ASML: It’s A Leading Semiconductor Player, But Don’t Buy Now

Summary

ASML is supplying the critical extreme ultraviolet lithography machines for the leading-edge foundries. It has no competitors in this market.

Investors have been willing to pay up for its dominance in this market.

However, its current valuation looks stretched, as growth is expected to slow.

We discuss why we think investors should wait for a deeper retracement first before considering adding exposure.

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Sundry Photography/iStock Editorial via Getty Images Investment Thesis

ASML Holding N.V. ( ASML ) is one of the leading players in the wafer fabrication equipment (WFE) market. As the only player capable of manufacturing extreme ultraviolet (EUV) lithography machines, ASML has no competitors in this category. Taiwan Semiconductor ( TSM ), Samsung ( OTC:SSNLF ), and Intel ( INTC ) have to depend on ASML to supply these highly coveted and costly machines. In addition, the secular demand drivers underpinning the 5G ramp, IoT, autonomous vehicles, and high-performance computing will continue to benefit ASML EUV demand.

ASML also telegraphed a backlog that amounted to EUR 19.6B in FQ3, including EUR 11.6B in EUV. Consequently, it has given them revenue visibility until early 2023, as the company continues to add capacity.

Nevertheless, we believe that a significant amount of growth premium has been baked into the stock’s current valuation. It leaves little margin for error and would require ASML to execute immaculately. While we do not question management’s ability to execute, we are also concerned about the potential or a correction due to excess capacity from 2023/24 onwards. ASML Stock YTD Performance

ASML stock YTD performance (as of 23 November 21).

It has been a fabulous year for ASML investors. The stock’s momentum has been robust all year as it rode the secular drivers underpinning its industry. Moreover, given its dominance in EUV lithography, investors are willing to continue paying up to own its shares. As a result, ASML stock’s YTD gain of 65.6% easily outperformed the Invesco QQQ ETF’s ( QQQ ) YTD return of 26.7%. However, its WFE rival Applied Materials ( AMAT ) stock is slightly ahead with a YTD gain of 72.5%. A Strong 2021 for ASML. What about its Prognosis Moving Forward?

SEMI 2021 mid-year total equipment forecast by segment. Source: SEMI ASML quarterly revenue & YoY change. Data source: S&P Capital IQ

It has been a banner year for the semiconductor industry and the WFE market. SEMI estimated that WFE sales would increase by 33.5% YoY in 2021. ASML guided for its revenue to grow by 35% YoY in FY21. Given the company’s solid performance in FQ1-FQ3 so far, we believe that ASML’s guidance is highly credible. It’s also well in line with the industry’s forecasts, so it’s highly reasonable as well. Despite the supply chain problems that ASML is facing, it still expects a robust FQ4, guiding for revenue of between EUR 4.9B to EUR 5.2B. CEO Peter Wennink emphasized (edited): We’re seeing continued strong demand from our customers across all market segments from both advanced and mature nodes, driving demand across our entire product portfolio. These end market trends are driving strong demand across all market segments and across our entire technology portfolio. Therefore, we continue to increase our capacity for all of our products to meet customer capacity and technology requirements. ( from ASML’s FQ3’21 earnings call ) ASML share of revenue by technology. Data source: Company filings ASML sales count of EUV machines. Data source: Company filings

EUV has driven sales for ASML tremendously over the last three years. We can easily glean from the growth cadence of the unit sales, and EUV’s share of the revenue. In FQ3, EUV’s share of revenue remains influential and consistent at 54%. In addition, its foundry customers have telegraphed their plans to increase CapEx intensity moving forward to support robust underlying demand. Therefore, we believe EUV’s share of revenue will remain robust.

Nevertheless, it’s also important to note that its DUV systems are critical in driving ASML’s revenue. Hence, while the secular demand underpinning EUV’s strength is commendable, the concern of overcapacity has been widely discussed along the mature nodes.

TSMC CEO C.C. Wei also discussed the possibility of an “inventory correction” moving forward. He articulated: Let me say that while we do not rule out the possibility of an inventory correction, but we expect TSMC’s capacity remain very tight in 2021 and throughout 2022. This […]

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