ASML: Bump in the road to secular growth
Revenue recognition is insufficient to change my view on ASML.
ASML, the Dutch semiconductor equipment manufacturer, reported earnings last week. The earnings were slightly better than market consensus but in trend terms highlighted a slow down from the strength of 2021. Annual earnings and revenue fell for the first time since 2019.
ASML is an interesting business. When I first came across the company in 2015 it seemed a high-risk play on the semiconductor theme. It had cyclical revenue and earnings, but its biggest asset was the hope that its EUV technology would become standard in the semiconductor manufacturing process. Fortunately, from 2017 EUV has come to dominate its niche.
ASML’s role in semiconductor manufacturing is lithography. Lithographers in semiconductor manufacturing imprint the space for each resistor on a chip. ASML’s EUV process enables at least 10 billion resistors to be printed on a chip the size of a finger-nail. Simply, they use light and lenses to draw on extremely flat silicon wafers. Its capability is unique and has enabled TSMC (who believed in the technology) to draw further away from Intel in its production capability.
This quarter’s results, however, were substantially weaker than the previous quarter’s and the corresponding quarter in 2021.
Partly, this reflects the lumpiness of ASML's revenue and recognition of that revenue. Particularly, the shortage of semiconductor manufacturing equipment has meant clients are prepared to take new units before compliance checks are conducted. These checks are now done on site and, until they are completed, ASML cannot recognise revenue from the shipments. ASML say euro 2bn of revenue (40% of Q1) was shipped in Q1 but will be recognised in Q2. ASML also makes the point that lead times on new units stretches to end-2023, again reflecting strong demand for the equipment.
But it also feeds the market narrative that ASML is close to peak production. It’s this broad view, coupled with the tech sell-off, that has driven poor stock performance in 2022.
My view remains that ASML is a core portfolio holding. I believe that it has a technological moat in an industry with secular growth.
As is observed across industries, there are increasingly barriers to entry in industries as a consequence of scale (the internet to iron ore) and technological know-how (industrial equipment to salmon farming). ASML has a unique technology that would require billions and many years to replicate, and a capability lead over nearest rival Nikon. It will be the dominant lithographer for the next decade.
It will be dominant in an industry with secular growth. Applied Materials (provides deposition equipment) estimates that between 2021 and 2025, the volume of data generated globally will grow 84% per annum. ASML will be essential in both the creation of this data (logic) and its storage (memory).
At a market capitalisation of euro225bn, euro18bn in sales, a gross margin of 50% and, room for significant buybacks, ASML has room to grow.