2023-07-19 09:36:03 ET
Summary
- ASML Holding N.V. reported strong Q2 results, beating previous guidance and expectations, with a 27% YoY growth rate and revenue of €6.9 billion.
- ASML continues to see resilient demand for its products, especially in DUV, which was able to offset some weakness in EUV demand. The order intake came in better than anticipated.
- The company continues to expand its margins, driving stellar EPS growth. Combined with solid shareholder returns, investors have little to complain about.
- Despite export restrictions to China set to impact ASML's DUV business from September, the company's long-term financial targets and growth outlook remain intact. The impact should be minor.
- ASML's stock remains expensive, but its valuation is justified given its strong market position and impressive growth outlook.
Investment thesis
I maintain my Buy rating on ASML Holding N.V. ( ASML ) and update my revenue and EPS estimates following the company's Q2 2023 results , which beat its previous guidance and that of Wall Street analysts. Despite facing its fair share of headwinds, ASML continues to show operational excellence and remarkable resiliency. Despite a 21% increase in share price over the last three months, I believe ASML shares still offer decent upside.
As my investment thesis remains unchanged, this is what I wrote three months ago:
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.
The latest Q2 results show that the company can still deliver stellar financial results despite tough macroeconomic headwinds and decreasing demand from its largest customers. Despite this, the company still reported impressive top- and bottom-line growth, as strength in DUV (deep ultraviolet) managed to offset weakness in EUV (extreme ultraviolet) sales. Moreover, new Chinese export restrictions are not expected to meaningfully impact FY23 results or the company’s long-term outlook, removing a significant risk. Meanwhile, management sees multiple megatrends that solidify its long-term potential.
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’s Q2 results did not disappoint
Earlier today, July 19, ASML reported its Q2 results . The company was once again able to beat its own estimates and those of Wall Street analysts as demand for its products remains relatively resilient. ASML reported revenue of €6.9 billion, which fell within the guided range of €6.5 billion to €7 billion but beat the analyst expectations of €6.74 billion. This represents an impressive YoY growth rate of 27%.
107 new systems shipped during the quarter, up 29% YoY and far above expectations. This was primarily driven by exceptional demand for DUV machines, for which ASML continues to see more demand than what it can produce. The demand environment for DUV machines is exceptionally strong, according to ASML, and will see much faster growth this year than previously expected.
Meanwhile, EUV sales were somewhat disappointing. According to CEO Peter Wennink, this is largely driven by a lack of skills to get fabs ready worldwide. Practically, he is saying that the likes of Intel ( INTC ), Samsung Electronics ( SSNLF ), and Taiwan Semiconductor Manufacturing Company Limited ( TSM , "TSMC") are having trouble getting fabs operational, which causes these companies to postpone their ASML equipment deliveries, which we are currently seeing reflected in EUV sales. These are lower as fabs are not ready for the machines.
Therefore, it is important to note that this is not a demand or operational issue, but ASML simply has to postpone the revenue realization due to a shift in demand timing. Crucially, ASML is only able to recognize revenue once the machine is delivered to the customer.
Back to DUV, demand from China for these machines was particularly strong. Chinese customers are having a lot of fabs ready, but it has a shortage of machines, which is driving this growth in demand for DUV. This resulted in China’s contribution to net sales growing to 24%, from just 8% in Q1. Meanwhile, sales derived from Taiwan saw the largest sequential decrease, from 49% of sales in Q1 to just 34% in the latest quarter. Though, these statistics highly vary every quarter.
ASML Q2 revenue by region (ASML)
This, then, brings us to the issue of Chinese export restrictions. ASML is currently still allowed to ship DUV machines to China as opposed to the ban on EUV equipment. Yet, this will change from September onwards as the Dutch and Japanese governments have come out with new export restrictions impacting the DUV business. The result is that ASML will no longer be allowed to ship so-called "advanced DUV emersion systems," impacting a number of ASML machines (not all DUV machines are affected by these new restrictions)
So far, this was as anticipated by ASML and will most likely slightly impact ASML’s revenue generation from China from the second half of the year. Still, the impact is expected to be so minor that it will not have a meaningful impact on the company’s FY23 results and long-term financial targets as this revenue gap is quickly filled with demand from other regions. The one uncertainty remaining here is the ruling by the U.S. government, which could come out with additional measures, further impacting ASML, but this remains speculative today.
Overall, the impact of Chinese export restrictions are expected to remain minimal. ASML has not been focusing on China for many years as its most advanced and expensive products were already under export control. Moreover, ASML has plenty of growth potential remaining outside of China, so I don’t view this as crucial to the investment thesis. Investors should definitely not make this larger than it really is.
Moving to the bottom line, the margin development for ASML also remains impressive. The gross margin expanded further in Q2 to 51.3%, up from 50.6% in Q1 and 49% one year ago. This was primarily due to higher system sales than anticipated. The gross margin improvement also resulted in a higher net income margin of 27.5%, boosting EPS to €3.54, up 39% YoY.
ASML did see its cash and cash equivalents fall sequentially to €6.3 billion, down from €6.7 billion in Q1 as the company keeps heavily investing in the business and production capacity. This is still up from €4.4 billion one year ago, though. The company's overall financial health is sublime and allows it to keep investing in growth while rewarding shareholders through dividends and share buybacks.
ASML's historical capital return (ASML)
ASML reports an improved order intake and resilient backlog
Most crucial to assessing the growth potential of ASML and the demand for its products are order intake and backlog. The order intake in Q2 was much stronger than anticipated and accelerated for the first time in a while. In previous quarters we have seen the order intake from ASML fall back as even the likes of TSMC, Intel, and Samsung are cautious with their capex spending. Yet, this quarter, the order intake accelerated to €4.5 billion, up from €3.8 billion in Q1. Important to note here is that this strong increase in new orders was driven by DUV equipment, which was able to offset the ongoing “weakness” in EUV orders as this came in flat sequentially at €1.6 billion. As a result of this strong order intake, the backlog still stood at €38 billion, down from €39 billion in Q1. This shows that despite sales and machine shipments growing by close to 30%, ASML continues to have a very strong backlog, which functions as a buffer when demand weakens.
Furthermore, I expect this weakness in EUV to be only temporary as semiconductor manufacturers are careful with their spending and already have a load of orders outstanding. The semiconductor recovery is taking a little longer than previously anticipated and the shape of the recovery remains to be seen, which is why ASML customers are holding back orders. This is what CEO Peter Wennink said on the Q2 earnings call about this impact:
On the end markets we see some first reports coming in that some end markets seem to be bottoming out. Which is good. But it means that our customers are still dealing with relatively high inventories. High levels and how do you deal with that? Basically by reducing the wafer output. And wafer output means that of course the utilization of our tools is also less.
In my recent TSMC article , I discussed that the company is expecting a gradual recovery from Q3 onwards and this should speed up in FY24 as demand for semiconductors, especially in Western countries, remains high. This is why TSMC remains committed to its Capex plans and international capacity expansion, which should, in time, drive more orders for ASML’s EUV machines as a crucial component in the fabs. Considering this, orders will most likely remain relatively flat in Q3 and accelerate further in Q4 as semiconductor production picks up further.
In the long run, the high demand for semiconductors and rapid industry growth, especially with the boost in production in the U.S. and Europe, should drive continued demand for these EUV machines as these are the only ones capable of producing the smallest nodes available today. As a result, the global EUV market is expected to grow at a CAGR of 21.5% through 2029, which includes further developments and new versions. With ASML holding a monopoly here, investors have nothing to worry about as the current slowdown in EUV orders is only temporary. Luckily, ASML is able to compensate for this weakness in demand for EUV with high demand for DUV equipment, which ASML has trouble keeping up with in terms of production.
Outlook & ASML stock valuation
Following the solid operational and demand developments in Q2, management guides for a very similar Q3 with net sales between €6.5 billion and €7.0 billion and a gross margin of around 50%. This reflects a challenging macro environment and pushed forward demand for EUV in particular.
For FY23, the company has upgraded the outlook as it now expects net sales to grow by closer to 30%, from a previous expectation of around 25%. The upgraded revenue outlook is partly driven by the development in “fast shipments,” which allows the company to recognize more revenue in FY23. For EUV alone, an additional €700 million will be recognized this year. Previously, ASML expected to push €3 billion in revenue to FY24 due to longer waiting times, yet this has now been reduced to €2.3 billion due to these fast shipments.
Furthermore, following the better-than-expected demand environment for DUV systems, ASML now expects to ship many more systems this year which should result in the DUV business growing 50% this year, compared to a previous expectation of 30%.
Meanwhile, the pushed-forward demand for EUV as a result of fab readiness results in a decreased expected growth rate for this segment. Management now expects 25% growth in EUV, compared to a previous expectation of 40%. As explained earlier, this is outside of the control of ASML and is simply the impact of demand timing.
The long-term expectations remain intact, according to CEO Peter Wennink. Going by this commentary, we could even see this being upgraded over the next couple of quarters as several megatrends are proving to be greater than anticipated:
Beyond 2024, it’s really the solid believe we have in the megatrends that are not going to go away. You can even argue that some of these megatrends, when you think about AI, are even more important than we thought, let’s say at the end of last year. But it’s not only AI, it’s also the energy transition, it’s the electrification of mobility, it’s industrial Internet Of Things. It’s everything that’s driven by sensors and actuators.
ASML remains perfectly positioned within the semiconductor supply chain to benefit from the growth in semiconductor demand as a result of the megatrends listed above. This will drive exceptional long-term growth, making it crucial for investors to look through the short-term cycles and to focus on the long-term boosters.
ASML long term outlook (ASML)
Following this guidance from management, the solid Q2 results, and promising business developments while also taking into account the near-term headwinds, I now project the following results through FY26.
(I expect ASML to report Q3 revenue of €6.81 billion and EPS of €4.65. I predict order intake to be between €4 billion and € 5 billion.)
Shortly explaining these estimates, I chose to remain somewhat conservative and now expect ASML to report revenue of €27.37 billion in FY23, representing growth of 29.3%, up from a previous estimate of 26%. This is driven by management’s expectation for growth of closer to 30% as it expects to ship meaningfully more DUV machines. This higher revenue will also boost EPS as I expect ASML to report a net income margin of around 28% for the full year, driving EPS up 37.4% to €19.43. These estimates include my expectation of a gradual improvement in demand towards the end of FY23, specifically for EUV, and the impact of new Chinese export restrictions to be minor. Furthermore, ASML should be able to leverage its massive backlog to offset any demand weakness over the next several quarters.
I have also increased my revenue estimates for the period FY23 – FY26 in response to management’s improved confidence in its long-term financial targets and the continued positive development of the underlying industries. While demand might be somewhat weaker today, the long-term outlook for advanced semiconductors remains incredible and ASML is perfectly positioned to benefit from this growth and the push for new fabs on the US and European continent. This solidifies my long-term expectations, resulting in higher revenue. Meanwhile, I have lowered my EPS estimates for FY25 and FY26 as I believe these were slightly too optimistic despite a higher revenue base.
Moving to the valuation, we can see that shares remain expensive despite an upgraded outlook, thanks to the 21% share price increase since its last earnings report. At a current share price of €667, shares are valued at a forward P/E of 34x, which is below its 5-year average of 37.5x. Obviously, a monopoly position in one of the most crucial industries for future economic growth does not come at a discount. And while the macroeconomic environment is very challenging today, resulting in decreased demand, the company continues to report very impressive growth rates, sees demand outpacing production capacity, and has a massive backlog to protect it against any downturns.
In short, this company rightfully trades at a significant premium to any of its “peers” (as far as there are any). Previously, I claimed a 32x P/E would be fair for this high-quality compounder, but with an improved outlook, the company showing it can perform under any circumstances, more clarity on the Chinese export restrictions, and megatrends like AI booming, I am perfectly comfortable increasing this fair value P/E estimate to 34x when also considering the impressive growth outlook.
Based on this forward P/E and my FY24 EPS estimate, I calculate a target price of €812 ($910), up from a previous €758, leaving an upside of 22%. (Please note, this target price is solely based on its forward P/E and is only for indicative purposes.)
Conclusion/Summary
ASML's Q2 results showcased its ability to outperform expectations and adapt to market dynamics. Despite temporary challenges, the company's strong backlog, resilient demand, and favorable long-term outlook position it well for continued growth
While demand for DUV machines remained robust, sales of EUV machines were affected by delays in fabs' readiness. However, this issue is expected to be temporary, and ASML only needs to postpone revenue recognition due to a shift in demand timing. Meanwhile, order intake exceeded expectations. The backlog remains strong at €38 billion, providing a buffer during periods of weakened demand.
Chinese demand for DUV machines was particularly strong. However, export restrictions are set to impact ASML's DUV business in China starting from September. The impact of these restrictions is expected to be minimal, and ASML's long-term financial targets and overall growth outlook remain intact.
ASML's guidance for Q3 reflects a challenging macro environment and the accelerated demand for DUV machines. The company expects net sales growth of close to 30% for FY23, driven by increased shipments of DUV machines. Despite near-term headwinds, the long-term growth prospects for ASML are favorable, as the company is well-positioned to benefit from the megatrends driving semiconductor demand.
Considering these factors, ASML's stock remains expensive but justified given its strong market position and impressive growth rates. With a forward P/E of 34x, ASML is trading at a premium compared to its peers, and rightfully so. Under challenging circumstances, the company's upgraded outlook and performance support a higher fair value estimate. Based on this, I upgraded my price target to €812 ($910), indicating a potential upside of 22%. Considering this, I believe ASML shares are a buy at a share price below €691.
Therefore, I rate ASML shares a buy following the Q2 results and upgraded FY23 outlook.
For further details see:
ASML Q2 Earnings: Several Interesting Developments, Still A Wonderful Company