When market uncertainty gives way to fear, stocks generally tend to fall, and while the market in the past week has been trying to rebound from lows in December that tested bear market territory for the major indices, the general tone has really focused more on the negative than anything else. If investors and analysts aren’t wringing their hands over trade, then it’s interest rates; and if not interest rates, then it’s global economic growth. Indications this week have mostly been positive on the trade front as officials from the U.S. and China met to discuss a trade deal. This morning, however reports that a breakthrough didn’t happen seem to be giving investors reason all over again to start worrying.
One of the biggest underperformers in the market since the last quarter of 2018 is the semiconductor sector, where investors have mostly been taking their queues from trade concerns. That makes sense, since so much of the case the Trump administration centers around intellectual property and technology concerns that relate to tech stocks in general. Semis are perceived as being particularly at risk since these companies have major exposure, either from a revenue or operational standpoint (and in many cases, both) in China. The general expectation around trade, however is that a deal will get done sooner or later, and that means that the decline to bear market territory for semiconductor stocks really presents interesting opportunities to work with fundamentally very solid stocks at very interesting valuation levels.
KLA-Tencor Corporation (TLAC) is a company that I think makes a lot of sense to keep in a watchlist right now. After hitting a high above $124 per share in March of 2018, the stock dropped with the rest of the sector, hitting a long-term downward trend low at almost $80 per share in late December. It’s been rebounding from that point, and has rallied almost 15% to its current price level. That looks to be setting a good technical opportunity to be in the right place at the right time for a bullish trend reversal in a fundamentally strong company with a pretty persuasive value proposition.
Fundamental and Value Profile
KLA-Tencor Corporation (KLA-Tencor) is a supplier of process control and yield management solutions for the semiconductor and related nanoelectronics industries. The Company’s products are also used in a number of other high technology industries, including the light emitting diode (LED) and data storage industries, as well as general materials research. Its products and services are used by bare wafer, integrated circuit (IC), lithography reticle (reticle or mask) and disk manufacturers around the world. The Company’s inspection and metrology products and related offerings are categorized in various groups, including Chip Manufacturing, Wafer Manufacturing, Reticle Manufacturing, LED, Power Device and Compound Semiconductor Manufacturing, Data Storage Media/Head Manufacturing, Microelectromechanical Systems (MEMS) Manufacturing, and General Purpose/Lab Applications. It also provides refurbished KLA-Tencor tools as service and support for its products. KLAC’s current market cap is $14.3 billion.
Earnings and Sales Growth: Over the last twelve months, earnings grew more than 36% while revenues increased by almost 13%. Growing earnings faster than sales is hard to do, and generally isn’t sustainable in the long-term; but it is also a positive mark for management’s ability to maximize its business operations. In the last quarter, earnings grew by almost 11%, while sales increased about 2%. KLAC operates with a very strong margin profile, with Net Income running at 22% of Revenues over the last twelve months, and increasing impressively over the last quarter to 36%.
Free Cash Flow: KLAC’s free cash flow is healthy, at a little more than $1.1 billion and translates to a useful Free Cash Flow Yield of 8.13%.
Debt to Equity: KLAC has a debt/equity ratio of 1.43. At first blush, that seems high; but a look at the company’s balance sheet provides a better perspective and shows that their debt is very manageable. The company has a little over $2.2 in long-term debt, but almost $2.8 billion in cash and liquid assets as of the last quarter. Along with their very impressive operating margins, this means that the company has both the ability to service their debt without difficulty, as well as excellent liquidity and financial flexibility.
Dividend: KLAC pays an annual dividend of $3 per share, which translates to a yield of about 3.23% at the stock’s current price.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for KLAC is $10.24 and translates to a Price/Book ratio of 9.04 at the stock’s current price. That seems high for n investor like me, that generally prefers to see ratios as close to 1 as possible; but their historical average Price/Book ratio is 15.14, which suggests the stock is trading right now at a discount of about 67%. That may seem very optimistic, especially since it puts a long-term target price above $150 per share. The stock’s all-time high was reached in March of last year around $124 per share, so I do think this is an over-optimistic forecast; however the stock’s Price/Cash Flow provides a more conservative, but still very attractive target since the stock trading about 26.5% below that historical average and puts the stock’s long-term target at a more reasonable $116. No matter which target you prefer to work with, KLAC looks like a stock that offers an excellent bargain opportunity.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s downward trend from March 2018 to the pivot low, and the 52-week low it reached at the end of the year; it also informs the Fibonacci trend retracement lines shown on the right side of the chart. The stock’s rally so far this year has pushed the stock within striking range of the resistance marked by the 38.2% resistance line at around $97 per share; a break above this price would validate the stock’s bullish momentum so far this year and also mark the beginning of a new upward trend that could actually reverse the downward trend’s bearish momentum.
Near-term Keys: If you’re looking for a short-term bullish trade, you should wait for a break above $97 before trying to buy the stock or work with call options; until that happens, you should expect the downward trend’s overall strength to work against your probabilities of success. If the stock does find a reason to drift, or drop from its current level, it should find short-term support around $87 per share based on a the pivot low that was reached in late October 2018. A drop below that point would be a good signal to consider shorting the stock or to start buying put options with a target price around the stock’s 52-week low around $81. The stock’s value proposition, however, along with a very nice dividend yield means that any kind of consolidation in this price area, or even a continued decline, could just make the bargain opportunity even better than it is now.