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ASML Holding ($ASML) Deep Dive
"An enabler of global digital transformation."
This write up was done in collaboration with, 99.99% of the work/research was done by Damia Othman, I just put couple of final touches.
If you would like to learn more about Damia, you can check out her substack& her Twitter page.
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Disclaimer is at the end.
The semiconductor industry is expected to grow at a CAGR of +9% between 2020-2030E. I believe ASML is one of the potential beneficiaries of the growing semiconductor industry.
ASML 0.00%↑ share price has increased by 20% YTD due to 1) strong YTD earnings results performance, 2) increasing demands for semiconductor supplies, and 3) a rising trend for Artificial Intelligence (A.I.) related stocks.
ASML Holding N.V. (ASML) is involved in the development, production, marketing, sales, upgrading and servicing of advanced semiconductor equipment systems. This includes lithography, metrology and inspection systems.
The group was founded in April of 1984 and is headquartered in Veldhoven, the Netherlands. It operates through its subsidiaries in the Netherlands, the United States, Italy, France, Germany, the United Kingdom, Ireland, Belgium, South Korea, Taiwan, Singapore, China, Hong Kong, Japan, Malaysia and Israel.
Share price performance since inception
ASML shares are listed on the Euronext Amsterdam stock exchange and Nasdaq as New York Registry Shares. Since its inception, the stock has climbed over 3,000% in line with the increasing demand for global digital transformation since the 1980s.
The ownership of ASML is divided into 34.8%% of various institutional funds, 0.03% of individual insiders and 65.1% of the general public thus providing healthy liquidity to buy and sell the stock.
Note that the biggest shareholders belong to BlackRock Inc. holding at 5.9% followed by The Vanguard Group Inc. at 3.7%.
ASML ownership breakdown
A global holistic lithography provider
The group provides chipmakers with hardware, software and services to mass-produce patterns on silicon through lithography. ASML also provides control software solutions for its lithography process and continues to support its customers be it for services, technical support products and upgrades of equipment.
It has a global presence across Asia, North America as well as the Europe, Middle East and Africa (EMEA) markets.
Key products and services with a global presence
Lithography Manufacturing Process
According to ASML, lithography is a driving force in the creation of more powerful, faster and cheaper chips. The manufacturing of chips becomes increasingly complex as semiconductor feature sizes shrink. At the same time, it is important to mass produce at the right cost.
ASML lithography product portfolio contributes to optimizing production and enables affordable shrink by integrating lithography systems with computational modelling, as well as metrology and inspection solutions.
Semiconductor Manufacturing Process
Lithography in the supply chain
ASML customers consist of leading microchip manufacturers grouped as Memory and Logic chipmakers. The company design the machines based on the customer’s input and they work collaboratively to ensure the machines run smoothly on their fabs.
Memory chips can store a large amount of data in a very small area. They are used in an increasing variety of electronic products like servers, data centers, smartphones, high-performance computing, automotive or personal computers and other communication devices.
Whilst Logic chips, which process information in electronic devices, are produced by two groups of manufacturers. The first group, known as integrated device manufacturers (IDMs), designs and manufactures Logic chips. The second group comprises contract manufacturers known as foundries. Foundry manufacturers produce chips for ‘fabless’ companies that focus only on chip design and distribution but do not manufacture microchips themselves.
The manufacturing of chips becomes increasingly complex as semiconductor feature sizes shrink, but there’s always the need to mass produce at an acceptable cost. According to the company’s 2022 annual report, ASML’s holistic lithography product portfolio helps to optimize production and enable affordable shrink by integrating lithography systems with computational modelling, as well as metrology and inspection solutions that help their customers to improve their yield.
On the supply side, ASML has around 5,000 suppliers whereby 39% are from the Netherlands, 41% are from the EMEA (excluding the Netherlands), 13% are from North America and the last 7% are from Asia.
Geographic revenue breakdown
Over 95% of ASML revenue comes from the Asia region which includes; Japan, South Korea, Singapore, Taiwan, China and the rest of Asia. Other locations like the Netherlands, EMEA, and the United States only accounted for 3.4% of the group’s total revenue.
Considering that the majority of the top semiconductor producers are based in Asia, this geographical breakdown makes sense. Note that the United States possessed around 12% of the world's global chip manufacturing capacity as of 2021.
Market use revenue breakdown
ASML customers using the lithography technology are from the Logic market which accounts for 47% of the group’s revenue. Whilst customers from the Memory market account for 26% of the revenue. The balance of 27% of the group’s revenue comes from services and field options for the installed base.
Over the past five years, the revenue from all three markets has been growing steadily thus contributing to ASML YoY solid topline growth.
Revenue from different technologies
The net system sales revenue in this case refers to the total revenue generated from both the Logic and Memory markets. Across the two types of markets, ASML systems sales come from its product lines like EUV, ArFi, Arf dry, KrF, and I-Line, as well as Metrology and Inspection.
Over the past five years, ASML's net system sales unit increased by 66% between 2018 to 2022. The revenue however has increased by 87% during the same period. As demand increases, and there is continuous development in the technology, the group is able to sell at higher prices.
Revenue is projected to CAGR at +13.1% for 2022-25E
According to consensus, ASML total revenue is projected to grow at a CAGR of 13.1% between 2022-2025E. While the management is projecting ASML to deliver 30% YoY growth for 2023E. This is driven by 1) stronger installed-based management sales, and 2) a continuous robust demand for semiconductor chips.
Net profit is projected to CAGR at +18.2% for 2022-25E
Moreover, the net profit is projected to CAGR at 18.2% for 2022-25E on the back of 1) steady sales growth and 2) slight improvement in gross margins as management continues to operate at the right costs through better costs management.
Gross margins are stabilizing
According to ASML's recent quarterly results briefing presentation, management expects to sustain its gross margins around the 50% level for 2023E. This is a 2.7%-points below its peak gross margin level in 2021 of 52.7%. Even then, still better than pre-pandemic levels of below 48%.
Global semiconductor market CAGR at +9% for 2020-2030
According to management, the global semiconductor market is projected to grow at a CAGR of 9% between 2020-2030. This is driven by steady long-term growth expectations within the smartphone, personal computing, consumer electronics, as well as wired and wireless infrastructure boosted by double-digit CAGR from the automotive, Industrial electronics as well as servers, data centers and storage markets. The growing trend for the semiconductor market should bode well for ASML as it is the biggest lithography manufacturer globally.
In order to maintain ASML’s competitiveness, the group has been steadily increasing its investments in Intellectual Property (IP) through various Research and Development (R&D) programmes. The patents are also a way to protect the company’s investments in its R&D from the use of its third parties and exploitation by its competitors, customers, suppliers and co-developers.
IP portfolio trend vs R&D Investments
Share repurchase program
On the 10th of November 2022, ASML announced a new share buyback program to be executed by the 31st of December 2025. As part of this program, the group intends to repurchase shares up to an amount of EUR12bn, of which they expect a total of up to 2mn shares will be used to cover employee share plans. ASML intends to cancel the remainder of the shares repurchased. The new program has replaced the previous EUR9bn share buyback program in 2021-2023 which was completed on the 18th of October 2022.
A share buyback is a good thing for investors as it reduces the number of outstanding shares in the market thus increasing the potential EPS of the company and making the shares more valuable to shareholders. ASML has been actively returning profits to its shareholders through share buybacks and dividends.
Regular share buyback and dividend distribution for shareholders
Healthy cash flows
Furthermore, ASML cash flow has been showing healthy signs of growth in line with the EPS trajectory with the exception of the decline in 2022 to EUR21.96/share vs EUR28.47/share in 2021. I believe this is due to higher CAPEX in 2022 (EUR1.3bn) vs 2021 (EUR900mn).
Typically, as FCF/share improves, the ability of the company’s delivering better earnings also improves. However, I do believe management has been adopting healthy cash flow management for the company which in turn may lead to better earnings prospects in the coming years.
Normalised basic EPS vs FCF/share
Despite the rosy outlook, I am cautious of the following risks which may limit earnings delivery by ASML:
Geopolitical tensions may affect trade routes and deliveries to customers as well as supply chain disruptions,
Competition for market share within the growing semiconductor industry,
The increasing complexity of products and technology may be costly without proper cost management,
Financial results coming in below consensus estimates and management earnings guidance.
Industry PE comparison
According to Simply Wall Street, ASML is currently trading at 34.5x PE which is on the pricier end of the industry average PE of 28.1x. Even then, I believe the current PE seems to be justified considering its market leadership position in the manufacturing of lithography market.
The share price has increased by about 20% YTD. It is currently trading around its five-year historical forward mean PE of 31.6x. At current levels, the share prices seem to be fairly valued on a one-year forward earnings basis.
On a mid-term basis, considering the strong earnings outlook and positive investors’ sentiment on the stock, I do find the stock to still be attractive. Note that ASML's share price is currently trading around EUR621.10/share.
Below are my target price projections assuming that the stock may be trading between 25-35x PEs based on consensus earnings forecasts between 2023E to 2025E. If there are opportunities in the near term, I would accumulate below the EUR600.00/share level. The risk here is when earnings forecasts come below the consensus estimates or management forward guidance.
Upside potential based on consensus earnings forecasts to various PEs
At the time of this publication, Damia Othman does not owns shares in ASML ASML 0.00%↑ but she is considering while I (YZ) don't.
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