ASML Stock: A Perceived Safe Haven, But Expensive

Introduction

On the morning of January 24, 2023, ASML Holding N.V. (NASDAQ:ASML) presented its Q4 2022 results and managed to beat both top and bottom-line estimates by analysts. The quarterly results looked decent but still resulted in a slight drop in share price when the market opened in Europe. Still, results were strong, and ASML expects strong continued growth for FY23, as customers of ASML expect the semiconductor industry to improve in the second half of 2023. ASML saw a strong inflow of orders and managed to keep its backlog strong despite an increase in sales.

ASML is one of my largest personal holdings and I remain very bullish on the company, as the long-term prospects look very good and were once again confirmed during the latest quarterly results.

ASML operates a monopoly as the only company able to build EUV machines for semiconductor manufacturing. EUV is the crown jewel of ASML, and for those unfamiliar with it, I recommend reading my initial coverage on the company from back in October. EUV machines are the only ones able to manufacture the highest-end semiconductors.

The need for high-end semiconductors is expected to significantly increase over the next decade as trends like cloud, AI, VR/AR, and other high-tech products increase in importance. That demand is high for the machines built by ASML. This was once again proven in the latest earnings release, as both last year’s growth and next year’s outlook were strong.

Within this article, I will take a look at the latest earnings results and review my thesis to see if the company is still a buy after the share price increased by 16% since my previous article back in November and surpassed my target price.

Let’s get to it!

Quarterly and FY22 results

ASML reported €6.4 billion in revenue for 4Q22 and outperformed expectations by a slight margin of €50 million. Revenue for the quarter did show impressive strength and grew 28.5% YoY. At the same time, ASML also continued to see a strong order inflow, as the company saw €6.3 billion in net bookings for the quarter of which €3.4 billion were orders for the higher-end EUV equipment. And although the net order intake was lower than the record intake of the previous quarter (€8.9 billion), the fact that order intake remained as strong as it did is to be called impressive by itself. ASML continues to see strong demand for its products and is absolutely not seeing any slowdown in demand despite economic weakness. Semiconductor manufacturers such as Samsung (OTCPK:SSNLF), Taiwan Semiconductor (TSM), and Intel (INTC) can simply not afford to wait out and get overtaken by the competition, as an order made today will still take over 2 years to be delivered.

Also, ASML is not vulnerable to cancellations, as companies need to make an upfront payment for their order, and canceling would mean they lose this payment, and get pushed to the back of the line. In an industry where technological advantage is key, having to wait for new equipment for an additional 2 years is simply not an option.

During the quarter, there has been some speculation about increased sanctions on ASML regarding the delivery of semiconductor systems to China. Currently, ASML is not allowed to deliver its high-end EUV systems to China, but the U.S. also wants to limit or stop the delivery of older and less advanced systems to China. So far, the Dutch government has not agreed to apply these sanctions and so nothing really changed for ASML. For FY22, China was responsible for 14% of the total revenue for ASML, a decrease from 16% one year earlier. This means that even if ASML would be restricted from delivering any equipment to China, this would only jeopardize 14% of revenue, and this share is already declining.

ASML delivered a total of 95 new lithography systems during the quarter, bringing the total for the year to 317, an increase compared to the 286 from the previous year. As discussed during its latest investor day, of which coverage can be read here, the main problem for ASML to grow revenues is production capacity. As shown by its backlog, ASML is having absolutely no problem with demand, but it simply cannot build more lithography machines as it works at maximum capacity. ASML plans to increase capacity to 600 systems per year by 2025/26, which would result in an increase of production space of approximately 65,000 m2.

ASML reported a gross profit of €3.3 billion for its 4Q22 and saw its gross profit drop slightly from 52.7% for FY21 to 51.5% for 4Q22. Net income came in at €1.8 billion and resulted in EPS of €4.60 ($5.0) which beat estimates by a solid €0.27. This beat was primarily due to an insurance settlement for the fire in the Berlin factory in January 2022.

For FY22 ASML reported €21.17 billion in revenue, a solid increase of 13.6% compared to FY21 revenue. While this growth does not seem that impressive and does not fully warrant the current high valuation for ASML, it is important to keep in mind that revenue would have been higher, but ASML slightly changed the way they deliver systems to customers. Whereas ASML previously build the entire machine in its factory to run its checks, they now do this at the customer’s factory. As a result, ASML was required to postpone some revenue realization to 2023 and this amounted to €3.1 billion compared to €2.2 billion expected. This means revenue would have been €24.27 billion for FY22 without this operational change and would have resulted in a YoY growth rate of an impressive 30%.

Net bookings for the full year came in at €30.74 billion and outpaced revenue resulting in a higher backlog compared to the end of FY21. Gross profit came in at €10.7 billion with a gross margin of 50.5% which was slightly lower than last year as a result of some inflationary pressure, though still well under control. Net income was €5.62 billion, resulting in FY22 EPS of €14.14. ASML reported a free cash flow of €7.16 billion for FY22, down from €9.9 billion in 2021. This is primarily due to some revenue being pushed to 2023 as a result of the operational change discussed above and higher investments. Still, this is double the amount of free cash flow generated in 2020.

Overall, it was another strong quarter for ASML, and the company seems resilient against any economic trouble thrown its way. This is what CEO Peter Wennink said during the call:

We continue to see uncertainty in the market caused by inflation, rising interest rates, risk of recession and geopolitical developments related to export controls. However, our customers indicate that they expect the market to rebound in the second half of the year. Considering our order lead times and the strategic nature of lithography investments, demand for our systems therefore remains strong.

As I mentioned before, ASML continues to see strong demand, and its customers point to renewed growth during the second half of 2023, showing strong prospects for the semiconductor market. ASML showed no weakness and continues to see strong growth going into 2023.

The growth outlook for ASML also continues to be strong for the remainder of the decade as discussed by ASML during its investor day in November. The image below shows the current expectations from ASML for the years until 2030, and the company looks poised for strong growth and believes it can deliver a 20% growth CAGR to investors based on revenue growth, margin expansion, dividend growth, and continued buybacks.

Balance sheet & dividend

ASML had total cash of €7.38 billion on the balance sheet by the end of FY22. Whereas ASML managed to significantly increase its cash from the previous quarter where total cash amounted to only €3.36 billion, it did end the year with slightly less cash compared to the end of FY21, when total cash stood at €7.59 billion. Still, the decrease is minimal. ASML holds a solid cash position, which allows it to invest in the business and return cash to shareholders.

In FY22, ASML returned €7.2 billion to shareholders through both dividends and share buybacks. This return of cash was covered by free cash flow.

ASML increased the dividend by 5.5% and has a forward yield of 0.8%. Although the yield might not look very attractive, the 5-year dividend growth rate of 46% combined with high share buybacks definitely is. ASML has also changed its dividend frequency to quarterly making it more attractive to dividend investors. The current payout ratio of just 35% means the dividend is well covered by its cash flows and has plenty of upside potential, as cash flows and margins are expected to increase over the next few years. ASML has been paying a dividend for 9 straight years now.

Outlook & valuation

ASML expects another strong year of growth for FY23. ASML aims for revenue to increase by over 25% for the full year, with a slight improvement in gross margins compared to FY22.

First quarter revenue is expected to be between €6.1 and €6.5 billion with a gross margin of 49% to 50%.

Considering these expectations, we should expect ASML to report revenue of approximately €26.5 billion which is based on a 25% growth rate. Although this growth rate could very well come in higher, I prefer to stay conservative, so let’s just assume a 25% growth rate. If ASML were to increase margins slightly compared to 2022, as indicated by its CEO, I think it’s safe to assume a gross margin of 51.5%, still below its FY21 gross margin. I expect continued high inflation to pressure margins for the first half of the year, but ASML is well positioned to increase margins over time and so I believe higher demand and lower inflation by the second half of 2023 will result in higher margins of approximately 1% for the full year.

The net income margin for FY22 was 26.6%. If we assume this to also increase slightly and expect a net income margin of 27.6%, this would result in a net income of €7.31 billion for FY23 or a 30% growth rate.

Current analyst estimates guide for revenue growth of 20% for FY23 and I believe these need to be revised slightly upwards. Current analyst expectations for FY23 EPS seem fair and in line with my expectations. Based on current analyst FY23 EPS estimates, this would result in EPS (in dollars) of $20.32. If we assume a P/E multiple of 35x, which seems fair to me considering ASML is staying very resilient, would most likely not be impacted by a potential recession due to high demand and a very high backlog and continues to grow at solid double-digits, I end up with a price target of $711. In my eyes, ASML is a safe haven during uncertain times.

With a current share price of $655 (premarket at the time of writing), the stock is definitely not cheap and has an 8.5% upside potential to my price target. Still, the share price has increased by 16% since my previous article on ASML, and back then I concluded the following:

To me, ASML is a no-brainer investment. It was already before this presentation, as I explained in my previous article, but this just once more confirms my thought on ASML. The one single problem I have with ASML is that the share price has now increased by over 40% since my previous article and since its earnings release. This makes the stock significantly more expensive and harder to recommend buying. Yet, I believe ASML is not cyclical at the moment as order and backlog keep increasing.

Yes, a P/E of over 40 is richly priced, but you must pay for quality, reliability, and incredible shareholder returns. This stock might very well have bottomed last month. Therefore, I will still put a gentle buy on the stock at its current price. I believe that as a long-term investor, any price below $650 is still okay. I would recommend buying bit by bit as the market uncertainty remains.

My opinion has not changed, and the latest results have only increased my confidence in this company. Also, with the economy still strong and ASML customers guiding for a better second half of 2023, I believe there is room for some positivity. The current share price is very demanding, but ASML is an incredible company operating a monopoly.

As ASML continues to deliver and growth rates remain strong, I believe analyst estimates for both FY24 and FY25 should also be revised upwards slightly as ASML continues to outperform and capacity expansion will drive faster growth. I believe expectations for both years should be closer to a 20% growth rate compared to the current 16% to 17% expected growth rates. I believe these estimates will be revised upwards over the next 6 months and will result in increased price targets from analysts.

Wall Street analysts currently hold an average price target on ASML of $760 per share (based on 36 analysts).

Risks

The one and only real threat to ASML and the current outlook seems to be the exposure to China and the pressure the US government is putting on the Dutch government to add more limitations to ASML machine shipments to China. I have discussed this before in this article and the 14% revenue exposure to China does not seem that worrying to me. With ASML increasingly focusing on EUV and higher-end innovations, the China exposure will most likely drop further over the next year as ASML is already not allowed to ship these machines to China.

If ASML were to lose the complete revenue share from China due to export restrictions, this would impact the business in the short term and might cause a lower share price. While from a long-term perspective, I do not view this as a huge issue, it is important to keep this in mind when considering buying ASML right now. The chance of such a ban looks more real than ever.

Conclusion

ASML delivered another outstanding quarter of growth, and the business outlook is strong. The company projected solid revenue growth for FY23 and confirms that it is not feeling any pressure from a deteriorating macroeconomic environment. Demand for its products remain extremely high and order intake was still strong.

Despite incredible strength, no company is a buy at any price and the valuation for ASML has become a tough one to swallow. The stock is currently valued at a P/E of above 40 which is rather expensive, even for ASML. Wall Street analysts currently hold an average price target of $760, but I have decided to go with a more conservative outlook and calculate a price target of $711 based on a P/E of 35.

I continue to believe that ASML is an excellent holding for any portfolio, but considering the recent increase in share price, I decide to downgrade the company to hold for now. This is primarily due to the fact that a lot of upside seems to have already been priced in after the recent increase in share price and the outlook from management was roughly in line with analysts’ expectations. Also, considering the risk of additional China restrictions, an 8.5% upside to my target price is very limited.

I do believe ASML Holding N.V. is a safe haven during uncertainty, and I recommend buying the company on any weakness. Personally, I look for a little more upside potential and believe the company is a buy below $630 per share right now.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.