ASML: Semiconductor Manufacturing Equipment Leader

When talking about artificial intelligence, about all the hype around this topic and about the new boom for semiconductors, most often companies such as NVIDIA or Super Micro Computer come up in the context. But today we are discussing the company ASML Holding, based in Europe, not so popular, but extremely important for the entire industry. Not only ASML is a key player in the entire hardware supply and manufacturing chain, but it could also be a major beneficiary of the AI revolution over the next 5-10 years. Why? Let’s figure it out together.

ASML is a Dutch company, a leading manufacturer of lithographic equipment for the microelectronics industry, necessary, among other things, for the production of chips, flash memory and microprocessors. The company, originally called ASM Lithography, was founded in 1984 as a joint venture between Advanced Semiconductor Materials International and the famous Dutch company Philips.

ASML Holding NV engages in the development, production, marketing, sales, upgrading and servicing of advanced semiconductor equipment systems for electronic devices production. The company is headquartered in Veldhoven, Noord-Brabant and currently employs 36,112 full-time employees. The firm 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.
Taiwan and China are the key consumer markets for ASML products, accounting for 52% of revenue.
The Korean market is the next most important with almost a 30% share of total revenue. Next come The United States (~10%) and Japan (5%)

The Netherlands’ ASML is the world leader in the market for equipment for the production of microelectronics, and its share, according to various estimates, ranges from 80% to 90%. The remaining market is divided between Japanese Nikon and Canon. In 2023, according to reports, ASML allocated EUR 3.98 billion to research and development, which is EUR 727 million higher than the previous year. ASML annual revenue amounted to EUR 27 billion for 2023. And when we are saying “the world leader” about ASML in the context of the semiconductor industry, this is not a simple play on words. Most of the chips simply would not have been released if not for the Dutch company.

A short story about the creation of semiconductor chips: from sand to processor

In technical terms, a modern processor is a large microcircuit consisting of billions of elements — transistors, also known as discrete switches. Transistors are responsible for turning on and off, that is, passing and blocking electric current. Discrete switches allow a computer’s integrated circuits to operate in a binary system. The passage of electric current is one, and the shutdown is zero. The different sequences of these numbers form information: programs, text, videos, pictures and music. Transistor sizes are measured in nanometers, which is a billionth of a meter.

Why is chip size so important? Many of us think that this is just some kind of fetish. The smaller the better, simply because making a small chip is as difficult as shoeing a flea. But size really matters in this case. Technically. In fact, it is not so much the physical size of the chip that is important, but the so-called technical process. The smaller the technical process, the greater its productivity. And the more it can enable the creators of new devices and technologies. Everything is more than simple.

The key material for making semiconductors is silicon, which is found in large quantities in ordinary sand and is generally a fairly common material. Pure silicon allows the production of microcircuits of any configuration. It is melted and made into a crystalline body, which is subsequently cut into thin plates 1 mm thick. The surface of each plate is polished to a mirror finish. The silicon blank is now ready to be sent to the chip manufacturing plant. That sounds a bit complicated for a non-technical mind. In fact, to demonstrate the complexity of the entire process, Bloomberg calculated the estimated cost of entry into the industry if you were to start a chip company from scratch: it will cost at least 10 billion investments. The already complex process is complicated by the fact that the production of the chips themselves requires special and very expensive equipment. And most of all such equipment is produced at ASML factories.

ASML plays a key role in the whole industry

Today we can take a risk and say that the basis of the economy is microchips. Semiconductors may contribute to only a small percentage of global GDP, but they really do power trillions of dollars of goods and processes. Most of the world’s GDP is produced by devices using semiconductors. There is Samsung in South Korea, Taiwan Semiconductor Manufacturing Company in Taiwan, Huawei in China, Intel and Texas Instruments in the US. They all produce chips at their own factories. But the machines they use for production are made primarily by one company: Dutch Advanced Semiconductor Materials Lithography.

The technology that makes all advanced chips possible is called extreme ultraviolet (EUV) lithography. A single EUV lithography system machine costs over $200 million. The complexity of both the technology and the supply chain gives ASML a strong competitive advantage. The time and cost it would take for a competitor to replicate the entire manufacturing process of a single EUV lithography machine creates very high barriers to entry. It can be stated that ASML is currently a monopolist in its industry. And you can be sure that it will maintain its position in the next decade.

As we have already found out, chip production, if simplified to the extreme, involves cutting a large sheet of silicon into small pieces, which are then packaged and programmed under use cases. It doesn’t matter whether we’re talking about TSMC, NVIDIA, Intel, AMD or any other tech giant that produces their own silicon chips — the algorithm is similar for everyone. The technology that is used to cut a silicon wafer into fragments is called ultraviolet lithography. There are different types of lithography, which differ in how finely or thinly the wafer is cut.

There is a wafer processing technology called deep ultraviolet lithography, or DUV, but it is an older and less efficient method. Here, companies such as Canon or Nikon can compete with ASML. Even though the technology is not advanced, it is currently almost impossible for new players to repeat and replicate it. What then can we say about extreme ultraviolet lithography (EUV) technology, which allows the production of processors with a size that achieves even smaller processes of 2 nm and beyond. All the major chip makers, including Intel, NVIDIA and TSMC, are forced to buy these ASML machines because they simply have no choice.

ASML EUV lithography is worthy of the title of the most sophisticated machine in the world. Each device contains more than 100,000 components sourced from specialized suppliers. Without EUV technology, it would be impossible to produce the world’s most powerful silicon chips — the same ones that are fueling the current boom in artificial intelligence. In short, the trajectory of computing technology is concentrated in the hands of a company with an almost 100% monopoly on a certain type of technology.

Samsung Sells Down Entire ASML Stake

Less than a month ago, news came out that Samsung, a large Korean manufacturer and an important client of ASML, sold its entire stake of ASML shares. Having bought them in 2012, the Korean company gradually reduced its share, and now ceased to be a co-owner of the business. Over the years, shares have grown from 40 to 890 euros (as of March 12, 2023), according to quotes from Euronext Amsterdam Stock Exchange. It is unlikely that this news can be interpreted in any way for the future price movement . Samsung solved its tactical problems. But this news allows us to build a bridge from an overview of the company and its activities to an analysis of its financial performance and, ultimately, to an assessment of its current value. The main question is haunting us: is it possible to repeat Samsung’s move and increase the capital by ASML shares by 22 times? Okay, let’s be realistic. At least a few «x» over the next five years will suit us too.

Financial performance of ASML Holding NV

According to ASML annual report, the company’s half-year revenue almost reached 14 billion euros, tripling in 5 years. However, ASML produces only 15% of EUV machine components in-house. The firm’s secret lies in its ability to coordinate manufacturers’ vast supply chains and integrate their products into a cohesive whole. ASML understands that every component of its machines is incredibly complex and requires expertise and investment. Instead of controlling all levels of production in-house, it decided to rely on several third-party suppliers, including Zeiss Group, Trumpf, Cymer. ASML is doing everything it can to protect its supply chain by investing in key suppliers, as it did with its $1 billion investments in Zeiss. Sometimes a manufacturer absorbs its suppliers if their financial situation threatens the entire chain, as was the case with Brion Technologies.

This is reflected in the gross margin graph, which increased from 41% to 50% during the same time. The value of gross margin and net profitability, which for the ASML company is 29%, are indicators of the positive impact of economies of scale and competitive advantage of the business. In this ASML case, the numbers rather confirm the words that were said at the beginning of the article in the description of the technologies and production of the Dutch giant. An additional metric that confirms our conclusion is the share of selling, general and administrative expenses to revenue. Currently, it does not exceed 4% and has a positive trend. How to interpret this? The company spends only EUR 1 billion out of 27 to serve all marketing needs and bear administrative and business expenses. 4% is even less than NVIDIA has, which generally does not seem to need active sales, advertising or marketing today, having a queue of buyers outside the doors of its factories.

Financial position of ASML Holding NV

ASML is a rather conservative company in terms of using debt. The company uses reasonable leverage in the form of debt, and although it grows faster than equity, the debt metrics remain within the limits that we at Eyestock call the benchmarks for an ideal company. ASML company is liquid and solvent in both the short-term and long-term run with a debt-to-equity ratio of 0.33 and a current ratio of 1.396.

The ability of ASML management to effectively use available capital

So, let’s imagine for a moment that we are all owners of an effective business. We have an excellent and high-tech production. We are not just a leader, we are even a monopolist. Of course, we cannot brazenly and unceremoniously dictate our terms and prices, since regulators are not asleep. But we don’t need this. All we need is to maximize profit and efficiency and take as much from the market as possible within the rules of the game, right? This is exactly what the company’s management does. When we evaluate efficiency, we usually look at parameters such as return on assets (ROA), return on equity (ROE) and return on invested capital (ROIC). But connecting these metrics with the previous block, where we talked about an insignificant but noticeable trend in increasing debt relative to capital and cash flow, we see that the company’s management does not hesitate to increase its financial leverage, that is, the share of borrowed funds in the formation of assets. If done with a risk-based approach, it is the most effective way to maximize the benefits of economies of scale. And we already know that ASML has more than enough of it. ASML ROE is 58% raised from 20% in 4 years!

Eyestock rating for ASML stocks

As a result of our research, we are presented with a mature mega-cap company ($387 billion as of March 12) with annual revenues of more than 27 billion euros, high business margins, an undeniable competitive advantage, a liquid and solvent balance sheet, a high return on capital and an average growth rate of net profit more than 40% over the last 5 years.

As expected, the company’s rating surprised Eyestock benchmark by 15% and amounted to 115%, which means that the ASML company is a relevant investment idea for long-term investment portfolios. The rating structure is extremely balanced. Can such a company be cheap?

ASML valuation

It can if you use the analysis data using Eyestock valuation method. We have been analyzing the value of ASML relatively recently using our valuation system; most recently, at the end of 2022 and autumn 2023, ASML stocks were at their minimum value levels. That is, the company’s valuation at that time based on the price-to-earnings ratio was minimal over the past 5 years. Using this insight, you could get a profit on your portfolio of 62% in 2 years. Of course, this result cannot be compared with Samsung’s deal, but it’s also good.

Now ASML is estimated at 43 its annual net profit, which at the end of 2023 amounted to almost 8 billion euros. This is more expensive than the average of 40, but there is still potential for maximum values at approximately 13%. By the way, let’s not forget that the company additionally pays dividends and the annual average yield is about 1%.

What does the future hold for ASML?

ASML management is very restrained and moderate in its forecasts and expectations. In fact, when studying the report in detail, one gets the feeling that we are really dealing with a very solid and mature company with the same level of management, which will not feed investors a bright future without having 100% confidence in it and realizing the full extent of the risk of changes in market conditions. Therefore, the manager is inclined to give very restrained forecasts, which scares off those in a hurry who want to double their capital in a short time on the hype of AI and half-leaders.

The company is “managing the cycle, preparing for greater growth in years to come” according to ASML CEO Peter Wennink. They believe that the industry is ready for a new breakthrough and will try to demonstrate equally strong financial business results despite macroeconomic and geopolitical challenges.
Let’s use the business development forecast from the company itself. We will not be modest and will take the values ​​at the upper limit.

Let’s assume that revenue will reach 60 billion euros by 2030, while the gross margin will increase to 60%, which means that the net profit margin will increase to approximately 36% from the current 29%. Thus, annual net income could be approximately 21.6 billion euros. This is almost three times higher than the current value, and four times better than the 2022 figures. Ok, let’s move on. How much can shares cost? Taking into account the above calculations, the average profit growth rate is expected to be approximately 20%, so this is below the current long-term growth rate for 5 years but corresponds to a shorter period of 2 years. This means that there are no compelling reasons to revise the company’s valuation multiples. If the company is valued by the market at the same 40 profits as on average in the current period, then its capitalization could exceed 860 billion euros. Then the share price on Euronext Amsterdam stock exchange could exceed 2,200 euros per share, and depositary receipts (DR) on the Nasdaq exchange may approach $2,500 per share. This is not a forecast or recommendation, but rather simple calculations based on historical financial presentation and the future view of the company’s management itself.

What should ASML investors pay attention to?

At Eyestock, we believe that our valuation model is comprehensive because a company’s financial statements somehow capture the actual results of the business. We are also convinced that constant monitoring of news and reading rumors only harms long-term investors and can lead them astray from an adequate assessment of the company. Despite this, we analyzed what factors could harm the company’s plans or, on the contrary, make its future even brighter.

The AI revolution is the main driver.
ASML is a leading company in the field of semiconductor equipment manufacturing. However, the tremendous development of the AI market opens up new opportunities and risks. Will the company be able to develop its technologies at the same speed level as the needs and demands of such flagships as NVIDIA will change? This is a question that no one has an answer to yet.

Economic war between the USA and China is the main risk.
With the beginning of the introduction of economic sanctions against Chinese companies by the United States in 2018, ASML found itself in a situation where the company was prohibited from supplying new products using the latest developments to Chinese consumers. Repairs and maintenance of previously exported vehicles are also prohibited. Of course, this affects both the development of the global market as a whole and the financial reports of ASML as well. It is difficult to calculate how many billions the company is missing out on every year due to restrictions.
According to De Telegraaf, ASML’s plans include the construction of several factories outside the borders of the Netherlands. The Dutch giant intends to implement its plans over the next few years, which will allow it to produce 600 devices for deep ultraviolet lithography (DUV, no longer the most advanced technology, but still relevant) and 90 devices for extreme ultraviolet (EUV) lithography by 2025 or 2026.

What are the alternatives for investors in the US market?

If for some reason you don’t like ASML idea or it is not available to you, but the semiconductor production and service equipment industry itself is attractive, you can turn your attention to the peers of the Dutch giant.
First of all, these are Lam Research Corp (LRCX on Nasdaq) and Cadence Design Systems (CDNS), but both companies are overvalued according to the Eyestock valuation. In the second line, you can consider KLA Corp (KLAC) shares, which are also trading above the maximum historical estimates, moreover, their rating does not reach the benchmark by as much as 8%. Well, it’s worth mentioning the giant Applied Materials (AMAT) as well, whose rating is 126%. This is even higher than that of the hero of our story today. And the price-to-earnings ratio is even lower for AMAT and it is currently 24. You can discover these companies as well using our collection.