2023-10-04 08:00:39 ET
Summary
- DUV will be the primary driver of growth for ASML in 2023 and 2024 on strong customer demand.
- EUV sales face short-term headwinds and customer delays.
- ASML's long-term goals of bringing high-NA EUV to market in 2025 offer significant upside potential.
I agree with most analysts when I say that I think you should buy ASML now for the revenue growth potential on extreme-UV (EUV) systems and their healthy profits and cash flow. With ASML’s CEO Peter Winnink clearly stating the long-term goals of bringing high-NA EUV to market in 2025 ( Q2 2023 Earnings Call ), combined with the completion of new fabs in 2025, I think the long-term upside is huge. However, I will take a contrarian stance when I say that for the rest of 2023 and 2024 that deep-UV systems (DUV), representing the older, more mature systems, will be the primary driver of growth.
With the Q3 2023 report coming out this month, we can review the Q2 earnings report to inform our expectations. Last quarter saw net sales of €6.9B, net systems sales of €5.6B (84% logic, 16% memory), and a gross margin of 51.3% (driven by DUV immersion revenue). However, the installed base business has been facing headwinds with the current market uncertainty, and growth is only expected to be around 5% YoY.
Q2 net system bookings were €4.5B – €1.6B for EUV and €2.9B for non-EUV (DUV, etc.), with ASML looking at a total €38B backlog of orders. Expecting pressure on free cash flow, the leadership has noted in the Q2 earnings call the need for prudence in managing cash flow and maintaining higher levels of cash. Despite the possible headwinds, revenue has been projected by leadership on a recent conference call to be strong across EUV and DUV, exceeding 25% YoY and 50% YoY growth. One major factor into the large change seen in DUV is due to fast shipment plans, where customers agree to do final acceptance tests on-site rather than in the factory. For customers willing to accept a reduced test protocol, ASML can realize the revenue from the shipment to be realized closer to the ship date of the system.
It is at this moment that I would like to take a contrarian stance on ASML – for the rest of 2023, expect the main upside for revenue growth to be DUV, not EUV. Let me explain.
First, we need to start with ASML’s revenue stream by product line. As we can see below, EUV is the single largest sector. The first production EUV systems were shipped in 2013 ( see ASML 2013 annual report ), and the volumes have been slowly ramping ever since as the technology matures. However, 10 years later, the DUV products still make up at least half the total revenue. These include argon-fluoride (ArF) excimer systems, ArF immersion (ArFi) where the wafer is immersed in water, allowing for an increase in feature resolution, and krypton-fluoride (KrF) excimer laser lithography systems. DUV demand still exceeds supply, which despite some delays has been more than compensated for by strong demand for mature nodes, with plans to ship more than 375 DUV systems (25% immersion). I believe that ASML’s ability to push more ArFi systems will be the key to maintaining the revenue growth expected by the market. DUV is a key target for replacement in legacy nodes and expansion of mature nodes. While these are not cutting-edge logic applications with customers of the likes of NVIDIA, AAPL, or AMD, they still represent large volumes.
Disaggregation of revenue by product line (ASML FY2022 Annual Report)
ASML has also made some changes to the DUV products to help meet demand. For example, changing the test procedure for some fast shipments to customers allowed for €700M to be realized in the first half 2023. Looking forward, based on the ASML’s 2023 Statutory Interim Report for the first half of 2023, we see that the main push has been to ship more units. The DUV lines are the only product lines of increased capability due to the mature technology. I expect to see this trend continue through the rest of 2023, helping shore up revenue growth from ArFi and KrF systems.
ASML’s EUV system may generate more revenue but has shown to be much more sensitive to customer deadlines and delays due to the smaller volume. Despite the recent plans for new fabs to be built across the US and the EU, the long lead times involved in setting up a fab mean that ASML will not realize the revenue until at least late 2024 or 2025. Customer adjustments in timing due to fab readiness and supply chain issues have led to a shipping target of 52 systems, representing only a 25% YoY increase in revenue instead of the projected 40%. This delay may not be a bad thing - in the Q2 2023 earnings call , CEO Peter Wennink communicated that with a large number of orders for EUV due in 2025 due to new fab openings. The delays may bridge the gap in revenues and allow for steady production capacity during the preparation for 2025. ASML has been coy about fast shipments of the NXE systems – we do not know the exact numbers for EUV vs. DUV but expect fast shipments to make less of an impact due to the less mature EUV technology.
ASML’s R&D expenditures have always been high, but they continue to allow ASML to drive cutting-edge UV lithography to new heights. In the first half of 2023, the R&D investments have mainly related to developments in the NXE:3800E system and improving the availability and productivity of installed EUV base systems. There are also plans to bring to market an EUV High-NA (numerical aperture) for both logic and memory customers; the ASML EXE:5000 high-NA scanner is expected to able to reach an optical resolution of 8 nm instead of 13 nm for ASML’s current EUV products. This corresponds to logic customers being able to move to the 2.1 nm node, and beyond. For investors looking for a high-tech, lower-risk exposure to AI growth and continued improvements in compute, ASML’s long-term goals are very well aligned with capturing revenue from the cutting-edge compute sector.
Feature resolution of EUV vs high-NA EUV (IMEC)
The large yearly investments into R&D are necessary for ASML to continue to mature the technology required to push Moore’s law to smaller and smaller features. It bears repeating that high-NA EUV is still at least two years off - I recommend that readers interested in the technical challenges with high-NA EUV lithography may find this review by Harry Levinson enlightening regarding the roadblocks to mature high-NA lithography.
It is important to take a moment to pause and note that ASML's high profitability and revenue growth need to be balanced by its current risk exposure. As outlined in the 2022 Annual Report , ASML's exposure to the global semiconductor market and extensive supplier network hold the potential to impact production capacity and revenue realization based on shipments of EUV/DUV systems to customers. While ASML is somewhat insulated from direct competition due to their extensive IP generated by R&D in the EUV space, DUV systems do face competition from Canon and Nikon. Additionally, the cyclical nature of semiconductor manufacturing in both memory and logic can affect the timing of customer shipments and impact revenue realization. Lastly, due to ASML's low volume and limited customer base, if one of their major partners delays or cancels their orders, this can greatly impact not just a single quarter but multiple quarters of sales.
YTD lows on the stock price of ASML, with steady revenue and profit growth is an excellent entrance point ahead of earnings. Note the 12-month low on the P/E. (TradingView)
Due to the aforementioned risks, ASML has observed a recent stagnation in the price over the past year. This has resulted in the lowest P/E ratio in a 12-month period, despite growing revenue and income. Looking forward, even with a conservative projection of 5-10% quarterly revenue growth, my price target for ASML for the end of FY2023 is $650-700. This forecast is based on two quarters of revenue growth and assuming a P/E range of 27-35 based on historical data, with the same profit margins for Q2 2023. The stock price has met some resistance at the current levels, but I think will rebound on consistency despite uncertain short-term forecasts. For those looking for an opportunity to buy, I think this is a great time ahead of the Q3 earnings report which comes out this month. For long-term investors, the end of FY2023 and early FY2024 may be the opportunity to grow your positions before ASML's long-term plans in high-NA EUV and revenue realization from new fabs begin to pay off.
In conclusion, I believe that ASML is poised to continue its revenue growth from sales of EUV and DUV systems. Despite some headwinds on the EUV side, I think that the DUV market is healthy and ASML’s move to fast shipments will allow them to reduce testing time in the factory, realize revenue sooner, and increase the total volume of sales. I believe the next two quarters will see revenue growth driven by DUV, and I have set my PT for $650-700 for the end of FY2023. Those waiting for high-NA EUV systems and revenue realization from new fabs currently under construction will need to wait until at least 2025; in the meantime, the focus should be on the growth upside in DUV.
For further details see:
ASML: DUV Is In The Driver's Seat For FY2023