ASML Holding (ASML -1.91%) is one of the most important semiconductor equipment companies in the world. The Dutch company is the world's largest producer of photolithography systems, which are used to etch circuit patterns onto silicon wafers. It's also the only producer of high-end EUV (extreme ultraviolet) lithography systems, which are used to produce the world's smallest and densest chips.
ASML's EUV systems cost about $200 million each and require multiple planes to ship. The world's most advanced chip foundries -- Taiwan Semiconductor Manufacturing (TSM -2.15%), Samsung, Intel, and Micron -- all use those EUV systems to manufacture their newest chips. ASML also sells cheaper and less advanced DUV (deep ultraviolet) systems to lower-tier foundries like UMC and GlobalFoundries, as well as integrated device manufacturers (IDM) like Texas Instruments.
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ASML's dominance of that crucial technology makes it a linchpin and bellwether of the semiconductor sector, but its stock has lost more than half its value this year. Let's review the bear and bull cases for ASML, and see if its year-to-date pullback represents a promising buying opportunity for long-term investors.
What the bears will tell you about ASML
The bears expect a combination of macro and regulatory headwinds to derail ASML's growth. On the macro front, slower sales of PCs in a post-pandemic world, inflationary and supply chain pressures for the smartphone market, and more conservative spending from data center operators are all expected to curb the market's appetite for new chips.
That slowdown is reflected in the gloomy guidance provided by Micron, AMD, Nvidia, and other chipmakers in their latest quarters. TSMC, ASML's largest customer, also recently reduced its full-year capex from $40 billion to $36 billion as the market's demand for new chips cooled off. All those warnings indicate that the global chip shortage -- which prompted many chipmakers to ramp up their production of new chips last year -- could become a supply glut soon.
On the regulatory front, the Biden administration recently passed new export restrictions for semiconductors, semiconductor equipment, and services to Chinese companies that manufacture chips at and below the 14nm node. That sweeping ban could exacerbate the supply glut and throttle its long-term sales in China. ASML generated 15% of its net system sales in China last year, which makes it the company's third-largest market after Taiwan (39%) and South Korea (33%).
In 2021, ASML's revenue and earnings per share (EPS) grew 33% and 69%, respectively, as the top foundries scrambled to buy new EUV systems. But this year, analysts expect ASML's revenue to rise just 11% as its EPS declines 6%. That deceleration indicates that ASML could face a cyclical slowdown as the growth of the semiconductor market stalls out.
What the bulls will tell you about ASML
The bulls will point out that the market's demand for ASML's systems is still outstripping its available supply. Back in July, ASML pointed out that supply chain constraints, not softer demand, was throttling its sales growth.
On TSMC's latest conference call, Investor Relations Chief Jeff Su also said that half of the company's $4 billion capex reduction was "related to tool delivery," which implies it didn't receive enough EUV systems from ASML, while the other half was a capacity reduction related to slower chip sales. TSMC still needs a stable supply of ASML's EUV systems, as well as its newer high-NA EUV systems, to maintain its lead against Samsung and Intel in the "process race" to manufacture smaller and denser chips.
Therefore, TSMC and its rivals won't significantly reduce their EUV orders simply because the semiconductor market faces a cyclical slowdown. Instead, ASML's growth should accelerate again as it resolves the supply chain issues and resumes its deliveries at a stable pace.
That's why analysts still expect ASML's revenue and EPS to grow 22% and 41%, respectively, in 2023. ASML's own long-term targets, which it updated last September, reflect that longer-term optimism. It expects to generate 24 billion to 30 billion euros ($29 billion) in revenue in 2025, based on low to high expectations for the broader semiconductor industry.
That forecast implies ASML's revenue could still increase at a compound annual growth rate of 7%-13% between 2021 to 2025. However, ASML could actually be sandbagging that guidance: It previously exceeded the high range of its 2016 and 2018 investor targets ahead of schedule.
Last but not least, ASML's stock doesn't look too expensive at 21 times next year's earnings. It isn't a screaming bargain yet, but its monopolization of a crucial chipmaking technology could easily justify that valuation.
Which thesis makes more sense?
I personally believe the bullish thesis for ASML makes more sense. The company faces some near-term headwinds, but I believe it remains one of the best long-term plays on the secular expansion of the semiconductor market. This is one stock you should definitely be buying while other investors are crying.
