Bet If You Wish To Invest In AI (NASDAQ:KLAC)

I have mentioned many times in my other articles that artificial intelligence (“AI”) is an over-popular and overcrowded sector right now. It seems to be a speculative bubble. Although many investors would disagree with me, I still think that larger companies in this field are more overvalued than smaller ones.

Although KLA Corporation (NASDAQ:KLAC) stock is lingering near its record highs, it could still be an interesting bet for people interested in the AI sector because of the company’s profitability. Although the company’s stock still appears somewhat expensive, it is still not as popular as Microsoft (MSFT), Nvidia (NVDA) or Advanced Micro Devices, Inc. (AMD). But let me explain my thesis in this article.

KLAC’s recent earnings results

KLA Corporation has recently published its fiscal Q4 2023 earnings results. In short, they were excellent.

According to the company’s press release,

• Non-GAAP EPS totaled $5.40, a beat by $0.54.
• Revenue was $2.36 billion (-5.2% Y/Y), a beat by $100M.

The management expects the following results in the first quarter of fiscal 2024 ending in September:

Total revenues – $2.35 billion +/- $125 million vs. consensus of $2.23BGAAP gross margin – 59.0% +/- 1.0%, Non-GAAP gross margin – 61.0% +/- 1.0%, GAAP diluted EPS – $5.02 +/- $0.60, Non-GAAP diluted EPS – $5.35 +/- $0.60 vs. consensus of $4.75.

But the recently reported results that made the stock price rise were not a one-off. KLA Corporation has been consistently publishing very good revenues and profit figures.

As you can clearly see from the annual revenue graph above, the trend line is very steep and there has been very good growth for a while.

The same is true of the quarterly revenue figures. Although quarterly sales often tend to be volatile, this is not the case with KLA Corporation.

The same is true of KLAC’s diluted EPS. These have been rising steadily for about 10 years.

As concerns the company’s quarterly EPS, these have been surging since 2019.

That is because of strong demand for KLA’s bare wafer, optical, and reticle inspection tools and services. But KLAC as a semiconductor business has been enjoying rising demand for this type of equipment, and many analysts think this trend would continue for a while.

But now I would like to cover some of the company’s fundamentals.

KLAC’s fundamentals

To start with, its financial profile is quite strong. Fitch rated KLAC with an A- rating with a stable rating outlook.

KLA’s financial profile is still quite strong in spite of its excessive spending on wafer fab equipment (WFE) for the period of three years. Diversifying the semiconductor supply chain adds growth markets in the U.S. and Europe. Higher free cash flows and low debt maturities mean the company is highly unlikely to face any liquidity concerns in the near future.

The agency expects the company’s annual free cash flow (“FCF”) to total between $1.5 billion and $2.0 billion. KLA’s cash levels are likely to remain near $2.5 billion. This means the company has plenty of opportunities to both invest through the cycle to keep up its leadership and technology positions and also reward its stockholders without additional debt. However, KLA’s debt-to-EBITDA may well remain near the higher end of the company’s target range of 1.5x-2.0x, which is good but not quite outstanding.

KLA Corporation’s research and development spending have allowed the company to get a substantial competitive advantage to its peers thanks to KLA’s superior products. At the same time, its stock is trading at lower multiples than do its peers.

The company’s profitability rank is very high, as you can see from the diagram below. As I have mentioned in my previous section, its margins are very high, especially if you look at the net profit margin. It is over and above the general 10% average. So, it is excellent.

KLA Corp’s cash flow history is as consistent as its revenue and net profit histories.

So, overall, KLAC is a financially healthy company.

Valuations

KLA Corporation is a semiconductor company. So, I compared it to the other companies in the same sector.

At the same time, I also decided to compare KLAC to other AI companies in terms of valuations. So, I decided to take Nvidia (NVDA), Advanced Micro Devices, Inc. (AMD), and Microsoft (MSFT) as some of the most popular companies associated with AI.

	NVDA	AMD	MSFT	KLAC
P/E Non-GAAP (FY1)	57.85	38.77	30.00	23.35
P/E Non-GAAP (FY2)	42.18	25.99	26.07	19.24
P/E Non-GAAP (FY3)	33.04	20.79	22.66	15.13
P/E Non-GAAP (TTM)	150.00	36.91	33.71	19.04
P/E GAAP (FWD)	72.03	217.57	30.22	25.32
P/E GAAP (TTM)	239.59	467.79	34.17	19.67
PEG Non-GAAP (FWD)	1.50	1.60	2.38	3.23
PEG GAAP (TTM)	NM	NM	109.93	1.04
Price/Sales (TTM)	43.95	7.78	11.62	6.46
EV/Sales (FWD)	26.03	7.64	10.31	7.61
EV/Sales (TTM)	43.74	7.62	11.44	6.53
EV/EBITDA (FWD)	59.68	27.27	20.60	18.27
EV/EBITDA (TTM)	185.87	44.21	23.86	15.23
Price to Book (TTM)	46.29	3.27	11.92	24.68
Price/Cash Flow (TTM)	166.42	58.54	28.06	18.75

Click to enlarge

Source: Prepared by the author based on Seeking Alpha’s data.

As you can clearly see from the two tables above, KLAC is cheaper than most of its fellow semiconductor companies as well as artificial intelligence giants.

But still it is not an absolute value play, especially based on its net current asset value. Yet, given its earnings growth, it still has plenty of growth potential. According to the earnings-based discounted cash flow model, KLA Corp should be trading for around $760 per share.

Risks

KLA Corporation is essentially a semiconductor business, its main operations are located in mainland China and Taiwan.

I guess it might be one of the biggest external risks for the company, given the complicated U.S.-China relations. There might be some restrictive measures either against China from the U.S. or against the U.S. from China, just the way it happened during the U.S.-China trade war in 2019. Semiconductors can take the hit this time.

Certainly, there is also a recession risk which could lead to low demand for semiconductors. The general economic downturn will also make the AI as well as the general high-tech sector appear less attractive to investors. So, KLA’s stock price is likely to fall in this case.

Conclusion

Overall, it appears to me KLA Corporation is an excellent bet on both semiconductors and artificial intelligence. I do not generally like these sectors at this very moment because of all the hype in the financial press. But this company could be a very sound bet thanks to its excellent profitability and reasonable valuations in comparison to its more overvalued peers.

Editor’s Note: This article was submitted as part of Seeking Alpha’s Best AI Ideas investment competition, which runs through August 15. With cash prizes, this competition — open to all contributors — is one you don’t want to miss. If you are interested in becoming a contributor and taking part in the competition, click here to find out more and submit your article today!