KLA Corporation (NASDAQ:KLAC) is one of those companies that becomes more important the more complicated the semiconductor industry gets. KLA makes the inspection and measurement systems that help chipmakers figure out whether those manufacturing processes are actually working.
That sounds less exciting. It may also be where the moat is.
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KLA’s stock now trades at about 34.84x forward earnings, which is not an especially cheap valuation for a semiconductor equipment company. The question, then, is not whether KLA is a good business. The more interesting question is whether its competitive advantage is becoming stronger as semiconductor manufacturing becomes more difficult.
Making an advanced chip is not simply a matter of putting smaller transistors on a wafer. As manufacturers move to more complicated architectures, new materials, high-bandwidth memory, and advanced packaging, there are more things that can go wrong.
That makes yield increasingly important. Yield is basically how many usable chips a manufacturer gets from a wafer.
A tiny defect can make an expensive wafer worthless. And when fabs cost billions of dollars to build, finding those problems quickly becomes extremely valuable.
This is where KLA has spent decades building its position.
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The company’s process-control systems inspect wafers and measure what is happening during manufacturing. But the real advantage is not just the equipment. KLA has built a huge body of knowledge around how customers use those systems, what problems they encounter, and which measurements actually matter.
That knowledge is difficult to replicate.
KLA’s CEO said competitors have tried to enter process control, but the business is difficult because it is high-mix and low-volume, with considerable customer-specific complexity. KLA also has roughly 1,600 to 1,700 applications engineers working with customers around the world.
That sounds less like a traditional equipment company and more like an organization that has accumulated decades of manufacturing know-how. That is a much better moat.
AI is making the moat more valuable
The AI boom is obviously helping KLA, but I think that explanation misses the bigger point.
AI is making semiconductor manufacturing more complicated.
High-bandwidth memory requires different manufacturing processes. Advanced AI chips increasingly rely on sophisticated packaging, where multiple components are brought together in ways that create new manufacturing challenges.
KLA is benefiting from both.
The company expects its advanced-packaging process-control business to reach roughly $1.1 billion in 2026, with growth running far ahead of the overall packaging market. Management said much of the acceleration has come from customers pulling KLA’s existing technology into new applications.
That is important because it suggests KLA does not always have to invent an entirely new business to find growth. As the industry changes, its existing technology can become useful in places where it previously wasn’t.
The company’s service business adds another layer. KLA generated $820 million of service revenue in the latest quarter, up 17% year over year, while roughly 80% of service revenue comes from contracts. Customers also have strong incentives to keep those tools running because the value of the wafers being processed through them is huge.
That creates recurring revenue and, more importantly, another relationship with the customer after the original equipment sale.
But a moat does not make the stock cheap
This is where investors need to be careful.
KLA’s competitive position looks excellent, but semiconductor equipment is still a cyclical business. Customers can delay factories, change spending plans, or suddenly find themselves with too much capacity.
There is also a longer-term threat from China.
Chinese equipment companies are improving, and export restrictions are giving them an incentive to develop alternatives to Western suppliers. Samsung and SK Hynix have reportedly been evaluating Chinese equipment for their China operations. The tools have not yet achieved widespread adoption, but successful qualification by major chipmakers could give Chinese suppliers an important foothold.
KLA’s answer is essentially that technology and customer relationships are difficult to replicate. That may be true, but investors shouldn’t assume it will remain so forever.
The valuation matters too. At 34.84x forward earnings, KLA is no longer priced like a forgotten piece of semiconductor infrastructure. But considering its expanding moat, it is not too expensive either.
The verdict
KLA has what I would consider a real moat, and it is not simply market share. It comes from decades of process knowledge, customer relationships, engineering expertise, software, and a massive installed base that becomes more valuable as semiconductor manufacturing gets harder.
The interesting part is that AI may actually strengthen that advantage rather than just increase demand for KLA’s products.
At 34.84x forward earnings, however, investors are not exactly getting a bargain. At the same time, it is not unreasonable either, especially for long-term investors.
Market Sentiment
Hedge fund sentiment toward KLA strengthened in the second quarter. According to Insider Monkey’s database, 81 hedge funds held the stock in Q2, up from 71 in Q1. The value of those positions also increased sharply, from about $5.11 billion to $8.55 billion. The rise in both the number of funds and capital invested suggests institutional investors have become more constructive on KLA’s semiconductor equipment opportunity.
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This article is originally published at Insider Monkey.
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