2023-05-16 14:14:05 ET
Summary
- The Trade Ban might negatively impact ASML's business.
- Subsidizing from Europe and the US might offset these factors.
- While ASML expects a market annual growth rate of 9% till 2030, the stock seems to be slightly overvalued.
- Considering the macroeconomic developments and the market position, an investment could still make sense right now.
My current position in ASML Holding N.V. ( ASML ; ASMLF ) - making up around 8% of my stock portfolio - is up ~25% and I will now be going into detail as to what I plan to do with this position.
Business
The Dutch company ASML creates cutting-edge technology systems, particularly in the area of lithography, for the semiconductor industry. A pattern is transferred onto a silicon wafer during the lithography process, which is used to make microchips, which are utilized to build the circuits for electronic devices.
When a silicon wafer is covered with a photo-resist material and exposed to patterned light, the material undergoes a photo-chemical process known as lithography . Depending on the particular type of resist utilized, the portions exposed to the light either become more or less soluble. The exposed or unexposed sections of the resist are then removed from the wafer, leaving a patterned surface. The subsequent etching and depositing procedures that produce the actual circuitry use this pattern as a template.
In order to attain ever-smaller feature sizes, ASML creates lithography systems that employ a variety of light sources, including ultraviolet and extreme ultraviolet (EUV) light. These devices enable the development of increasingly sophisticated and accurate microchips by accurately controlling the light and pattern transfer process through the use of sophisticated optics and algorithms. ASML has solidified its position as the go-to supplier for advanced lithography systems with a commanding revenue market share of over 90% in the overall lithography equipment industry and a 100% market share in the most cutting-edge technology, Extreme Ultraviolet (EUV) - used for producing the most advanced microchips with 7nm, 5nm, or 3nm nodes. The following categories can be used to divide their general business:
Geographically, ASML's business breaks down as follows:
Fundamentals And Outlook
Despite a slowdown in the semiconductor business in the second half of 2022, ASML had an extraordinary Q1 2023 with a spectacular quarterly revenue rise of 91% up from €3.5 billion to €6.7 billion compared to the same period last year. In the first quarter of 2023, the company's gross margin was 50.7%. Although there has been a minor dip, the general improvement since 2019 when it was over 45% is still visible.
The operating margin for Q1 2023 of 32.5% paints a similar picture and remains in line with the general margin expansion of the company.
Outlook
The company's management has expressed optimism about the following months' financial performance. For the second quarter of 2023, they project net sales of between €6.5 billion and €7 billion, with a healthy gross margin of between 50% and 51%.
The management of ASML anticipates net sales growth of over 25% for the entire 2023 fiscal year, translating to revenue of over €26 billion and a little increase in gross margin.
ASML Investor Presentation Q1 2023
The corporation presented their newest financial forecast for the coming years at their investor day in 2022. The management forecasts that revenues will be between €30 and €40 billion in 2025 and between €44 and €60 billion in 2030.
A number of important factors, including the anticipated expansion in semiconductor end areas including automotive, data centers, industrial, and consumer electronics, are what are driving the optimistic forecast. Through 2030, the semiconductor market is expected to increase by around 9% annually, which should lay a solid foundation for ASML's future prosperity.
Their expected top and bottom line is visualized here:
ASML's expected top and bottom line ((data: marketscreener.com) )
ASML is also increasingly expanding its services business, which is already generating 27% of the revenue - as can be seen above. Because what is better than capitalizing from a growing market once? Exactly, doing it twice! Through long lasting service agreements when buying equipment from ASML, it locks in customers over several years and is thereby diversifying their business and making it more resilient in an potential economic downturn. This in turn provides stability and security for both the company and its customers.
ASML Investor Presentation 2021
Macroeconomics
The current macroeconomic situation for ASML presents a "double-edged sword":
One the one hand, there is somewhat of a "Cold War" in technology, particularly between China and the United States. Given that ASML has sold more than €8 billion ($8.8 billion) in chip lithography equipment in China over the past ten years and still has active maintenance contracts for the machinery there, this could have a detrimental effect on its business. However, the Dutch government has yet to clarify several parts of the new limitations on the sale of chip technology to China, including whether ASML is able to support chip-printing machines that have already been sold in the nation.
On the other hand, there are growing efforts to become increasingly independent from China in terms of semiconductor production, especially due to the increasing tensions between the US and China.
The US's percentage of the world's semiconductor production has decreased, from 37% in 1990 to just 12% presently. This change is the result of the concentration of 75% of the world's chip manufacture in East Asia, which was principally fueled by significant government subsidies. The main client of ASML, Taiwan Semiconductor ( TSM ), has benefited most from this assistance.
The semiconductor industry has received roughly €43 billion in subsidies from Europe and $52 billion from the US in response. These investments emphasize the strategic significance of the industry and the need to strengthen local production capacities by assisting businesses with the acquisition of new manufacturing equipment or the expansion of current capacity.
Companies like Intel ( INTC ) will need more sophisticated machinery as they move toward a business model that is increasingly centered on manufacturing, similar to TSMC. As a result, firms like ASML, who provide essential manufacturing tools and technology, will probably experience increasing demand as a result of increased legislative support for and funding for the semiconductor industry. Political leaders' increasing support and recognition of the industry may create growth prospects, spurring financial investment and technological advancement.
Ultimately one thing is certain:
Regardless where the chips are ultimately produced, ASML, the market leader in this industry, is likely to provide the equipment needed to produce them. Since the semiconductor sector and its expansion are intricately linked, ASML's position in this ecosystem is crucial.
Interesting enough, ASML might even stand to gain from the technological "race" between China and the United States and its allies in the west. Both sides of this struggle for technological dominance are largely reliant on the machinery provided by ASML. These significant players in the tech industry will continue to depend on ASML's cutting-edge equipment to expand the limits of what is achievable in the semiconductor industry, regardless of geopolitical dynamics. ASML could therefore establish itself as the shovel seller of the 21st century gold rush between China and the West.
Recession As A Major Risk
According to experts' average forecast there is a 64% chance of a recession by the end of 2023. ASML might face negative short term impacts, particularly given the recent reduction in TSMC's order for extreme ultraviolet (EUV) equipment. While the semiconductor market in general is highly cyclical, I believe that the overall growth of this market will continue steadily even amidst some minor hiccups on the way due to the aforementioned reliance of the global economy on the semiconductor technology.
Valuation
I think we can all agree that ASML is a top-tier company, known for its exceptional quality and performance. However, it's worth noting that companies of this caliber rarely trade at fair or even low valuations.
Given this context, it's important to take a closer look at ASML's current valuation to gain a better understanding of the price offered for this valuable lithography gem by Wall Street. Therefore, I created a Discounted Cash Flow Analysis for two different scenarios: Bear- and Bull-Case. The blue cells in the analysis represent the assumptions made to evaluate ASML.
Bear-Case
- Revenue and Gross Margin: The revenue and gross margin prediction for 2025 and 2030 comes right from the low end of management's guidance. As they stated that they expect approximately €30 billion and 54% in 2025 and €44 billion and 56% in 2030.
- EBIT Margin: For 2023 to 2030 I assumed an EBIT Margin of 32%, right in line with the average of the last 3 years.
- Financial Result And Taxes: I averaged the values of the last three years and therefore used 12% to calculate the Net Profit for the years 2023 to 2030.
- Tax Rate: Here I used 16.5%, which is also stated by the management's target rate for 2025 and 2030.
- Free Cash Flow: Using the Tax Rate above, I calculated the EBIAT and afterwards tried to determine a suitable EBIAT to FCF ratio. In that case I think 37% seems reasonable, compared to 74% in 2021 and 31% in 2022.
- WACC: I assumed a, in my opinion conservative, WACC of 12.25% .
- Perpetuity Growth Rate: The perpetuity growth rate assumed for the analysis is 3.5%.
Bear Case DCF ASML (Data: seekingalpha.com; ASML.com)
This analysis gives us a target share price of €418.05 ($458.55). With considering this and assuming ASML will grow this conservatively, the company seems to be overvalued by around 35%.
Bull-Case
This time I used more optimistic assumptions, they are once again briefly summarized here:
- Revenue and Gross Margin: The revenue and gross margin prediction for 2025 and 2030 comes right again from management's guidance. But this time I used the high end of the guidance and therefore €40 billion and 56% in 2025 and €60 billion and 60% in 2030.
- EBIT Margin: For 2023 to 2030 I also assumed an EBIT Margin of 32%, right in line with the average of the last 3 years.
- Financial Result And Taxes: Here I also used the same value as in the Bear-Case: 12%
- Tax Rate: Here I also used 16.5%, which is also stated by the management's target rate for 2025 and 2030.
- Free Cash Flow: Using the Tax Rate above, I calculated the EBIAT and afterwards tried to determine a suitable EBIAT to FCF ratio. In that case I've chosen the same 37% as above.
- WACC: I assumed a WACC of 12.25%.
- Perpetuity Growth Rate: The perpetuity growth rate assumed for the analysis is 3.5%.
Bull Case For ASML (Data: seekingalpha.com; ASML.com)
Based on our analysis, we've arrived at a target share price of €557.62 ($611.66) for ASML. Given this target price and assuming the company will continue to grow at an optimistic rate, it appears that ASML is currently slightly overvalued.
Conclusion
Based on our Discounted Cash Flow analysis and taking into account the two distinct scenarios offered by ASML's management, we arrive at a price target for ASML shares of roughly $460 to $610 (or €420 to €560) till 2030.
I however think that the bear-case scenario for ASML seems very unlikely and the bull-case scenario appears to be pretty conservative. With that in mind and the fact that ASML is operating excellently in an unequaled market position, one might argue that paying a premium for ASML is more than justified.
Given these factors, I recommend ASML as a 'Buy'. However, from a personal investment perspective, I would wait for the share price to reach around the $600 mark before further expanding my already significant position in the company.
For further details see:
ASML: How Macroeconomic Tensions Might Actually Benefit The Company