2023-06-25 10:00:00 ET
Summary
- ASML Holding has experienced a 50% increase in share price since October, but there are concerns about declining new orders for its EUV Systems.
- Despite these concerns, ASML's backlog sits at 39 billion Euros, and the company expects revenue growth of 25% in FY 23.
- An inverse DCF model suggests that ASML can remain an attractive long-term investment, with potential for further growth in owner earnings and revenue.
ASML Holding ( ASML ) has seen a strong rebound in its share price over the last months. It is up 50% since I rated it a strong buy amidst the semi slump last October, representing 5% of my portfolio. Despite the great recent performance, also in the wake of the current hype around Artificial intelligence, there has been some worry from investors about a decline in new orders coming in, potentially showing weakness in the demand for ASML's products.
Declining EUV Orders
A lot of the investment case for ASML lies upon their EUV Systems (Extreme Ultraviolet Lithography). EUV orders disappointed in Q1, potentially the reason the stock initially sold off around 4% despite beating estimates, declining slightly quarter-on-quarter. This shouldn't have come as a surprise to investors. ASML indicated potentially weakening bookings coming into the new year. We can't forget that ASML had around nine quarters of strong net bookings growth, ranging between 3.7 billion and 8.9 billion Euros a quarter. The backlog currently sits at 39 billion Euros, almost twice ASML's annual revenue (21 billion Euros FY 22) and well over twice annual system sales (15 billion Euros FY 22).
Furthermore, we have to expect orders to be lumpy. ASML sells extremely high ASP machines. High-NA EUV tools represent a part of these orders and won't be shipped until 2025 and beyond, costing 350 million Euros each. Low-end EUV also costs, on average, 170 million Euro per machine, so, understandably, orders can be lumpy. So far, customers generally are asking for faster shipments; despite the slowdown in memory, logic is going strong. Nvidia's ( NVDA ) commentary on its last earnings clearly indicates this.
Recession fears
ASML expects FY 23 to see revenue grow by 25%:
- EUV with 40% growth
- non-EUV with 30% growth
- Installed Base Management with 5% growth
We can see that Installed Base Management, ASML's services and upgrade business, lags at just 5% expected growth. This segment represented around 27% of sales in FY 22. Generally, it grows with the installed base, but customers are more selective in getting these upgrades due to recession and cycle fears. While machine shipments have long lead times, upgrades can be done much faster. Due to long-term planning, customers can not just give up their place in the shipment queue but can postpone upgrades. This current headwind should subside as the cycle turns further and customers need to increase output—nothing to be worried about.
If we would fall into a deep recession, there could be a risk of orders getting canceled, but due to the amount of backlog and strategic importance of these machines, I see a low probability of any real risk here.
Bottlenecks and used tools
To build these incredibly complex machines, ASML has a network of hundreds of suppliers of unique parts. The largest bottleneck is German ZEISS, responsible for the light source used in EUV machines. The company expects the supply chain to return to normal sometime this summer. Coming out of 2021, CEO Peter Wennink stated that DUV was undersupplied by 40-50% on a unit basis. ASML has since taken steps and significantly increased its capacity planning for these "older" machines, which have more demand than anticipated. The situation corrected a bit, but ASML is still undersupplying by around 20%. Even as memory players pushed out DUV demand, other players, like Chinese companies, are ready to take these machines.
Another tailwind is that mature nodes operated a lot on used equipment. An example is Texas Instruments ( TXN ), which used to build fabs with used equipment. With its aggressive plan to build out the next decade of capacity ( you can read more about it in my article ), the company is switching from 200-millimeter wafers to 300-millimeter wafers. This range has much less used equipment, a tailwind for ASML's DUV business.
ASML is still attractive
To value ASML, I am using an inverse DCF model. I use a 10% discount and 3% perpetual growth rates. I use both traditional Free Cash Flow and Owner Earnings (Free Cash Flow + Growth CapEx - Stock based compensation +/- Net Working Capital Changes)to smooth out possible distortions in cash flows. To estimate the growth CapEx, I usually subtract Depreciation and Amortization from Capital Expenditures (1.57 billion Euros - 536 million Euros) to arrive at around 1 billion Euros. Stock-based compensation is not a huge issue; ASML is just diluting shareholders by 75 million, basically nothing compared to its Free Cash Flows of 8.2 billion. NWC Changes roughly even out, but we can see a lot of distortion from Accounts receivable, Inventories and Changes in NWC.
Overall we arrive at 12% required growth in owner earnings for the next five years, followed by 9% growth for five years. On its last investor day, ASML gave long-term guidance until 2030, indicating revenue growth between 10-14%. Additionally, gross profit margins should expand a few hundred basis points due to scale economics and efficiencies. This leaves me quite optimistic that ASML can remain an attractive long-term investment. I hold a 5% position in ASML and wouldn't be opposed to adding to it if an opportunity presents itself.
For further details see:
Should We Worry About ASML's Falling Orders?