2023-04-25 14:29:20 ET
Summary
- ASML Holding N.V.’s unchallenged leadership position in the semiconductor lithography market should ensure that it will continue to be one of the most important companies in the world in the foreseeable future.
- At the same time, due to its importance, ASML would continue to be exposed to various geopolitical developments that could have a direct impact on the performance of its shares.
- As such, this article highlights all the upsides and downsides of owning ASML shares in the current environment of heightened geopolitical risks.
It won't come as a surprise for a lot of people if I state that ASML Holding N.V. ( ASML ) is probably one of the most important companies in the world right now. The chips that Taiwan Semiconductor Manufacturing Company Limited ( TSM ) produces for companies such as Apple Inc. ( AAPL ), Nvidia Corporation ( NVDA ), Advanced Micro Devices, Inc. ( AMD ), and even Intel Corporation ( INTC ) are made with the help of EUV (Extreme Ultraviolet Lithography) machines that were pioneered by the Dutch industrial conglomerate ASML who now has a monopoly over the semiconductor lithography market.
As such, it's no surprise that the company has been at the center of attention in recent months. The Biden administration has been increasing pressure on its allies and the Netherlands in particular to prohibit sales of advanced semiconductor machines to China to diminish Beijing's capabilities to create advanced chips that could be used for military purposes. Earlier this year, the Biden administration finally managed to strike a deal with the Dutch officials to prohibit sales of some immersion lithography gear to China, which could have a direct impact on ASML performance in the future.
Considering this, it makes sense to highlight ASML's recent performance, figure out what parts of its business are likely to be affected the most after the recent deal, and conclude whether its stock is still a worthy investment in the current environment of heightened geopolitical risks.
Is The ASML Growth Story Far From Over?
If we take geopolitics aside for the moment and look at ASML's recent earnings report for Q1 that was published earlier this month, we'll see that despite all the fearmongering that Europe is going to deindustrialize due to high energy prices the opposite has happened, and the Dutch semiconductor giant has delivered a stellar performance. ASML's revenue in the first quarter was up 91.4% Y/Y to €6.7 billion as its gross margin stood at 50.6% while its net income was €2 billion. The company was able to deliver such great results mostly thanks to the high demand for its unique EUV and deep UV machines.
What's also important to note is that ASML's management has noted that the business would continue to grow at an aggressive rate, and in Q2 its sales are expected to be in the range of €7 billion. As such, it's safe to say that ASML's growth story is far from over, especially since its backlog at the end of March stood at almost €39 billion, which is almost two times its expected 2023 sales.
On top of that, there's also an indication that the demand for its EUV and other tools would remain strong in the following years as major fabs that are run by companies such as TSMC and Samsung are continuing to develop 2nm chips that should be ready for mass production by 2025. Thanks to this, it's likely that if ASML continues to aggressively grow its sales as it did in the previous couple of quarters, then it has all the chances of reaching €30 billion to €40 billion in annual sales by 2025 per its calculations that were presented at the end of last year.
Considering all of this, the Street continues to be bullish on the company's future despite all the macroeconomic and geopolitical challenges. It believes that ASML's stock has a 30% upside from the current levels, as its sales and profits are expected to increase annually at the aggressive double-digit rate in the following years. However, since the stock already trades at nearly 9 times its forward sales while its forward P/E is over 30x, ASML might not be a good fit for value investors who like to minimize risks as much as possible. But if ASML's business continues to aggressively grow at the forecasted rates while the changing geopolitical landscape won't disrupt its operations much, then there's a case to be made that the upside is reasonable given the company's monopoly over the semiconductor lithography market.
The Changing Geopolitical Landscape
Last year, the Biden administration began to actively impose various restrictions on trade with China as a part of the broader trade war policy that started under the Trump administration back in 2018 and is still ongoing. The most prominent were restrictions on exporting highly advanced chips, such as Nvidia's A100 GPUs that are used for various AI-related infrastructure.
At the same time, at the beginning of this year, the Biden administration began talks with its Dutch and Japanese counterparts to impose stricter export controls on a wide set of lithography tools that are manufactured by companies such as ASML. As noted earlier in this article, at the end of January, the Netherlands sided with the United States and imposed similar export restrictions on lithography tools to China. At the same time, Dutch Prime Minister Mark Rutte in March wrote an op-ed in which he argued that those export restrictions would help the country and its companies to better protect their intellectual property and not lose their technological edge to adversaries.
Even though those restrictions on paper would limit ASML's ability to work with its Chinese customers, the reality is that the company itself began to diversify its operations a couple of years ago and has been gradually decreasing its exposure to China. As such, it's questionable whether those restrictions will severely affect its operations anytime soon. If we look at the pie chart below, we'll see a year ago, China accounted for 34% of ASML's sales in Q1'22.
However, the latest data from Q1'23 shows that the exposure to China has decreased to 8% in a single year, primarily thanks to the major increase in sales of ASML's EUV machines that are expected to remain in high demand and outweigh the potential loss of a major portion of the Chinese market.
Considering this, it's safe to assume that the export restrictions on lithography tools that the U.S. and Dutch governments imposed earlier this year won't significantly affect ASML's operations anytime soon, especially if we consider that in Q1 the company delivered solid returns while significantly decreasing its exposure to China at the same time.
However, the real problem for ASML is that it replaced the Chinese market primarily thanks to major new orders from Taiwanese TSMC, which produces ~90% of most advanced processors using the machines of the Dutch company. The problem with this is that in the current era of heightened geopolitical risks, there's constantly a possibility that Beijing decides to invade the island nation, which could lead to ASML losing its major client and a significant chunk of future sales.
However, the good news is that if Beijing sticks to the status quo in the following years, then there's a solid chance that ASML would be able to greatly minimize its geopolitical risks. That's because in addition to export restrictions to China, the Western countries began to implement various programs that aim to move the production of semiconductors back home using taxpayer funds. The United States is about to begin distributing $280 billion in funding for new fabs and R&D centers on its soil this year, while the European Union recently approved the €43 billion deal to boost semiconductor production in Europe.
Thanks to this, ASML is also going to greatly benefit from all of those programs as companies like TSMC, Intel and Samsung already announced new plans to build new fabs on American and European soil and would use ASML's EUV machines to build their chips there. TSMC already plans to manufacture 3nm chips for Apple and others on its new Arizona plant in 2024, while Intel itself last year built the new Fab 34 in Ireland specifically for ASML's EUV machines to produce its latest Intel 4 chipset in the European Union. Therefore, if Taiwan's status quo is maintained in the following years, then there's every reason to believe that ASML would be able to greatly minimize its geopolitical risks, have no exposure to China, and continue to grow at an aggressive double-digit rate to reach its ambitious goals as the chip production moves West at the same time.
The Bottom Line
ASML Holding N.V.'s unchallenged leadership position in the semiconductor lithography market ensures that it will continue to be one of the most important companies in the world in the foreseeable future. Its recent solid earnings results show that the demand for its EUV machines and other tools would remain high for years to come as chipmakers are now actively using governmental subsidies to manufacture new fabs and bring production back to the U.S. and Europe.
At the same time, it seems that the latest export restrictions to China didn't have any major material impact on ASML's operations. If Beijing sticks to the status quo and doesn't invade Taiwan anytime soon, then the company would more than likely reach its long-term goals and more than double its annual sales in the following years. As a result of this, it's safe to say that ASML Holding N.V.'s premium price is justified and there's a case to be made that its shares have more room for growth even in the current era of heightened geopolitical risks as its business has become too important and too big to fail in the first place.
For further details see:
ASML: China Is Irrelevant