2023-04-26 00:14:39 ET
Summary
- ASML is the market leader in advanced semiconductor equipment systems manufacturing.
- Their almost unrivaled range of lithography systems provides the company with a huge customer base reliant on their technologies.
- Recent innovations and rapidly growing demand for EUV lithography systems have spurred orders and profitability for the firm.
- Strong and stable fiscal fundamentals combined with a decent intrinsic 19% undervaluation make the firm an attractive pick even from a value perspective.
- Cumulatively, the factors currently affecting the company earn shares a Buy rating.
Investment Thesis
ASML Holding N.V. ( ASML ) has enjoyed a strong FY22 spurred by their EUV lithography sales and general demand for lithography systems. Strong growth prospects combined with fundamental profitability have led to a YTD bull-run of around 13%
Their robust economic moat driven by a wide selection of microchip manufacturing systems and extensive intellectual properties should help increase the stability of their revenues for years to come.
When combined with a filled order book, the company looks to be in a strong position to remain profitable even through a recession in the short-term.
Company Background
ASML | Homepage
ASML is a Dutch multinational advanced semiconductor equipment systems manufacturer. They produce lithography, metrology and inspection systems for memory and logic chip manufacturers which are used by chip foundries to produce advanced processors and other semiconductor chips.
Their new extreme ultraviolet (EUV) lithography systems are essentially unrivalled within the market. ASML’s continued knowledge and IP have created a significant moat for the firm which has allowed the company to establish what is essentially a monopoly within the industry.
Given the rapidly growing demand for semiconductors of all sorts, especially with the increase in devices connected to the “internet of things”, demand for ASML’s manufacturing systems should remain resilient for decades to come.
Nonetheless, a difficult macroeconomic environment combined with a potentially short-term decrease in demand for semiconductor chips means the future is a little cloudier for ASML.
Therefore, a fundamental company analysis and intrinsic value calculation must be completed to fully understand what sort of investment opportunity may exist in ASML from a value perspective.
Economic Moat – In Depth Analysis
ASML has a wide economic moat thanks to the extensive IP & product portfolio of manufacturing equipment on offer, their upstream position within the industry and thanks to their continuous drive for innovation.
The firm’s business strategy to provide customers with a holistic portfolio of lithography products and services has proven resilient even in the face of difficult macroeconomic headwinds.
ASML FY22 Report
ASML’s products range from mass-production oriented lithography manufacturing systems to advanced and novel chip production as well as cost control-oriented mature chip production. To be clear, ASML manufactures the equipment used by other manufacturers such as TSMC to produce the semiconductor chips we use in our smartphones.
A devotion to providing best-in-class customer support along with equipment upgrade and maintenance solutions allows the company to ensure customers can enjoy an increased level of productivity, operational quality and reliability compared to the equipment from rival firms.
ASML FY22 Report
The company’s novel and innovative EUV technology has taken years to develop with the fruits of their R&D voyage finally beginning to be enjoyed by the firm. EUV lithography essentially allows chip manufacturers to produce even smaller microchip structures which can allow for increased efficiency and performance.
Many of the newest chips currently being designed for computers, phones, tablets, wearables and even cars rely on lithography technology for the mass-scale manufacturing of these semiconductor chips. This should provide ASML with a rapidly growing long-term demand and market for most of their lithography systems.
Overall, ASML’s wide, varied and differentiated set of products and services helps create a significant economic moat for the company. ASML essentially operates as a monopoly within the lithography equipment manufacturing industry with their only notable rivals being LAM research and Tokyo Electron.
I believe ASML’s more unique set of EUV machines should significantly increase their moatiness moving forwards as the development of a similar technology for another company would be almost prohibitively expensive, not to mention the duration of time required for such a business to be developed.
As a manufacturer of microchip manufacturing systems, ASML enjoys a position which occupies the very top of the semiconductor chip ecosystem.
ASML Fy23 Q1 Report
The above infographic perfectly illustrates ASML’s dominant position as the most upstream element of the entire microchip ecosystem. Without ASML’s technologies and products, the foundries could not produce the designs fabless chip designers such as Apple or AMD can create.
This illustrates the absolute reliance the entire industry has on ASML’s products. Considering the demand for semiconductors is only growing, and at a rapid rate too, ASML seems to be placed to benefit from any and all advances within the industry.
Overall, I believe ASML has a robust and wide economic moat driven primarily by their differentiated and competitive lithography systems as well as their upstream position within the industry. While competitors do exist within the space, none have the resources or scale of ASML which makes competing with the Dutch business incredibly difficult.
Financial Situation
ASML has had a profitable and robust history for much of their recent existence. Their 5Y average ROIC is an impressive 26.21 with the last three years averaging closer to 31%. An equally impressive set of 5Y average gross, operating and net margins of 48%, 29% and 26% respectively illustrate the profitable and sustainable operation currently present at ASML.
ASML FY22 Report
FY22 was an outstanding year for the company with net sales having risen by over €2.6B to a total of €21.2B. This growth was particularly driven by strong logic system sales of €10.1B (4% YoY growth) and memory system sales of €5.2B (34.2% growth).
Net sales from their service and field option sales also showed healthy growth of 15.8% to a total of €5.7B. Gross profits increased thanks to volume increases in Deep Ultraviolet (DUV) systems thanks to an overall growth in their installed base.
Cumulatively these factors allowed the company to have a gross margin of 50.5% for FY22. ASML also repurchased €4.6B shares and paid over €2.6B in dividends (based on US GAAP figures).
The company also spent a massive €3.3B on R&D in FY22 which reflects their continued efforts to support and innovative within their holistic lithography business. Most investments were directed at enhancing their high-volume manufacturing of EUV equipment. I view these R&D costs as not only necessary but welcomed as this should help the company stay ahead of their competitors.
Overall, the impressive FY22 has put ASML in a fantastic position to benefit from future demand and illustrates just how profitable their operations can be.
ASML Q1 FY23 Press Release
ASML continues to show strong fiscal results as published in their FY23 Q1 report. Total net sales growth of 5% compared to Q4 meant €6.7B was earned by the company. This exceeded management guidance of €6.5B, which is welcomed news for investors.
A healthy €2.0B was left as net income with an operating margin of 32.7% being achieved in Q1. Basic EPS totaled €4.96.
The primary driver for this strong FY23 Q1 was continued excellence in results from their EUV business which grew 5% as a representation of net system sales compared to Q4. The strong growth seen by their end-use category of memory chips also saw a healthy 6% growth compared to the previous quarter.
TSMC accounted for the largest portion of net system sales at 49%, with Samsung accounting for a sizeable 26%. While ASML has broken these categories down my nation, these two manufacturers are essentially ASML’s largest clients and are responsible for this geographic dominance.
The U.S. (with Intel being the largest customer) accounted for 15% of net sales with China, Japan and EMEA accounting for just 10% total.
While it is clear that ASML has a heavy reliance on a couple manufacturers, the huge nature of these chip fabricators means risk is relatively well mitigated. Samsung, TSMC and Intel are essentially indispensable elements of the semiconductor chip ecosystem thus eliminating the risk for ASML of one of these companies going bust.
Clearly, ASML is continuing to exhibit very strong fiscal performance thanks largely to their innovative EUV technology finally beginning to be required for mainstream chip production. This strong demand for EUV has been compounded by a continuously growing demand for microchips in general resulting in robust sales growth for their less cutting-edge (in the context of microchip manufacturing) DUV lithography systems too.
Perhaps the only negative factor from this quarterly report was the slowdown in orders compared to previous quarters. While net orders already decreased 28% in Q4 FY22 compared to Q3, bookings fell another 40% in Q1 to just €3.8B.
While this may sound alarming at first, this drop in system bookings was largely expected by management. The negative sentiment facing global financial markets as a whole due to the forecast of an impending 2023 recession has left many companies scaling back their capital expenditure outlooks for the year.
ASML also still has around €39B in their order book at the end of Q1 FY23 which represents a truly huge volume of stable and predictable revenues. While some of these orders could get cancelled if a recession is entered, this is incredibly unlikely in the industry given the current lack of supply of key lithography equipment.
This makes ASML a lucrative choice for investors given the relative resilience the company should have against a recessionary period. Their stable set of revenue streams and huge order book decrease ASML’s immediate exposure to short-term macroeconomic conditions.
Seeking Alpha | ASML | Profitability
Seeking Alpha’s quant assigns ASML with an “ A+ “ profitability rating. I believe that this rating is a representative snapshot illustration of the company’s overall profit generating prowess.
ASML’s balance sheet looks to be in relatively healthy shape. The company currently has €23.1B in Total Current Assets while Current Liabilities only total €17.9B. This illustrates the conservative fiscal strategy being pursued by management with regards to their growth strategies. For investors, such a well-managed and liquid company is excellent news.
The company has a debt/equity ratio of just 0.36 which again is fantastic to see from an investor perspective. Their quick ratio (current assets minus inventory divided by current liabilities) is 0.70.
ASML FY22 Report
ASML has just €4.3B in long-term debt with a majority of debentures maturing after 2027. While the company has €746M maturing in 2023, ASML may still choose to engage in refinancing of this debt to ensure it doesn’t weigh-down on their FCF for the year.
ASML operates with a financial leverage of just 4.12 which is fantastic to see, especially given the overleveraged nature of many tech and chip manufacturers.
Overall, it is clear that the management at ASML is laser focused on continuing to improve the profitability and market position of their company. ASML’s broad range of products continues to drive significant profitability with their EUV investments now contributing positively to net incomes.
Valuation
Seeking Alpha | ASML | Valuation
Seeking Alpha’s Quant has assigned ASML with an “ F “ Valuation rating. I find this valuation relatively incorrect as it suggests either an over or approximately fairly valued entity at present time.
I believe ASML stock is trading at a slight discount.
The firm is currently trading at P/E GAAP FWD ratio of 30.35 and a P/CF TTM ratio of 23.49. Their FWD EV/EBITDA of 24.13 is not excessive in my opinion, nor is their EV/Sales FWD of 8.44. While these figures are generally above the sector median, I believe given ASML’s strong growth expectations and margin improvements, these figures are not at all excessive and thus do not indicate an overvaluation.
Seeking Alpha | ASML | Summary
From an absolute perspective, ASML shares are trading lower than their almost $900 peak in late 2021 but still relatively high, especially given their 5Y average. Over the YTD, ASML has seen a strong 13% rally driven by positive market sentiment and their strong Q4 results.
On a YoY basis, ASML has left engaged investors with essentially dead-money returns yielding just 3.56%.
By accomplishing a simple financial valuation based on the calculation below and using the estimated 2023EPS of $20.84 a realistic r value of 0.15 (15%) and the current Moody’s Seasoned AAA Corporate Bond Yield, we can derive a base-case IV for ASML of $767.
The Value Corner
When using this reasonably realistic CAGR value for r, ASML appears to be undervalued by a substantial 19%. Even when using an incredibly conservative CAGR value of 0.12 (12%), shares are valued at around the $650 mark, still representing a 5% undervaluation.
Therefore, I believe ASML as a company is currently sitting somewhere between fairly valued and modestly undervalued. If the firm is able to harness the expected growth in demand for EUV lithography systems, I fully believe this base-case figure could be achieved.
In the short term (3-10 months) it is difficult to say exactly what the stock will do. Much depends on the prevailing macroeconomic conditions and the ability of global economies to skirt a recession in 2023.
Given that most fundamental market metrics are forecasting a recession, the potential for reducing capital expenditure from chip fabricators due to decreased end-user demand in consumer discretionary products could potentially harm ASML profits.
In the long term (2-4 years) I expect their position as the leader in lithography equipment manufacturing to become even stronger. Their unique and differentiated selection of lithography systems provides substantial economic moat which should help guarantee future growth and profitability.
I believe current share prices are not quite in value or deep-value territory yet, as the base-case 19% undervaluation does not leave much in terms of a margin of safety.
However, given the high-quality business model at ASML and domineering market position, I believe this 19% margin may provide value-oriented investors with just enough breathing space to hypothesize building a position in the firm.
Risks Facing ASML
ASML faces a relatively substantial risk from the highly specialized nature of their products along with their reliance on EUV sales in particular. Given the huge investments the company has made into the technology, ASML has become reliant on widespread EUV adoption to drive future profits and shareholder returns.
While this adoption seems to be taking place right now and growing at an almost exponential rate, it is difficult to forecast definitely.
While there seem to be no current real competitors for EUV lithography, this could of course change. The emergence of a new manufacturing technology could leave EUV lithography being osculate or uncompetitive.
I must note that this scenario seems incredibly unlikely to me. Nonetheless, it is important to consider and highlight the huge importance for ASML to continue their R&D drive to ensure their technologies cannot easily be superseded.
ASML is also exposed to the threat of unstable revenue streams arising from the cyclical nature of the industry. As mentioned earlier, any decrease in consumer discretionary spending (which is often the case in recessionary periods) on high-tech products which utilize microchips could lead to an overall drop in orders and thus revenue for ASML.
While their current order book places the company in a strong position to deal with any short-term headwinds, a longer-term slow-burn recession could tangibly harm ASML’s profitability.
From an ESG perspective, ASML does not face any particular risks. While their technology is quite energy intensive, it is ultimately up to the operators of the equipment to decide what form of power these ASML machines are provided with.
Summary
ASML has had a strong last couple of years which has transformed the profitability of the organization. The increasing rates of adoption of chips requiring EUV technologies for their manufacturing has accelerated the process while strong end-user demand has further spurred lithography machine demand.
A strong and robust product portfolio has allowed the company to become involved in the manufacturing of a huge variety of semiconductor types which increases the firm’s moatiness significantly. Valuable IP and intangible assets further differentiate the company from their competitors and increase the likely-hood of ASML remaining at the forefront of the industry.
While 2023 looks a little more uncertain from a macroeconomic perspective, ASML’s robust set of revenue streams and solid order book should help solidify returns in the short-term, even if a recession were to occur in 2023.
Given the current small undervaluation present in the firm, and their high-quality business model, I believe building a position from a value-perspective may just about be possible.
Therefore, I rate ASML stock a Buy. Strong Buy will be warranted if shares were to drop closer to the $560 mark so that a 30% margin of safety could be achieved.
For further details see:
ASML Holding: Solid Fundamentals And Future Profitability