2024-01-16 00:29:22 ET
Summary
- ASML has a competitive advantage and strong growth prospects in the semiconductor industry.
- The company has a high return on invested capital and a shareholder-friendly approach to capital allocation.
- And the next market cycle is likely to bring rapidly increasing revenues, and ASML is already positioning itself to take advantage of this.
The ASML Investment Thesis
I wrote an article a few days ago where I said that TSMC ( TSM ) is probably the most important company in the world right now and of course that was a provocative statement where I expected people to either agree with me or say that ASML Holding N.V. ( ASML ) is the most important company in the world right now. And both companies have arguments in their favor, but at the end of the day, both companies are very important to our economy, and that is really the key factor.
ASML has built up a huge competitive advantage over the past decades by thinking ahead and allocating capital efficiently. And such a large lead over the competition is one of the greatest margins of safety. If you just know that your company is miles ahead in an industry that is going to grow tremendously over the next few years, the profits are very likely to follow.
And in my opinion, ASML did a fabulous job in 2017 when they bought a 24.9% stake in Carl Zeiss SMT GmbH for €1 billion. ASML has identified the company that is the most important element in the supply chain of their market and has secured their services. Lithography Optics are the most complex and costly part, and Zeiss has been ASML's supplier and expert in this market since 1983. Without Zeiss Semiconductor Manufacturing Technology, ASML would not have the competitive edge it has today.
And Zeiss SMT will be equally important for the next generation of EUV. Zeiss, TRUMPF with its Laser Amplifier , the Fraunhofer Institute and many others have played a major role in the development of EUV technology. In this way, one could say that the success of ASML is also a joint venture between German and Dutch companies as Zeiss and TRUMPF are both from Germany.
And in 2020, ASML bought another German company, Berlin Glas Group, which makes ceramic and optical modules, so its M&A activities are all focused on strengthening ASML's competitive position. ASML is really good at managing risk, and many people see ASML's exposure to Taiwan and China and are afraid to invest in this company, but ASML has a strong long-term approach and they are known for their excellent risk management.
And unfortunately, a lot of people don't dig deeper when they see that a company is exposed to certain countries that they think are high risk, but they often don't see how many of their companies that they have in their portfolio are actually exposed to the same threat.
ASML's Metrics and Balance Sheet
The conservative, long-term approach is also reflected in ASML's balance sheet . The company is not over-leveraged and its liquidity is strong. They have only $5.28 billion in long-term debt and their current cash + equivalents position is $5.26 billion, so if they wanted to, they could pay off almost all of their LT debt with cash. That really speaks to the strength of the balance sheet.
And if we exclude the cash and just look at the net income / LT debt ratio, we see that the TTM net income of about $8 billion is 1.5 times the debt. Another strong indicator, as many investors consider a balance sheet safe when debt is less than 4 times net income. But the hard times are when it counts, and therefore it is better to compare with a worse year, and even there ASML's balance sheet is well equipped. December 2020 net income of $4.34 billion is still well below the threshold for net income to be less than four times debt.
And it is always good when the interests of shareholders and management are aligned, so a look at the proxy statement is an informative read. In this case, return on average invested capital ("ROAIC") is one of the performance targets, which I very much welcome as it is also very beneficial to shareholders in the long run. The targets are also nice with a 30%+ target and therefore achieving this target should lead to the creation of value for shareholders.
Technology leadership is also very important for a company like ASML, which is highly dependent on its knowledge and superior technology. But I am not a fan of the total shareholder return targets because the normal target is zero percent. A different target might have been better here.
ROIC And Capital Allocation
ASML's ROIC chart looks like you want it to look for a company you own. A rapid increase over the last 5 years with a relatively low cost of capital. With a WACC of about 10%, the ROIC-WACC spread stands at a whopping 45%. Both figures and especially the high ROIC underline the competitive advantage that ASML has. Normally a 20% ROIC is quite impressive, but ASML beats that even more. ASML's efficient use of capital while still having such great growth opportunities is a wonderful prospect for shareholders.
Additionally, ASML is one of the best dividend growth companies in the world with a 10-year CAGR of 25.05% . The dividend yield is currently low at 0.9% , but if it continues to grow at this rate, or even slightly less, it will provide a nice boost to total shareholder return.
And as if that were not enough, with ASML you do not have to worry about being diluted by too much SBC, as the share count has been steadily shrinking over the last 5 years. So the capital is really used efficiently by the management, as their actions show that they are very shareholder friendly.
And management has indicated that the top 3 priorities for capital allocation are:
- 1. Investing in the business
- 2. Grow the dividend
- 3. Buyback shares
But that because of the current environment, they are doing less buybacks and using the capital for other areas.
So we have a fast-growing dividend, high returns on capital, and a declining share count. The only thing missing is a low multiple that allows for multiple expansion. But you can't have it all.
A P/E multiple of 34x does not leave much room for multiple expansion, although it has been much higher in recent years. But the gains for shareholders are more likely to come from earnings growth and dividend growth. However, a multiple in the thirties seems fair to me for a company with such a strong competitive advantage.
ASML Investor Presentation
Until 2013, ASML returned €5 billion to shareholders, and now it is €30 billion, so they have returned €25 billion to shareholders in the last 10 years, with the dividend portion becoming more and more significant due to the great growth rate.
ASML's Reverse DCF
Currently, the stock is pricing in an EPS CAGR of 14% over the next 10 years. However, since 2018, the EPS CAGR has been 28% , which is well above the implied 14%. Therefore, the stock looks undervalued if ASML can maintain its historical CAGR. And the potentially better margins of the 3800 plus all the growth opportunities should give ASML enough opportunity to continue to achieve its historical CAGR.
What could EPS look like in 5 years?
Seeking Alpha Earnings Estimates
The guidance for 2024 is flat, as we are in the part of the cycle where customers are delaying purchases and Chinese companies were buying before the sanctions kicked in. But that is the cycle of this industry , where there is an overbuild and then companies work through their inventory before the next wave of big investments comes. And usually the best time to invest is when revenues are flat, so investors can take advantage of the next part of the cycle.
And because of the market cycle, the multiple now looks higher than it really is. So the forward P/E for 2025+ is more the right thing to look at. It will be the future earnings that will determine where the share price will be, not the previous year's earnings.
And ASML has a lot of momentum for the future. All subsidy programs for the semiconductor industry will benefit ASML. The fabs that are being constructed need ASML tools. And through the US Chips Act, EU Chips Act, Integrated Circuit Industry Investment Fund China, Invest Taiwan Initiative, K-Semiconductor Belt South Korea and the Specified ICT Utilization from Japan, there is more than enough money.
And many different types of nodes are needed for the trend industries of the future, such as AI, hyperconnectivity, edge computing, energy transition, healthcare, automotive, and many more. And because EUV technology is truly superior to DUV in that it is smaller, faster, more powerful, and has a better cost profile, many customers will adopt it. Fewer process steps reduce production cycle time, which in turn reduces energy and water consumption.
Risks
I think the weight that many put on the China risk for ASML is exaggerated. Historically, only 15% of revenue comes from China, and the ban initially only applied to advanced manufacturers, so ASML estimated in its last earnings call that the impact would be only 10% to 15% lower revenue from China. But in a turn of events, ASML had to cancel some shipments of mid-tier DUV machines , which will likely increase the loss. So now with the NXT 2500i and NXT 2100i the ban has been increased, but ASML says this only affects a small number of customers . And the impact on revenue will be minimal.
But the loss of revenue will be more than offset by the investments Intel and Samsung will make over the next few years. Especially the US is likely to be a top 3 or maybe even top 2 customer of ASML in the future, driven by all the subsidies. And if they have their way, Intel will eventually replace TSMC as the top customer, but I think that is unrealistic.
And ASML somehow suffers from its own success, as its machines are so reliable that 95% of the systems sold in the last 30 years are still in use . It is great for the customer to get such a high quality and incredibly robust machine, but of course it would be better for ASML if the customer had to buy a new machine every few years. They try to achieve this with new, groundbreaking technology, but for some customers the mid- or low-end machines are enough and they do not need the most advanced.
But one risk that is often not talked about is that quantum computing could change the landscape. ASML is also active in this field , but who will be the best companies in this field cannot be predicted yet, and the competition is intense with Google (GOOGL), Amazon (AMZN), IBM ( IBM ) and many other well-funded companies with large R&D budgets and the best experts in the field.
Conclusion
Even if revenue from China and Taiwan were to disappear completely, ASML would still be producing probably the most in-demand equipment today. Revenues would drop very sharply at first, but other companies would immediately try to fill the gap because the demand is just that big. ASML will always find companies that want to buy its machines because they recognize the huge TAM and the growth opportunities that they can serve with the products they can build.
And as with its investment in Carl Zeiss SMT GmbH, ASML has a talent for identifying weaknesses and turning them into strengths. It is possible that the export bans have secured years of investments by European and American companies that exceed the revenues from China by a multiple.
For further details see:
ASML: How A Vulnerability Became A Competitive Advantage