Michael Vi
Not Seeing A Recovery Yet
I have previously voiced confidence in the growth outlook for semiconductor equipment and ASML (NASDAQ:ASML) management’s ability to execute on the tailwind. However, in my previous coverage, I have also voiced valuation concerns that are compounded by macro pressures. Today, although ASML stock is up more than 20% from the lows touched in early October, I continue to remain more bearish than bullish. Specifically, looking at the overall semiconductor landscape, especially the equipment side, I warn against turning too bullish, too soon. As I see it, the equipment CAPEX investment cycle for most foundry companies has peaked sometime during the past 12–18 months. Samsung, for example, projected FY 2023 capital expenditure of 54 trillion KRW, essentially flat YoY, while semiconductor capex specifically is expected to decrease by 5% YoY. Moreover, the vendor/ buyer dynamic between ASML and foundry companies looks to have shifted in favor of the buyers, as ASML is slowly building up inventory.
Notably, in the past quarter ASML received only three orders for EUV tools in the third quarter, significantly lower than what analyst consensus expected (~9 tools). At least equally disappointing was the insight that existing EUV tool orders in the backlog were experiencing customer-driven shipment delay requests. Investors should thus expect that the substantial EUV backlog, currently valued at approximately €15 billion and ~75 tools, is likely materializing much slower than expected. In that context, headwinds for ASML are caused by a multitude of factors, including delays in fab construction, a weak semiconductor demand backdrop, as well as a broader economic weaknesses.
ASML complemented the soft fundamentals with a somewhat lackluster outlook: The company now expects overall revenues for 2024 essentially to be flat YoY, followed by a pick-up in sales in 2025. However, I point out that while the disappointing 2024 forecast looks quite certain, the 2025 confidence is clouded by uncertainty and some speculation (long term outlook is not as easy to forecast as the short term).
The feeble demand environment for ASML’s semiconductor manufacturing equipment translates into weak Free Cash Flow generation, not only in 2023, but also into 2024. Consequently, the company’s buybacks during the third quarter amounted to only €100 million, a material drop from the €900 million repurchased through the first six months of the year. Notably, ASML’s TTM equity yield, including buybacks and dividends, has now compressed to below 2% (down from ~3% seen in FY 2022) less than half the return promised by both short-dated and long-dated U.S. treasuries.
The good news for investors is that the headwinds from export controls to China look less severe than feared. ASML’s preliminary perspective suggests that approximately 10-15% of their sales in China, roughly around €1 billion, could be at risk in 2024 due to these changes. However, I would remind investors of the quite significant risk of additional export tightening.
I admire The Long-Term Story …
While I am cautious on ASML’s short term outlook, I am more bullish on the company’s structural equity story. In my view, ASML stands as the predominant force in lithography tools, which is a crucial component in the modern economy, facilitating all of the technology verticals that are poised to see safeguard economic growth into the future. More specifically, with an estimated, approximate market share nearing 90% in EUV lithography, ASML essentially monopolizes the next-generation of semiconductor equipment.
… But Not At The Current Price
That said, however, I am not buying, nor advising to buy, ASML stock at current valuation multiples, especially considering the multitude of previously disused short-term business headwinds. Investors should consider that ASML stock is currently trading at a 33x P/E forward multiple for consensus 2024 earnings– this is a materially higher multiple than quoted on some of the most promising “GARP” tech stocks, e.g., Meta Platforms (24x) and Google (24x). In fact, even the almighty Apple stock is cheaper than ASML, at 29x forward P/E. The main reason why I don’t think ASML deserves to trade at a premium to Meta or Google relates to the company’s relatively stronger exposure to economic cycles. Moreover, compared to some of the tech giants, ASML’s business fundamentals falter to be protected by network effects (Google, Meta), or brand value (Apple). As I see it, for ASML, investors are well-advised to target an entry multiple between 20-25x.
Seeking Alpha
Investor Takeaway
The recent bullish uptrend in ASML stock does not match with an overall fundamental recovery in the semiconductor landscape. In fact, the CAPEX cycle for foundry companies’ equipment investment seems to have peaked in the last year or so; and a rebound should not expected prior to 2025. For ASML, the headwinds are visible in the lower-than-expected orders for EUV tools, paired with delays in shipments on the existing order book. This soft demand scenario affects the company’s Free Cash Flow and buyback activities, with ASML’s equity yield for TTM having compressed to below 2%.
While ASML stands strong in the long-term structural equity story due to its dominance in lithography tools, the current stock valuation may not warrant an investment. With ASML trading at a significantly higher forward P/E multiple compared to other promising tech stocks, entry considerations suggest aiming for multiples between 20-25x. I assign a “Hold” rating.
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