TSM - ASML Earnings: Another Rock-Solid Q4 Release

Summary

• ASML Holding N.V. just released its fiscal fourth quarter earnings and beat analyst estimates.
• The release showed positive growth in both revenue and earnings per share.
• ASML has a strong economic moat, being the only company currently selling extreme ultraviolet lithography machines.
• It does face the long-term risk of Chinese lithography companies entering the market.
• Nevertheless, ASML's fourth quarter earnings release showed that the company's virtual monopoly status is driving strong performance.

ASML Holding N.V. ( ASML ) just released its fiscal fourth quarter earnings. The release beat analysts' estimates on revenue and earnings per share ("EPS"). The release came at a difficult time for the semiconductor industry. Semi companies like NVIDIA ( NVDA ) and Micron Technology ( MU ) missed expectations in their recent earnings releases , as a slowing tech sector curbed demand for their products. In light of this, ASML's release was very, very impressive.

ASML stock was up very slightly at the time of this writing (mid-day Wednesday), while the tech-heavy NASDAQ index was down. The price moves were a vote of confidence in a stock that has out-performed the market consistently over many years.

ASML is a popular stock for a number of reasons. For one thing, it's a virtual monopoly -or more precisely, a virtual monopoly in the high end of its market. There are technically other companies that do lithography, but ASML is the only one shipping extreme ultraviolet lithography, the most advanced and expensive type of lithography tech. Recently, the Chinese company Huawei patented some EUV tools of its own, but as of January 2023, those tools are still in the R&D phase. ASML is the only company shipping this technology.

ASML's earnings release demonstrated the power of being dominant in a challenging industry. In a quarter when RAM prices declined and many companies missed on earnings, ASML beat and delivered positive growth. It was a strong signal from a company that many believe is among the strongest in the entire semiconductor industry. Accordingly, I remain bullish on ASML stock, as I was in my previous article on it.

ASML Earnings Recap

ASML's earnings release was strong, boasting metrics like:

• $6.43 billion in sales, up 11.2% sequentially.

• $21.2 billion in full year sales, up 13.7% year over year.

• 95 new lithography systems sold, up 18.75% sequentially.

• 317 in full year lithography systems sold, up 10.8% year over year.

• $3.3 billion in gross profit, up 10.1%.

• $1.8 billion in net income, up 6.8%.

• $4.60 in diluted EPS, up 7.22%.

• Guidance for 25% revenue growth in 2023.

It was a very strong showing. In a previous article, I praised Taiwan Semiconductor's ( TSM ) recent earnings release , as it showed strong year-over-year growth. ASML's release showed positive year-over-year growth AND sequential growth, which TSM's release didn't. This easily makes ASML's fourth quarter release among the best to come out of the semiconductor industry for the 2H 2022 period.

Why the Release Was Strong

Prior to ASML's release being published, I was expecting it to be good. I had no specific opinion on whether the release would beat estimates, but I did expect positive growth. The reasons I held this opinion were twofold:

1. ASML's technology is necessary for making computer chips.

2. ASML has a monopoly on the high end of its market.

The necessity of lithography systems in making computer chips stems from how chips are made. They are produced by engraving patterns on a silicon wafer, which requires some kind of cutting mechanism. Because the patterns on computer chips are so small, this has to be done using photolithography, which uses light and chemicals to cut patterns and affect the conductivity of the wafter. ASML develops extreme ultraviolet ("EUV") photolithography systems, the most advanced lithography systems in the world. There are a few other companies that develop lithography tech, but ASML is the only company that is actually shipping EUV technology. Companies developing deep ultraviolet ("DUV"), the second best standard, include Japan's Canon ( CAJ ) and Nikon ( NINOY ).

Recently news broke that China's Huawei had made breakthroughs in EUV lithography . Specifically, the company filed patents for EUV lithography systems for manufacturing at sub-10nm processes. This would seem to imply that there are now two companies on earth now capable of making EUV machines. However, it should be noted that Huawei's EUV machines are not actually in production. In addition, the company might have some trouble exporting EUV tech to the same markets that ASML serves. The U.S. is currently in a chip war with China , banning exports of various chip making devices and inputs to the country. The U.S. specifically doesn't want China to be able to do EUV in-house, it has leaned heavily on the Netherlands to ban selling EUV equipment to China for this reason.

Recently, the Netherlands consented to the U.S.'s requests , so ASML's sales to China will presumably either end or be curtailed. This was once thought to be a negative catalyst to ASML itself, although the company's bullish 2023 guidance seems to call that into question. The point is that the U.S. is putting a variety of sanctions on Chinese chip makers, which might benefit ASML by allowing its de-facto monopoly to continue in the West, even after Huawei starts shipping EUV.

Valuation

Next up, we have ASML's valuation. This is perhaps the least bullish part of the analysis. ASML is pretty expensive, not only for a European stock, but also compared to U.S. tech stocks, trading at :

• 47 times adjusted earnings.

• 49 times GAAP earnings. That is to say, earnings going by generally accepted accounting principles ("GAAP").

• 13.89 times sales.

• 33 times book value.

• 28 times operating cash flow.

These multiples are all very high across the board, even for a stock with an economic moat. As I wrote earlier, it's very impressive that ASML is delivering positive revenue and earnings growth, when most semi companies aren't. However, 7.2% EPS growth (what was observed last quarter) isn't exactly the kind of thing that justifies a 47 times earnings multiple. Many banks have earnings growth at that level, and they usually don't trade at more than 10 times earnings. Now, ASML is forecasting 25% growth in 2023, if we see that kind of growth, then ASML will begin to look more attractive. For now, though, it has to be said: this is a very expensive stock.

Risks and Challenges

As we've seen, ASML is a high moat stock with a partial monopoly that is putting out good earnings. Valuation aside, it is a very attractive picture. However, there are many risks and challenges that investors will have to keep in mind here, including:

• The monopoly ending. A big part of why ASML is able to out-perform its industry is because it has a de facto monopoly on EUV. In terms of EUV systems shipped, that monopoly is rock solid. However, in terms of the technology itself, the monopoly is being challenged. Huawei claims in its patent filings that it can now do EUV lithography at processes less than 10nm. This is getting dangerously close to the same thing that ASML does. As I mentioned in the section on competition, it's not clear that Huawei will ever be allowed to sell these systems in the United States. The U.S. is clamping down hard on trade with China, and chips are in the line of fire. So, ASML's monopoly in some markets may last a long time.

• A general slowdown in the chip industry. One risk to ASML's business is the ongoing chip slowdown. Many segments in the industry are seeing lower prices and sales volume: RAM prices are going down, NVIDIA's chips are seeing lower demand, etc. This is in principle a headwind for ASML. So far, it hasn't hurt ASML's business. After all, it's a monopoly, so if any segment of the chip industry is thriving, it will continue to buy from ASML. However, if the weakness in semis actually accelerates, then that fact may start to show up in ASML's earnings.

• Valuation. As mentioned in the previous section, ASML is a very expensive stock. If you take ASML's TTM free cash flow per share ($20.56), and discount it at 10%, assuming no growth, you get a price target of $205-not even a third the current stock price! Of course, assuming no growth for a company like ASML isn't valid, given that it just guided for 25% full year 2023 growth. But this rough terminal value calculation does show that ASML needs to continue growing to be worth it. It's not a stock where the investment thesis can withstand deceleration.

The Bottom Line

The bottom line on ASML's fourth quarter earnings release is this:

It proves what ASML bulls have been saying all along, namely that ASML is a stock with a rock-solid economic moat that is out-performing the chip sector. In a period where many chip companies are seeing sales fall and earnings go negative, ASML is still growing on the top and bottom lines. Of course, investors are paying for all this resilience: the company's stock is among the most expensive in the semi space. It's for this reason that I don't personally own ASML, preferring the more modestly valued Micron and TSMC.

Nevertheless, this is a great business. If ASML stock were to test its 2022 lows again, it would be a slam dunk buy. For those with very long time horizons, it is a modest buy even today-you can't just assume that a high-moat business will fall to a cheap valuation.

Given my personal investing habits, 47 times earnings is a bit of a stretch. For a value investor, ASML is not the best pick out there. However, the company itself will most likely do well.

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