Company Overview: MKS Instruments, Inc. (NASDAQ: MKSI) offers instruments, systems, subsystems, and process control solutions for sophisticated manufacturing processes that measure, monitor, deliver, analyse, power, and control critical parameters. Its operating segments are 1) Vacuum & Analysis (V&A), which provides various products in the gas and vapor delivery, gas composition analysis, electronic control technology, reactive gas generation, power generation, and vacuum technology fields, 2) Light & Motion (L&M), comprising a portfolio of lasers, photonics, optics, temperature sensing, precision motion control and vibration control products, and 3) Equipment & Solutions (E&S), involved in the marketing of a range of products including a laser-based system for manufacturing of Printed Circuit Board (PCB).

MKSI Details

Key Takeaways from Q3FY21 (ended September 30, 2021)

• Double-Digit Growth in Revenue: In Q3FY21, the company's total revenue amounted to USD 741.9 million, representing a 25.79% increase year-over-year from USD 589.8 million.
• Improvement in Operating Margin: MKSI reported an operating profit of USD 175.3 million for the current quarter, representing a higher operating margin of 23.63% vs. 19.74% for Q3FY20, attributable to a 389-bps reduction in total operating expense ratio.
• Surge in Net Income: The company's net income increased to USD 132.4 million in Q3FY21 from USD 91.7 million in Q3FY20, representing diluted earnings per share (EPS) of USD 2.38 in Q3FY21.

Revenues & Gross Profit Key Highlights; Analysis by Kalkine Group

Recent Developments:

• On October 26, 2021, the company declared a quarterly dividend of USD 0.22 per common share, payable in cash on December 10, 2021, to shareholders of record on November 29, 2021.
• On July 01, 2021, MKSI signed an agreement to acquire Atotech Limited, a German speciality-chemicals technology company and a provider of electroplating solutions, for a total transaction value of USD 5.1 billion. Under the agreement, MKSI will pay a cash consideration of USD 16.20, plus issue 0.0552 of its common stock in exchange for each outstanding share of Atotech. The transaction is expected to close in Q4FY21.
• On July 20, 2021, MKSI received an order for ESI Geode HDI from TTM Technologies, Inc. through a drilling system for TTM's facility in Guangzhou, China.
• On July 15, 2021, MKSI acquired Photon Control Inc., a manufacturer of optical temperature sensors for semiconductor wafer fabrication. This acquisition aims to further MKSI's technology solutions for its key customers in the semiconductor market. 

Segment Wise Results Q3FY21

• V&A Segment: This segment accounted for 12% of the total revenue in Q3FY21 and reported YoY growth of 33.71% to USD 483.1 million. The gross margin for the segment improved to 46.8% in Q3FY21 from 45.3% in Q3FY20, attributable to higher volumes.
• L&M Segment: This segment accounted for 13% of the total revenue in Q3FY21 and expanded by 18.65% YoY to USD 208.7 million. MKSI witnessed a mid-single-digit growth of 5.2% in gross margin primarily due to improved volumes, favourable product mix, better inventory management, slightly offset by unfavourable absorption.
• E&S Segment: This segment represented 75% of the total revenue in Q3FY21 and witnessed a YoY decline of 4.75% to USD 50.1 million. The gross margin declined by 0.4% in Q3FY21.

Balance Sheet & Liquidity Position

• Strong Cash Position: The company exited Q3FY21 with a cash balance (including short-term investments) of USD 879.6 million, 5.22% more than USD 836.0 million at the end of FY20.
• Cashflow from Operations: Operating cash inflow in YTD September 30, 2021 increased to USD 445.2 million from USD 366.0 million in the prior corresponding period.
• Debt Reduction: MKSI's reported total outstanding debt of USD 818.7 million at Q3FY21 end, lower than USD 829.5 million reported as of December 31, 2020.

Key Metrics: In Q3FY21, MKSI's operating and net margins were 23.6% and 17.8%, higher than 19.7% and 15.5%, respectively, reported in Q3FY20. ROE stood at 5.0%, 80 bps higher than the Q3FY20 return. Debt/Equity was 0.30x as of September 30, 2021, lower than 0.37x on September 30, 2020.

Profitability and Leverage Profile; Analysis by Kalkine Group  

Top 10 Shareholders: The top 10 shareholders together form around 48.96% of the total shareholding, while the top 4 constitute the maximum holding. The Vanguard Group, Inc. and Wellington Management Co., LLP hold the maximum stake in the company at 10.23% and 8.79%, respectively, as also highlighted in the chart below: 

Top 10 Shareholders; Analysis by Kalkine Group 

Risk Analysis

• Customer Concentration Risk: MKSI derives much of its revenue from a limited number of customers. In FY20, its top ten customers accounted for ~44% of the total revenue. Further, in Q3FY21, its top two customers Lam Research Corporation and Applied Materials, Inc., represented 18.4% and 10.6% of its total revenue, respectively.
• Dependence on Semiconductor Industry: Sales to semiconductor capital equipment and device manufacturers represented ~59% of MKSI's FY20 revenue. Hence any downturn in demand posed by contraction in capital spending in these critical markets could harm the company's operations.
• Supplier Concentration Risk: MKSI depends on a limited number of suppliers for some of the key components and subassemblies used in manufacturing its products. Any lag in the supply of the requisite quantity or unfavourable pricing could distort its production and, in turn, negatively impact its overall performance.
• Exchange Rate Fluctuation Risk: The company conducts its business in many currencies other than USD, with international revenue representing ~55% of its total FY20 revenue. Though it has taken currency forwards contracts to mitigate the fluctuation in prices, still this risk persists, thus making it vulnerable to exchange rate fluctuations.

Outlook

• Looking forward, MKSI expects to clock revenue of USD 760 million (+/- USD 30 million) in Q4FY21, along with a non-GAAP diluted EPS of USD 2.85 (+/- USD 0.26).
• The estimates consider the industry-wide supply chain constraints, which are expected to continue in the near future, and exclude any contribution from the Atotech acquisition.

Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative)

Source: Analysis by Kalkine Group

*% Premium/(Discount) is based on our assessment of the company's NTM trading multiple after considering its key growth drivers, economic moat, stock's historical trading multiples versus peer average/median, and investment risks. 

Stock Recommendation: Over the last six months, MKSI's share price has corrected 13.30%. The stock is currently trading close to the mid-point of its 52-week range of USD 111.13 to USD 199.44. We have valued the stock using the EV/Sales multiple-based illustrative relative valuation method and arrived at a target price with an upside of low twenties (in percentage terms). We believe that the company can trade at a slight discount compared to its peer's average, considering its customer and industry concentration, currency risks and dependence on a limited number of suppliers. We have taken peers like CyberOptics Corporation (NASDAQ: CYBE) and AXT Inc. (NASDAQ: AXTI). Considering the strong top and bottom-line performance, improved profitability margins, recent acquisitions, decent outlook, and current valuation, we give a "Buy" recommendation on the stock at the current price of USD 153.0, down 0.59% as of November 03, 2021, 10.22 AM ET.

MKSI Technical Chart, Data Source: REFINITIV 

Note 1: The reference data in this report has been partly sourced from REFINITIV.

Note 2: Investment decision should be made depending on the investors' appetite for upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the valuation has been achieved and subject to the factors discussed above.

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