While semiconductor manufacturing supplier ASML Holding (ASML -1.03%) was not immune to the pandemic, supply chain challenges, inflation, and rising interest rates, it has held up better than many other technology companies. But now that many economic experts think a worldwide recession is likely, many investors wonder how well the company will fare in a slowing economic environment.
Here's why ASML is a safe harbor in the current economic storm.
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Strong demand for ASML products trumps recession concerns
In January 2022, research and consulting firm Gartner issued a press release stating that worldwide semiconductor revenue grew 25.1% in 2021 to reach $583.5 billion, crossing $500 billion for the first time. Yet despite rapid growth, semiconductor manufacturers can't build advanced chips fast enough to satisfy demand.
In response to the chip shortfall, top manufacturers like Taiwan Semiconductor Manufacturing Company (TSM -0.34%) and Intel (INTC 0.64%) plan to make massive investments to keep up with the rising demand for state-of-the-art chips. And since ASML's lithography systems are crucial in manufacturing modern chips, these chip manufacturing capacity expansions are already showing up in increased demand.
The company's second-quarter 2022 results showed new orders (bookings) rising to 8.5 billion euros, from pre-pandemic Q2 2019 bookings of 2.8 billion euros. This booking number indicates robust demand and is the highest quarterly level in company history.
In addition to solid demand, ASML has a very healthy backlog of 33 billion euros that it can count on if order demand slows. According to industry reports, the lead time on ASML's most advanced equipment is approximately 12 to 18 months. Since chipmakers need ASML machines to remain competitive, as they are the only solution available on the market to produce advanced chips, customers will be unlikely to consider losing their place in line, except under the direst conditions.
Moreover, ASML customers have already told the company that they will not cancel their orders even if demand slows down in their end markets. Consequently, management believes that a moderate recession would only have a limited effect on its results.
The supply chain and inflation are ASML's Achilles' heel
While ASML has plenty of demand, its main problem is that it cannot supply its customers with its machines fast enough. Since the third quarter of 2021, management has blamed its problems of delayed production starts on supply chain issues.
To cover up some of these supply chain challenges, ASML started utilizing fast shipments in 2021, a program that forgoes testing the lithography machines in its factories. Instead, ASML performs the formal testing and acceptance at the customer's site. Customers get to use the machines faster, but ASML must defer revenue to later quarters.
Some investors have a big issue with ASML's use of fast shipments because the deferred revenues hurt current results. For instance, ASML initially projected year-on-year revenue growth of 20% for 2022, but has since lowered expectations for revenue growth to around 10% in the Q2 earnings report.
In addition to supply chain woes, rising inflation has become a massive concern for the company. ASML is encountering inflation in two forms. First, rising labor costs result from the company's need to boost its headcount to meet market demand for its products, in a job market short of semiconductor engineers. The second inflation concern is rising component pricing because of higher material and transportation costs.
ASML reduced its full-year 2022 gross margin expectations from 53% to 52% in the first quarter because of inflation. In addition, the company lowered gross margins further in Q2, to between 49% to 50% for 2022, based on supply chain issues and the use of fast shipments.
ASML Gross Profit Margin (Quarterly) data by YCharts
Is now the time to buy?
While the adverse effects of inflation and supply chain problems have hurt current results, both issues are only a short-term concern. ASML should be able to correct supply chain issues over the next several years by working with its partners to get production capacity up to speed. As for inflation, ASML will eventually raise pricing to counter inflation's effects. Higher interest rates should also dampen inflation over the next year or two.
And over the longer term, the company's results are driven more by global megatrends fueling demand for advanced and mature chips. Therefore, you can expect production to ramp higher over the next several years to meet demand, resulting in a reacceleration of revenue growth, with gross margins moving toward the company's goal of 54% to 56% in 2025.
If you are looking to buy a high-upside growth company resistant to a recession, ASML should be a solid bet in the current environment.
