The semiconductor industry saw a record $556 billion in revenue for the full year of 2021. According to analysts, total revenue is supposed to nearly double in size by 2030. But how can investors capitalize on this massive opportunity?
Owning shares of Advanced Semiconductor Materials Lithography, or ASML (ASML 1.46%), might be the best way to capture this opportunity; here's why.
The only game in town
ASML is the sole manufacturer of EUV lithography machines. EUV (extreme ultraviolet) lithography is what enables advanced chips to be "printed" on silicon. As chip designs get smaller, it becomes increasingly difficult to print those designs; EUV technology enables this difficult process. Each EUV machine that ASML creates sells for over $100 million.
ASML does not design or manufacture any semiconductor chips. It designs and manufactures the machines that create the chips. Some of its biggest customers are TSMC, Samsung, and Intel. As the lone manufacturer of these machines, ASML has taken a monopolistic hold on advanced chipmaking. Without ASML's lithography machines, global technological advancement would stop dead in its tracks.
There is no greater competitive edge than owning an entire market. ASML faces no competition in the EUV lithography space, which allows it to maintain high margins that have grown significantly. During the last three years, gross margin has increased 16 percentage points to 52% and operating margin has grown by 41 percentage points to 32%. These numbers are the top tier in the semiconductor space and translated to 222% growth in earnings per share over the last five years as well as a 762% increase in free cash flow.
The 9.9 billion euros in free cash flow for 2021 has been used to reward shareholders. Looking back to last year, 1.4 billion euros was paid out in dividends while 8.6 billion euros was used to buy back shares. That is nearly 5% of all shares outstanding.
Good value, but with one risk
ASML currently trades at a market cap of roughly $200 billion with a free cash flow of $12 billion. These numbers create a price-to-free cash flow multiple of 16, which gives it an attractive valuation compared with its peers. So why is ASML trading at such a cheap price?
One reason might be the supply chain issues that have hit the semiconductor industry harder than most. The Biden administration stated that these issues shaved 1% off of U.S. GDP in 2021. For ASML, quarterly revenue is down 25% year over year and deferred revenue is almost double what it was in 2020.
Deferred revenue means that ASML has taken advanced payments for its products without delivering on those orders -- customers have bought machines that haven't been manufactured yet. The increase in deferred revenue is likely due to major supply chain issues. The orders keep coming in for machines to increase chip fabrication capacity without ASML having the supplies needed to manufacture those machines. The deferred revenue is a liability on the balance sheet until it is realized and moved over to the top line. This $8 billion in deferred revenue will move to the top line in years to come, further boosting growth.
The supply chain is an inherent risk when you invest in any company with exposure to the global economy, but even so, I think that ASML is well-positioned for success. With ASML at a market cap of just under $200 billion, I think this is a great opportunity to buy one of the most important companies in the world.
