They say that necessity is the mother of invention. As such, this difficult period of supply chain issues, shortages, and high inflation could be fertile ground for companies to find new and better ways to operate. After all, the pandemic showed companies that they could function effectively with many or all of their employees working from home. What new efficiencies might be developed in the current constrained environment?
For example, semiconductor equipment company ASML Holdings (ASML -1.25%) has a problem: It lacks enough capacity to meet its customers' demand, and those supply constraints are leading to long wait times for buyers. Since ASML has a monopoly on some technologies that are essential for chipmakers, this has been very disruptive to some customers. While there are some concerns about a potential glut of PC and smartphone chips, shortages persist for other types of cloud, industrial, and automotive chips.
However, ASML has adapted, figuring out a new way of operating that could actually pay dividends in the future, even after current supply chain problems ease.
Fast shipping leads to delayed revenues
Demand for its machines has far outstripped supply, so ASML is now shipping its machines as soon as they leave the factory -- before it conducts their final tests. Instead, that testing occurs at the end customer site. This actually speeds up the process, allowing clients to begin running wafers sooner than they would have been able to if qualification had occurred at ASML's factories.
For ASML, though, there's an accounting downside to this change. The company can't recognize revenue from a machine's sale until that machine is fully qualified. So even though ASML's customers are receiving their machines earlier, ASML can't officially put the revenue from them on the books until much later.
As a result, ASML was only able to recognize revenue for 12 extreme ultraviolet lithography (EUV) machines last quarter, even though it shipped 14. For the year, ASML will ship 55 systems, but will only recognize revenue for 40 of them. So even though it will ship all the hardware it intended to ship this year -- about 20% more machines than last year -- it won't be able to recognize all that revenue in 2022, so its revenue growth will only be 10% this year, in contrast to its initial guidance for growth of 20%.
But there could be a silver lining
On its recent second-quarter conference call with analysts, management said that in the future, fast shipping will go one of two ways. Either ASML will return to testing at its own sites once the supply constraints ease, or it will continue fast shipping and have final testing occur at its customers' sites.
If ASML continues fast shipping all its systems without problems, it may get permission to recognize revenue when it ships a system, even if final testing hasn't been done. Thus far, none of the systems it shipped before final testing have had problems, so the current method actually seems to be working rather well.
This is a win for both ASML and its customers. If the equipment maker made this procedure standard, it wouldn't need to keep as much testing equipment and personnel on hand, and it wouldn't have to hold its machines in inventory for as long. Therefore, fast shipping has the potential to increase its capacity and reduce its working capital requirements.
Once ASML has permission to recognize revenue for fast shipments sooner, the company will see a revenue spike, as booked revenue "catches up" with shipped orders. But even beyond that point, an increase in throughput that doesn't sacrifice quality is a good thing for any manufacturing business.
Look for companies improved by today's difficulties
In periods of stress, great management teams tend to find ways to adapt. Those trials by fire can yield improvements that set businesses up for future success once the period of difficulty ends.
As we enter earnings season during a time of supply constraints, high inflation, and wavering consumer demand, look for companies that are adapting and turning their obstacles into opportunities. Odds are, they will be better businesses coming out of this inflationary period, which means they could be your next great stock buys.