ASML Holding (ASML 4.09%), the world's largest supplier of lithography systems for the semiconductor industry, might not be a familiar name to many investors. But the Dutch company's stock has roughly doubled over the past 12 months, and it could still have room to run, for four simple reasons.
1. It's an essential supply chain player
Lithography systems use light to print circuit patterns onto silicon wafers. ASML controls nearly 90% of this market, and its top customers include Taiwan Semiconductor Manufacturing (TSM 0.79%), Intel (INTC 0.84%), and Samsung.
ASML spent the past two decades developing its latest EUV (extreme ultraviolet) lithography machines, which are now being used to develop the world's smallest and most advanced chips. TSMC, for example, produced Apple's (AAPL 4.01%) newest 5nm chips with ASML's EUV machines.
2. The semiconductor market is benefiting from secular growth
The semiconductor market is cyclical, but its troughs could become shallower and its peaks could climb higher as the secular growth of newer markets -- including 5G networks, cloud and AI services, connected cars, and automated homes and factories -- generates fresh demand for more chips.
The global semiconductor market grew 5.4% in 2020, according to IDC, and could grow another 7.7% to $476 billion in 2021. The firm expects new 5G phones, expanding cloud services, and the post-pandemic recoveries of the auto and industrial sectors to drive that acceleration.
TSMC, which accounted for 31% of ASML's revenue in 2020, plans to increase its capex from $17.2 billion in 2020 to up to $28 billion in 2021 to keep pace with that demand. Samsung and South Korea's other chipmakers are also expected to boost their average capex by more than 20% this year. In short, demand for ASML's high-end lithography systems won't cool off anytime soon.
3. ASML has a history of generating robust revenue and earnings growth
ASML's revenue rose 18% to 13.98 billion euros ($16.89 billion) in 2020. It shipped its 100th EUV system during the fourth quarter, and 26 million wafers were exposed to its EUV machines at the end of the year.
EUV systems, which cost much more than ASML's other lithography systems, accounted for just 8% of its total system shipments in 2020 but generated 43% of its total system revenue.
The EUV segment's revenue surged 59% in 2020, marking an acceleration from its 49% growth in 2019, and should continue growing as TSMC, Samsung, Intel, and other top foundries ramp up their spending to produce smaller and more powerful chips.
In late 2018, ASML predicted its annual revenue would land somewhere between 15 billion euros and 24 billion euros (between $18 billion and $29 billion) by 2025. It plans to update that forecast during its next investor day in June, but the rising capex at the world's top foundries, the recent shortage in automotive chips, and the crucial role of semiconductors in the tech war between the U.S. and China all indicate ASML will narrow its guidance toward the high end instead of the low end.
ASML's gross margin rose from 44.7% in 2019 to 48.6% in 2020, and it expects that expansion to continue as it ships more EUV systems. Its net income jumped 37% to 3.55 billion euros ($4.29 billion).
4. Years of strong growth are projected and the stock is reasonably priced
Analysts expect ASML's revenue and earnings to rise 33% and 40%, respectively, this year, led by surging demand from the 5G, high-end computing, and rebounding memory markets. That would put its revenue at 18.59 billion euros ($22.45 billion) -- which is already well above the low end of its target for 2025.
Wall Street expects ASML's revenue and earnings to rise another 11% and 18%, respectively, in fiscal 2022. Assuming it generates at least 10% top-line growth over the following three years, ASML's annual revenue could easily hit 27.5 billion euros ($33.1 billion) in 2025.
ASML's earnings should keep pace with its revenue as it sells more higher-margin EUV systems and continues its ongoing buybacks. It could also pump more of its excess cash into its dividend since its forward yield of 0.5% is easily supported by its low payout ratio of 30%.
Based on these estimates, ASML trades at 40 times forward earnings. The stock isn't a bargain, but its dominance of the lithography market and the secular growth of the semiconductor market arguably justify that slight premium. Simply put, investors looking for an alternative way to profit from the soaring demand for semiconductors worldwide should consider buying his oft-overlooked stock.