Morningstar - Q2 2021 - 69

EXHIBIT 2

Onward and Upward Wafer fabrication equipment spending is poised for steady
growth, led by broad-based demand from leading chipmakers.

with performance or efficiency to generate
a premium or a positive margin. If you stagnate,
then competition catches up, and it becomes
a very price-sensitive battle.

Total WFE Market
$100,000M

PROJECTION

75
50
25
0
2008

2010

2012

2014

2016

2018

2020

2022E

2024E

Source: Morningstar Research estimates, Gartner.

control tools. These are used to verify that a chip
was processed correctly after it runs through,
say, a lithography tool from ASML or an
etch tool from Lam. As parts are getting smaller
and defects potentially becoming harder
to identify, KLA's tools are critical to making sure
that chips are functioning correctly or yields
are high. They directly benefit from this rising tide
of complexity.
Similar to how ASML dominates the lithography
market, KLA dominates the process diagnostic
and control market, with about 60% market
share. They have industry-leading profit margins,
really strong cash flow, and better operating
margins relative to their peers as well. They are
critical in the transition from technology to
technology, while some of their peers are more
dependent on capacity expansion, where
customers are building out new fabs and adding a
ton of equipment. KLA is kind of a pure-play
investment on increasing complexity and more
immune to short-term economic shocks. Let's
say there's a sharp decrease in demand, and
TSMC decides to cut capex by 15% to 20%. They're
likely to buy fewer tools for their actual
manufacturing facilities, but they'll still be working
in the R&D setting and ramping up new
technologies that will be coming out in future
years. KLA is instrumental in helping them achieve
that. That's why we view them very favorably
relative to the overall space.

We're moving from an environment where PCs
and smartphones are the primary end market for
chips to one where everything we use is.
Everything is smart and intelligent and using some
sort of AI. There's computer vision, which
allows a car to realize that the car in front of it has
stopped suddenly so it needs to brake. Natural
language processing enables our smart assistants
to recognize what we're saying and answer
questions. Then there are more sophisticated AI
applications like self-driving, or recommendation
engines, or any sort of healthcare application.
Pretty much every industry is going to be touched
in some way, shape, or form by increased
connectivity and increased intelligence.

Lam Research has shown some novel technologies
in recent years in the areas that they focus on,
and they've gained quite a bit of share. In the
There's also all this data that's been collected
Growth
of $10K
in-the
etch and
and is just waiting to be monetized. There are a lot
specific markets that Lam plays
deposition markets-there is a lot of competition,
of companies with
data sitting in the cloud
$12.0K
with Applied Materials and Tokyo Electron
or in their data centers, but they don't necessarily
11.70
competing in similar subsegments. But also,
have a cost-effective
11.5 way to monetize it. The
11.69
PRFIX
AI trend is allowing companies to unlock the value
they've historically been more dominant on the
of all the data that11.0
they hold.
memory side of things, with customers like
Micron and Samsung. Meanwhile, they've been
10.5
increasing their logic and foundry capabilities,
The winners in the
semiconductor space are going
and we expect them to gain more share there as
to be the ones that help those customers
Morningstar
10.0whether in connectivity or 5G
well, with customers like TSMC and Intel. US Core Bond figure out solutions,
9.5 AI applications. This is
This is a shorter-term call on their competitiveness
or Big Data and other
01/2018
01/2019
01/2020
being a little bit better than some of their
what is going to push the overall semiconductor
peers'-at the end of the day, four of these five
and computer industry beyond personal devices
like PCs and smartphones.
firms are rated wide moat.
Lallos: You recently increased your fair value estimates

Lallos: What risks should investors be prepared for?

for these major suppliers, as well as narrow-moat
Tokyo Electron.

Davuluri: The COVID-related demand trends
have been strong, and there's always risk
that as things start opening up, some areas may
be negatively impacted, which could cause
a short-term correction. Or there may be a glut of
inventory after we've been dealing with all
these shortages, and that may overcorrect. But if
we look at a five- or 10-year horizon for the
overall semiconductor space, I think all the trends
that we discussed are likely to be up and
to the right. K

Davuluri: Yes. In addition to short-term demand
being a lot stronger across the board, the
2021 expectations for wafer fab equipment were
much higher than we'd anticipated.
Lallos: We've touched on some of the trends driving
semiconductor demand. What are the overarching
themes in this space?

Davuluri: The semiconductor space is a constant
battle against commoditization. You want
to keep innovating, keep pushing the envelope

Laura Lallos is managing editor of Morningstar magazine.

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