ASML Setting New Records For Orders, And The Peak May Not Yet Be In Sight

 

These are unusual days in the semiconductor sector, as fabs continue to commit more capex to expand production and ease global shortages across multiple markets. That, in turn, has fueled record orders for ASML (ASML), but this lithography leader has more than just a short-term story. Between increasing chip content in markets like autos and factories (robotics, IoT, et al), and seemingly endlessly higher expectations for performance in areas like AI and communications, demand for leading edge EUV lithography systems looks strong through 2025.

These shares were already hard to value back in late January, as there was no real question of strong incoming order growth, but valid questions about exactly how to value that growth (or whether to just give up and say “buy it anyway”). Now the shares are 40% higher and with a quarter in hand where orders exceeded the prior peak by 60% … and likely more orders on the way.

Valuation seems more like an exercise in “pick your price target and work backward”, but in the short term at least it’s hard to argue with playing growing capex spending through a leading supplier of enabling equipment with a near-monopoly across most of its business and a literal monopoly in the most sophisticated equipment.

 

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ASML Setting New Records For Orders, And The Peak May Not Yet Be In Sight

ASML Riding High On Exceptional Demand For Its Leading-Edge Semiconductor Tools

With strong demand for leading-edge logic chips and improving demand for memory chips, pretty much everything is going ASML's (ASML) way these days.

When I last wrote on the company, I said, "give me a 10% pullback" and I'd be tempted to buy in. The shares pulled back about 7% and then shot up nearly 60%, handily beating the NASDAQ and SOX indices, though trailing other semi cap equipment names like Applied Materials (AMAT), Advanced Energy Industries (AEIS), Lam Research (NASDAQ:LRCX), and Tokyo Electron (OTCPK:TOELY) to varying degrees. Pull the comparisons out to a year and ASML looks more competitive, but still not a sector leader - a reminder, perhaps, that valuation can still matter at the margin.

As things stand today, I continue to love this business, but the valuation is even harder to handle. Yes, top companies deserve premium valuations, and ASML's moat and growth prospects absolutely merit designation as a top company. Still, I believe interest rates are more likely to head higher than lower from here, and I just can't find an argument for valuation beyond a sort of musical chairs relative value approach.

 

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ASML Riding High On Exceptional Demand For Its Leading-Edge Semiconductor Tools

ASML Continues To Execute, And The Sell-Side Keeps Pushing Higher Targets

From time to time you’ll see sell-side analysts put themselves through contortions that would make an acrobat reach for the Advil, and that often happens when they feel the need to justify ever-higher price targets for strong operating stories that have already breached prior targets. That seems to be the case today with ASML (ASML), as the sell-side has defended a lower 2021 outlook from this highly-valued semiconductor equipment supplier as “providing certainty and confidence”.

Let me be clear – I love ASML’s business and would be happy to own it at the right price. I just think it’s interesting to see how other analysts will justify their price targets when valuation gets extreme. I found these shares too expensive last quarter and they have since underperformed the NASDAQ and the SOX, and have actually declined a bit. Although the shares certainly aren’t a bargain by conventional means, it’s a name to watch if this recent tech correction accelerates.

 

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ASML Continues To Execute, And The Sell-Side Keeps Pushing Higher Targets

A Small Hiccup In Orders Means Little For ASML's Future

I hope ASML (ASML) shareholders will forgive me for saying I hoped for a more extreme reaction to second quarter results - a quarter in which ASML posted a modest revenue miss, a modest operating margin miss, and the weakest order number in over four years - as an opportunity to buy in at a reasonable (or at least more reasonable) price would be very welcome. Rationality has prevailed, though, and while there was a bit of a sell-off, the shares have already regained most of the lost ground.

ASML remains a unique story in the semiconductor equipment space as the only provider of extreme ultraviolet (or EUV) lithography systems, a key enabling technology for advanced semiconductor production. With leading-edge applications like smartphones, switches, and so on only just starting to use chips that require EUV, I see significant growth in the years ahead.

The "but", as long-time readers of mine can no doubt anticipate, is the valuation. There's just no conventional approach by which ASML is cheap. The best I can do is point to other secular growth stories that trade at even richer multiples (like Amazon (AMZN), Nvidia (NVDA), and Salesforce.com (CRM)) and suggest that ASML could still have some room to run, but that reminds me too much of the sort of justifications used to support ever-higher price targets in prior bubbles.

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A Small Hiccup In Orders Means Little For ASML's Future

The Strategic Value Of EUV Limits ASML's Downside

Lithography specialist ASML (ASML) reduced guidance on March 30 and did indeed see an impact to results in the first quarter, but I would argue that the results (including orders) reflect the underlying strategic value and necessity of the company’s lithography systems (especially the emerging EUV opportunity) – a reality that significantly mitigates the company’s downside risk in this period of significant economic upheaval.

The full-out panic back in March did take these shares back below $200, and I hope readers who had watch-list’ed this name stepped up and took advantage, as the shares have shot back up almost 60% and once again trade at a healthy premium. While another Covid-19/recession-related pullback is at least possible, investors are once again left dealing with a stock that offers “okay” potential from here.

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The Strategic Value Of EUV Limits ASML's Downside

A Guidance Hiccup Barely Registers With ASML

Semiconductor equipment stocks have come roaring back on strong logic/foundry orders and anticipation that memory orders will soon come back in force. That hasn’t left many bargains, but this is a momentum-driven sector now. To that end, ASML (ASML) has been quite strong since my last update, rising almost 30% and more or less keeping pace with an assortment of semi equipment names like Advanced Energy (AEIS), Applied Materials (AMAT), and VAT Group (OTCPK:VACNY), while Lam Research (NASDAQ:LRCX) has done even better over that time.

I’ve been pretty straightforward in the past that these momentum situations are not my preferred investment environment and that’s just how it often is with semiconductor equipment names – they sell-off too much in the downturns and shoot back too far when spending recovers. Be that as it may, ASML still has a lot going for it, including a monopoly in the nascent EUV lithography market and upside to over EUR 20 billion in revenue in five years. I will say that ASML’s valuation is reasonable today in the context of its peer group, but the entire group is trading at a premium to normal drivers like near-term margins and revenue growth.

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A Guidance Hiccup Barely Registers With ASML

ASML Has A Lot To Live Up To

In terms of moats, how do you not love ASML (ASML)? Not only is the company almost the only game in town in deep ultraviolet lithography (or DUV) with around 85% share, they are the only game in town in next-gen extreme ultraviolet lithography (or EUV), a new product category that will start to contribute much more meaningfully to revenue in the second half of 2019 and into 2020 and beyond. As lithography is a critical step in chipmaking, that puts ASML in a commanding position in a critical part of the foodchain, particularly as EUV tools are effectively essential for chip nodes below 7nm (and useful at 7nm).

There are some points of controversy around the stock, particularly with respect to the ramp timeline for EUV tools, how deeply EUV tools will penetrate the memory segment over the next few years, and the sort of gross margins that the company can really generate. The bigger issue for me, as an investor, is valuation. A virtual monopoly supplier in a growing industry certainly deserves a premium, but I’m not entirely comfortable with what looks like a prospective annual return on the low end of the high single-digits.

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ASML Has A Lot To Live Up To

Investopedia: Should Investors Hang Around For More From Applied Materials

From the fall of 2012 until very recently, my bullish call on Applied Materials (Nasdaq:AMAT) finally started to pay. Shares rose nearly 50% in six months as investors finally started to believe that NAND capex spending was going to improve and that the flat panel business had likely bottomed, not to mention some confidence that the company would see better results with different leadership. Although these shares are not overpriced on a free cash flow basis, investors who want to stay exposed to semiconductor equipment may want to think about switching over to the stocks of companies with better individual growth stories.

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Seeking Alpha: Thinly-Traded Edwards Group Could Outperform On Semi Equipment Pickup

When it comes to companies tied to the semiconductor capital equipment cycle, talking about valuation often feels pretty pointless. Creating accurate long-term models is a Sisyphean task, and the realities of the market mean that the stocks often go much too low in the bad times and much too high in the good times. With that in mind, then, Edwards Group (EVAC) doesn't necessarily jump out as a screaming bargain today, but I suspect that a recovering in the cyclical semiconductor, panel, and LED markets will lead to significant stock performance for a year or two.

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Thinly-Traded Edwards Group Could Outperform On Semi Equipment Pickup

Seeking Alpha: Ultratech Ultrainteresting

While a very strong year for the stock has propelled Ultratech (UTEK) above $1 billion in market cap, this is still far from a household name in semiconductor equipment. That could still work in investors' favor, as Ultratech addresses several appealing markets with above-average growth potential. Although valuation does look a little stretched, waiting for this stock to get meaningfully cheaper could be in vain as it offers a clean balance sheet, solid growth prospects, and leverage to improving capital spending in the chip space.

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Ultratech Ultrainteresting

Investopedia: ASML And The Obvious - Weak Trends And A Bid For Cymer

In contrast to Applied Materials (Nasdaq:AMAT), which has repeatedly made moves and comments that have left investors scratching their heads, ASML (Nasdaq:ASML) continues to operate and report along highly predictable lines. Although there's evidence that industry conditions are even weaker than previously supposed, ASML didn't really surprise with its third quarter earnings, nor its announcement that it's acquiring Cymer (Nasdaq:CYMI). What is frustratingly less obvious, is what constitutes a fair price to pay for ASML today.

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Investopedia: Growing Niches Should Propel Ultratech Higher

Niche markets are often spoken of poorly, as they don't typically offer the sort of huge addressable revenue opportunities that tech investors value. In the case of Ultratech (Nasdaq:UTEK), however, I wouldn't be so quick to dismiss the company as just a niche player. With opportunities to expand the utilization of market-leading tools for advanced packaging, laser annealing and LED production, Ultratech could be looking at several years of above-market growth or a takeout offer.

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Investopedia: Still Little Good News From Applied Materials

Two-thirds of the way through 2012, it's pretty clear that not only were expectations for a semiconductor and semiconductor equipment recovery wrong, they were off by a wide margin. As Applied Materials (Nasdaq:AMAT) continues to see business erosion, it has to test the patience of even the most loyal or long-term shareholder. While spending will recover someday and the shares will have their day again, the shares are likely to be volatile in the short term.

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Investopedia: ASML Gets TSMC To Sign On The Dotted Line

So far, it looks like ASML's (Nasdaq:ASML) unconventional customer investment plan is shaping up as an offer that the biggest semiconductor companies can't refuse. Intel (Nasdaq:INTC) already committed to purchase as much as 15% of ASML's shares and invest over $4 billion, and now huge semiconductor fab Taiwan Semiconductor (NYSE:TSM) (aka TSMC) has chosen to join in as well.

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Investopedia: Can Intel Manufacture An Edge?

Companies have been lining up to tell investors how tough the PC market is these days, so there was a little bit of relief when Intel's (Nasdaq:INTC) second quarter numbers were basically on target. The issue for investors, though, is that near-term pressures in the PC market and a relatively unimpressive valuation could well weigh on shares even as the company has an improving long-term outlook.

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Investopedia: Is Moore's Law Fueling Intel's Investment in ASML?

Maybe the corporate world's never-ending capacity to surprise is what has kept me so interested in the equity markets for over 20 years. In the latest example, Intel (Nasdaq:INTC), a company famous for playing suppliers off each other and encouraging/supporting small up-and-comers, is taking a significant stake in lithography equipment maker ASML (Nasdaq:ASML) and agreeing to help fund the company's R&D efforts. While this is an unusual deal in many respects, it seems to acknowledge (if not cement) ASML's market leadership, as well as the challenges of continuing to push the leading edge of chip development.

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Investopedia: Cymer Still A Leading Light

Normally, large market share would sound like a golden ticket for shareholder returns. It's not so simple when it involves the semiconductor equipment industry, and Cymer (Nasdaq:CYMI) has proven to be just as cyclical as customers like ASML (Nasdaq:ASML) and other equipment companies like Applied Materials (Nasdaq:AMAT). With the photolithography industry on the cusp of both a rebound in demand and a major new technology cycle, investors may want to revisit this story.

The Big Dog in a Critical Step
Photolithography is an essential step in the manufacturer of semiconductors as the light source imprints the circuit pattern on the wafer. What's more, increasingly sophisticated light sources and photolithography machines have helped make Moore's Law a reality and enabled increasingly complex chips.

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Investopedia: Investors Can Do Better Than Taiwan Semiconductor

In many respects Taiwan Semiconductor, also known as TSMC, (NYSE:TSM) acts as a proxy investment for the semiconductor industry at large. Boasting a who's who client list and the most capacity in the business, Taiwan Semiconductor rises and falls with the fortunes of the sector, but manages to do reasonably well even in the worst of times. While Taiwan Semiconductor is a well-run company, the valuation on the stock today suggests that investors willing to take on additional risk could do better with individual chip stocks.

Will There be a Second Half Rebound in Expectations? 

Like the semiconductor sector as a whole, investors went into 2012 with fairly strong expectations for a rebound in chip demand and revenue. So far, though, those expectations seem like they may have been a bit hasty. Once again, both Texas Instruments (NYSE:TXN) and Altera (Nasdaq:ALTR) revised guidance lower for the first quarter of 2012 and TSMC has also modestly trimmed its expectations for logic chip sales growth in 2012.

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Investopedia: Applied Materials A Long-Term Play In A Short-Term Market

Leading semiconductor equipment company Applied Materials (Nasdaq:AMAT) posted stronger than expected revenue and raised guidance for fiscal 2012. So, it's off to the races, right? Not exactly. While conditions do seem to be getting better in the equipment world, analysts remain very skeptical about the persistence of this recovery and expectations for the company are all over the map. Although its valuation looks too low for the full cycle, the short-term world of Wall Street couldn't care less about more than one quarter.

Less Bad Is Better
Applied Materials didn't have a strong quarter, but it was less rotten than many analysts feared. Revenue fell 19% from last year and was up very slightly on a sequential basis as reported. Stripping out the Varian acquisition, sales would have been down about 9% sequentially.


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Seeking Alpha: FSI International - This Small Semiconductor Company Could Clean Up

It has already been a fairly solid year for many companies in the semiconductor equipment space. With guidance from major players like Applied Materials (AMAT) and ASML (ASML) suggesting that dawn is breaking and the merger between Lam Research (LRCX) and Novellus (NVLS) hinting that business is getting back to normal, investors seem to be willing to consider risky stories again.

That could set up the right sort of one-two punch for investors in FSI International (FSII). Like many other small equipment vendors, FSI was hit hard by the downturn in equipment spending. Unlike some of those small peers, though, FSI is coming into a cyclical upswing with a new product and the potential for some real sales momentum. Couple that with the fact that this stock is barely followed and has about 10% short interest, and it may not take much for this stock to do even more in 2012.

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