ASML Holding NV (NASDAQ:ASML) is one of the world's leading semiconductor companies today, practically a monopoly and therefore benefiting from the secular trends surrounding the growth of AI and the like. Its business model is somewhat complex, developing the main lithography machines for chip manufacturers, being cyclical, and having to invest heavily in R&D.
Despite these challenging factors, ASML is one of the companies with the most moats in this industry, and this is reflected in its financials, such as good profitability indicators, revenue growth, and cash generation.
Another important point of the thesis is that its price, although not a bargain, is more appealing than the main peers related to this topic, without losing out on quality and competitive advantages.
The Resilience of ASML's Business and Moats
According to ASML Lithography is at the heart of the semiconductor industry. Today, there is no way to envision a growing future for AI, data centers, and the like without the machines that the Dutch company manufactures.
The company still sells machines of various technologies, such as ArFi, ArF Dry, KrF, and I-Line, but the main ones are those using EUV technology. Even though sales in units are less representative of this technology (with 11 units sold in Q3 24 against 42 for KrF, for example), Extreme Ultraviolet machines already represent a good part of ASML's revenue. This is because this is a cutting-edge technology in which ASML is a pioneer and practically has a monopoly on production, and these machines cost several million dollars.
ASML: A Solid Pick for Capitalizing on AI Innovation
Source: ASML IR
Another compelling part of the thesis is that a portion of this revenue is recurring, called Installed Base Management, which in the last 12 months amounted to 4.34 billion, equivalent to around 22% of total revenue. And with this revenue growing, there is greater predictability, mitigating the cyclicality of machine sales, but also entrenching better relationships with customers.
As far as geography is concerned, in addition to the major Western semiconductor players, such as Taiwan Semiconductor Manufacturing Co Ltd (NYSE:TSM) and Intel Corp (NASDAQ:INTC), ASML also sells to Chinese producers, which adds more risk to the thesis.
This close relationship with customers, contracts, and the monopoly on EUV production mean that ASML's moats are very wide. It's very difficult to imagine new competitors entering this segment, and we can also cite the technology barrier to entry. The company took time and a lot of investment to get to this level, investing in both R&D and acquisitions, accelerating inorganic growth, and showing a great allocation of capital.
ASML: A Solid Pick for Capitalizing on AI Innovation
Source: ASML IR
The construction of these moats and continuous investments had a direct impact on the company's financials. As can be seen in the graph below, in addition to growing revenue in recent years, gross margin and net income margin have also evolved a little.
ASML: A Solid Pick for Capitalizing on AI Innovation
Source: GuruFocus
Cash flow reflects the company's cyclicality, but has continued to show good progress in recent years. Both free cash flow per share and EPS show that ASML has been able to generate value for its shareholders, both through its robust business model and through capital allocation, distributing dividends, and carrying out buybacks, which make these per-share metrics even better.
ASML: A Solid Pick for Capitalizing on AI Innovation
Source: GuruFocus
Robust Growth Prospects for ASML
According to Statista, the CAGR of the worldwide semiconductor market is expected to be ~10% by 2029. Fortune Business Insights estimates a CAGR of 14.9% by 2032. Both estimates are attractive to ASML, which, as a monopoly and an essential player in the industry, should capture a significant part of this growth, possibly even a little more, but in a more cyclical way.
ASML: A Solid Pick for Capitalizing on AI Innovation
Source: Statista
ASML itself at its Investor Day mentioned that it expects attractive growth until 2030, with revenues between $46.2 bn and $63 bn, with a good CAGR for EUV.
In short, there are several trends driving this industry and consequently the demand for ASML machines. Machine learning, IoT, AI, among others. Several products, from the simplest to the most complex, currently have chips, i.e. it encompass a range of industries such as automotive, cloud, smartphones, and the like, making the company's growth prospects very robust and clear, even with cyclicality.
Key Risks For ASML's Thesis
One of the main risks is its exposure to China. In addition to the risk of economic slowdown, there is also the risk of tariffs and regulation. This discussion is not new, but it is an ongoing risk for the company. Even though ASML is not an American company, any obstacles to exporting to China could affect it, and consequently cloud the growth of the topline.
Its cyclicality is also a risk. If, in the coming years, companies that are well-supplied decrease their investments in this type of infrastructure (either due to lower demand for chips, lower investments in production, or the like), there will be a decrease in revenue and possibly in margins. This risk is mitigated when we think about the long term. From one year to the next, there may be a significant slowdown, but when we think about 10 years, the CAGR should be high, making compounding possible even with more volatile financials.
Another related risk is dependence on certain clients. Such as Taiwan Semiconductors, Intel, and Samsung, if something happens to them, ASML will consequently be affected, whether by postponing orders, reducing the number of machine sales, and the like. Taiwan Semiconductors, for example, has some geopolitical risks, while Intel is struggling and in the middle of a turnaround.
Finally, although the company has a huge moat and a relevant technological barrier, maintaining this leadership requires continuous investment in R&D, and delays or slippages in the development of new technologies (such as EUV) can have a significant impact, so there is also an execution risk.
In short, ASML's wide moats manage to mitigate a lot of the risks, and together with secular trends make the company's future clearer, but it is still necessary to keep up with the obstacles listed above.
ASML Valuation Highlights Margin of Safety
One of the highlights of the thesis is that ASML is one of the main AI-related players, has the wide moats mentioned, but is still not traded at as high a level as other names. Among the reasons is the weaker guidance that the company released in the last quarter, causing the stock to accumulate more than a 20% drop in the last six months.
Although the revisions accompanied this weaker guidance, ASML's multiples contracted. Among the major AI names, the company has one of the most attractive forward price-to-earnings ratios. The mean of the last 5 years is 36.3x, but it is currently trading at 26x. Meanwhile, all the other selected names, such as Nvidia Corp (NASDAQ:NVDA) and Advanced Micro Devices Inc (NASDAQ:AMD), except Taiwan Semiconductors, are trading above 30x earnings.
ASML: A Solid Pick for Capitalizing on AI Innovation
Source: GuruFocus
For a cyclical company with great growth prospects, the forward price-to-earnings alone doesn't say much, but we can already see that it's an attractive level both against its history and against other comparable players. Even so, in order to guarantee a greater margin of safety, we're going to make a conservative forecast. Using the estimates 2024 and 2025, and from then on using some conservative assumptions, it is possible to find a price-to-earnings of 23x as early as 2026, and a value of just under 20x in 2029.
ASML: A Solid Pick for Capitalizing on AI Innovation
Source: Author; GuruFocus
Note that in the table above, I tried to estimate a cyclicality for the results, such as revenue growth falling to 5%, along with a lower margin, stabilizing at 7% growth in the final years with a margin of 29%. Even with these conservative assumptions, it is already possible to find an average net income growth of 12% (between 2025 and 2030). This makes me think that there is a margin of safety for ASML. It's possible that the company will surprise positively, with a net income margin that expands at a better rate than expected or exceeds 31% in better cycles. In addition, if we consider the top of the company's revenue guidance for 2030 (~$63bn), a net income margin of 29% already implies a price-to-earnings of 15.5x, falling to less than 15x if we consider a margin of 31%, more in line with the top of the cycle and possible efficiency gains, revenue mix and the like.
Checking this in an equity model, to find a fair price of ~$720 for ASML, it is necessary to project growth of 16% per year for the next 10 years and have a growth rate of 10% in the terminal stage and a discount rate of 8%.
Although the base scenario is not one of tremendous asymmetry, ASML still looks attractive at current prices for 2 main reasons. 1. there is a possibility that the company will be able to surprise positively and achieve something closer to the top of the guidance in 2030 (as the market projects) and with better margins, causing a big increase in earnings yield; and 2. ASML is a premium company and deserves a premium valuation, due to the strength of its competitive advantages and essentiality in secular trends.
The Bottom Line
Putting all the pieces together, ASML can be characterized as a company with 1. many competitive advantages, 2. a business model capable of generating shareholder value, 3. with secular growth prospects, and finally, 4. with a compelling valuation.
These factors, despite the cyclicality and some risks specific to the thesis, justify my optimism about ASML.
