2023-04-20 08:58:39 ET
Summary
- ASML released its 1Q23 results earlier this week and managed to outperform its own previous guidance and that of analysts.
- Revenue growth continues to be strong and margins came in much better than anticipated.
- The one negative to be pointed out from these results was a significant decrease in new orders compared to previous quarters, and large customers are possibly cutting back on investments.
- Still, ASML has a very impressive and sticky backlog of €39 billion, which gives it a sufficient buffer to get through these challenging times.
- I upgraded my estimates and rating on ASML as the company reported much better results than I anticipated.
Investment thesis
I upgrade my rating on ASML Holding N.V. ( ASML ) from hold to buy and update my revenue and EPS estimates following the company's 1Q23 results which beat its previous guidance and that of Wall Street analysts. However, despite these solid results, the shares lost 3% in the following trading session after the company did report a drop in new orders.
ASML is an incredibly important company in the global semiconductor industry, if not the most important one. Through its highly advanced EUV technology, the company enables semiconductor manufacturers to build the world's most advanced chips. And with the company holding a monopoly in this industry, it is incredibly well-positioned to benefit from the increase in demand for these advanced semiconductors, driven by new technologies like AI, ML, IoT, and cloud computing. I recommend reading my coverage of its investor day here for a more in-depth analysis of ASML, its technology, and long-term targets.
Management has ambitious plans to continue growing the company, primarily through capacity increases, as demand remains much higher than current capacity. Therefore, the growth outlook for ASML looks incredibly strong. In addition, the company already reports impressive margins, but with revenue outgrowing Capex, these margins are expected to expand significantly over the next couple of years, driving strong EPS growth. Add to this an excellent management team that is shareholder-focused and plans to reward shareholders through both dividends and share buybacks over the next several years, and we have a great investment opportunity. ASML is one of my largest personal holdings and for good reasons. Yet, negative headlines have been emerging lately. New export restrictions to China and possible investment budget cuts at its largest customer have put some pressure on the share price as ASML might be facing some near-term headwinds. Still, I believe this company is a no-brainer to long-term investors and the current share price weakness could offer a great opportunity.
I last covered ASML back in January when the company reported its 4Q22 results. With the shares priced for perfection back then, I did not see much room for further upside in the near term and recommended investors waited for a better entry point to initiate a new position or increase an existing one. Today, shares are down 8.5% since this article, possibly offering a much more attractive entry point for investors as financials remain strong. In this article, I will take you through the latest developments and financial results and update my estimates and view on the company accordingly.
ASML delivers another quarterly beat and excellent financial growth
On the morning of April 19, ASML reported another set of excellent financial results as we have gotten used to from the company over recent years. Revenue for the first quarter of 2023 came in at €6.7 billion (5% growth sequentially), which was comfortably above the guided range of €6.1 billion to €6.5 billion, and the €6.3 billion guided for by analysts. This earnings beat was the result of faster EUV and DUV installations which meant ASML was able to realize more revenue for this quarter. The company realized EUV revenue with a total worth of €2.9 billion, total systems revenue came in at €5.3 billion, and installed base management revenues were €1.4 billion.
To further break this down, Taiwan (or TSMC ( TSM )) accounted for the largest part of revenue once more with a massive 49%, followed by South Korea (Samsung ( SSNLF )) with 26% and the US with 15%. And while this might not look extremely well diversified, this is no different from any other quarterly report as only a small number of companies have the financial resources and manufacturing capabilities to afford buying ASML's most expensive EUV (and DUV) machines. As a result, ASML only has a small customer base with TSMC, Intel ( INTC ), and Samsung as its primary customers. And while this does result in some exposure risks, ASML has excellent relationships with these companies and a monopoly in the very crucial EUV technology which makes these companies dependent on ASML technology. Yet, ASML is heavily exposed to geopolitical threats with China looking to reclaim Taiwan and with it deriving 49% of revenues from this single country, any conflict here would have significant consequences for ASML and while this is highly unlikely, it is something investors need to be aware of. However, today, it does not look like a serious threat or reason to doubt an investment in ASML.
1Q23 revenue by region (ASML)
Moving back to the financial results, ASML reported a 50.6% gross margin which was above the 49-50% that management guided for and above the 49.7% expected by analysts. This was primarily the result of the higher realized system's sales. 1Q23 net income was €2 billion, showing a 29% net income margin, which resulted in an EPS of €4.96 (up 8% sequentially). The company ended the quarter with total cash on the balance sheet of €6.7 billion, down from the €7.4 billion reported at the end of the previous quarter.
While results so far look really strong, the largest focus from analysts was on the order book and the quarter's order intake, following the report from earlier this week that its largest customer - TSMC - was planning on cutting its expected capital spending for this year as the downturn in the semiconductor industry is weighing on financial results. Of course, this is not great for ASML as it could indicate its largest customers are cutting back on spending which could very well result in lower order intake. Yet, earlier today, TSMC released its quarterly results and with this confirmed that it still plans to invest between $32 billion and $36 billion and is not cutting its investment plan, which is good news for ASML.
Still, order intake was not as strong as in previous quarters for ASML. For the first three months of this year, ASML recorded net system bookings of €3.8 billion, comprised of €1.6 billion for EUV and €2.2 billion for non-EUV bookings. In the previous two quarters, the total net system bookings still totaled €8.9 billion and €6.3 billion. Of course, this slowdown is no surprise with the current economic pressures causing a slowdown in spending by large semiconductor manufacturers. Still, this slowdown was more significant than anticipated by analysts which is the primary reason for the lower share price in the following trading session. Yet, I believe the market is massively overreacting to these numbers. ASML still has a system backlog of €39 billion, two times last year's revenue. This backlog is still incredibly strong and creates a sufficient buffer for ASML to get through these challenging times.
Contributing to this is the fact that cancellations are also highly unlikely. Even with large semiconductor manufacturers cutting back on spending, ASML's EUV equipment is still in high demand, and manufacturers can't afford to fall back to the end of the line and lose their prepayment. The backlog is sticky, creating a buffer for ASML to get through these challenging times, even with the order intake falling. Once the economic situation improves and demand for semiconductors drives higher revenues for the likes of Intel, Samsung, and TSMC, order intake for ASML will also quickly accelerate again.
Investors should not forget that secular tailwinds remain strong, primarily driven by incentives from both the European Union and the US government. Earlier this week, the European Union confirmed that they passed the €45 billion Chips Act to boost semiconductor manufacturing on the continent and decrease its dependence on Asian manufacturing. As a result, Intel, back in March, stated that it plans to invest €80 billion in Europe alone on chip manufacturing, supported by these incentives. And this, obviously, will also be very good for ASML as all these new factories will need to be supplied with ASML's most advanced equipment. Moreover, to regain its manufacturing leadership, Intel has already ordered ASML's next-generation EUV systems - High NA EUV. So, my point is that ASML is seeing very strong secular tailwinds from the overall increase in demand for high-end chip manufacturing driven by AI, IoT, ML, and cloud computing. ASML still holds a monopoly in EUV equipment which is needed to manufacture these high-end chips, making it the primary beneficiary over the longer term. Therefore, a short-term downturn should definitely not worry any long-term investor.
Despite significant economic headwinds and worries, ASML does continue to see healthy demand for its products, primarily for DUV systems. As a result, demand still exceeds ASML production capacity which is a positive. This is what CEO Peter Wennink said about this during the earnings call:
Customers continue to see demand weakness in consumer-driven end markets, causing the industry to actively reduce inventory and lower the utilization of their production base while demand in other end markets such as automotive and industrial remains relatively strong.
The focus for ASML remains on capacity expansion to satisfy growing demand. Through this, ASML continues to believe in its long-term financial targets as shown below. This shows significant margin improvement as revenue outgrows capital investments and impressive revenue growth.
ASML long-term targets (ASML)
Finally, ASML is also not forgetting about its shareholders. It increased the dividend by 5.5% and, based on a current share price of €567, shares currently yield slightly over 1%. Of course, this does not sound that attractive, but considering the strong company growth outlook and dividend growth history of ASML, this is a solid starting point with a long runway of dividend growth ahead.
In addition, ASML buys back a significant amount of its shares to increase shareholder value as well. In 1Q23, the company bought back 0.7 million shares for a total of €400 million, which will continue over the following years. Yet, management stated that they will slow down these repurchases slightly as they look to increase the cash reserve for possible depressed free cash flow generation in future quarters. Still, long-term shareholder returns are expected to be excellent.
China export restrictions
One of the leading subjects from the last couple of months and one of the leading risks for ASML continues to be its exposure to China and the incoming export restrictions from the Dutch government. As of today, ASML is still waiting for the Dutch government to publish further details on the export control restrictions. This is what management said about this during the earnings call:
Due to these upcoming regulations, ASML will need to apply for export licenses for shipment of the most advanced immersion DUV systems. As we said earlier, we interpret most advanced to pertain to TWINSCAN NXT:2000i and subsequent immersion systems
We should not forget that ASML was already not allowed to ship its most advanced EUV systems to China. As a result, only 8% of 1Q23 revenue was derived from China and this has been decreasing over the last several years. Therefore, management does not expect these new Dutch export restrictions to have a meaningful impact on either 2023 revenue or its long-term financial targets. Therefore, I don't believe investors have anything to worry about as the impact is expected to be minimal.
Outlook and valuation
For 2Q23, ASML guides for revenue of between €6.5 billion and €7 billion, which is meaningfully above the estimates from analysts which guided for €6.42 billion prior to the earnings release. Therefore, analyst projections and price targets will most likely be updated over the next few weeks. In addition, the gross margin is expected to be between 50% and 51%, in line with last quarter. R&D and SG&A are expected to increase in line with revenue as the company continues to invest in its production capacity and headcount.
For the full year, ASML expects to report EUV growth of around 40%, non-EUV growth of about 30%, and installed base business growth of 5% YoY. This should translate into a revenue increase of 25% YoY for FY23, in line with earlier guidance.
Regarding this guidance, I stated the following back in my January article:
Considering these expectations, we should expect ASML to report revenue of approximately €26.5 billion which is based on a 25% growth rate. Although this growth rate could very well come in higher, I prefer to stay conservative, so let's just assume a 25% growth rate. If ASML were to increase margins slightly compared to 2022, as indicated by its CEO, I think it's safe to assume a gross margin of 51.5%, still below its FY21 gross margin. I expect continued high inflation to pressure margins for the first half of the year, but ASML is well positioned to increase margins over time and so I believe higher demand and lower inflation by the second half of 2023 will result in higher margins of approximately 1% for the full year.
The net income margin for FY22 was 26.6%. If we assume this to also increase slightly and expect a net income margin of 27.6%, this would result in a net income of €7.31 billion for FY23 or a 30% growth rate.
While management reaffirmed its FY23 outlook, I believe the strong beat and significantly stronger margins allow for a slight update in my FY23 outlook and the years beyond. Following this update for FY23, I now arrive at the following expectations until FY26.
Shortly explaining these estimates, I now expect ASML to report revenue growth of 26% for FY26, driven by a higher number of system deliveries, primarily in the second half of the year. In addition, I updated my net income margin estimate from 27.6% to 28% after the company reported a net income margin of 29% for 1Q23. As a result, EPS growth is now expected to be 33%, compared to a previous 30% expectation. For the following years, I expect revenue growth to drop to the mid-double digits level as ASML grows capacity but the rule of large numbers kicks in. In addition, EPS will grow at a much stronger pace, driven by increasing margins as guided by management and continued share buybacks. For comparison, my FY25 revenue estimate is at the midpoint of the revenue target given by management on its investor day in November 2022 and shows strong growth ahead.
Moving to the valuation, ASML is currently valued at a forward P/E of 30x based on my EPS estimate for FY23, which is slightly above the analyst consensus. And I believe this current valuation is already factoring in most of the potential risks that come with owning these shares. Considering the continued high demand for its products, an EUV monopoly, the double-digit expected growth rates, and a solid backlog, I believe this company deserves to be valued at a premium.
Back in January, I awarded a 35x earnings multiple to the shares, but I am lowering this slightly due to some negative catalysts potentially weighing on the share price in the near term, which include lower order intake and China export restrictions. Therefore, I believe a 32x P/E is fair for ASML.
Based on my FY24 EPS estimate and a 32x P/E ratio, I calculate a target price of €758 ($830), leaving investors with an upside of 34%. (Please note, this target price is solely based on its forward P/E and is only for indicative purposes.) For comparison , 34 Wall Street analysts currently maintain an $818 price target combined with a strong buy rating.
Conclusion
I remain incredibly bullish on ASML and believe it will deliver outstanding returns for shareholders over the next decade, driven by its EUV monopoly, capacity expansion plans, and secular growth expectations for semiconductors worldwide.
With a price target of €758 ($830) per share, I believe the current share price offers an attractive entry point after the shares have sold off following a lower-than-expected net order intake and the news of TSMC cutting its investment budget for 2023 (which turned out not to be true).
Following my updated outlook, increased price target, and a more attractive entry price, I upgrade my rating on ASML to a buy . ASML holds an incredibly strong position in the global semiconductor industry due to its monopoly in EUV technology and therefore, the company looks poised for strong continued growth. I recommend that investors look through the near-term headwinds and negative headlines and benefit from the current share price weakness as any price below €636 ($697) offers a solid risk-reward profile.
For further details see:
ASML: Don't Be Worried About The Drop In New Orders