Before ASML Holding (ASML -1.95%), a leading manufacturer of advanced chipmaking equipment, released its third-quarter earnings on Oct. 19, investors got two pre-Halloween scares.
First, on Oct. 7, the U.S. Department of Commerce released new rules prohibiting U.S. companies from exporting advanced semiconductor technology to China.
Second, Taiwan Semiconductor Manufacturing (TSM 0.36%), the world's largest manufacturer of advanced chips, said during its Oct. 13 earnings call that it was lowering capital spending in 2023. Since at least 60% of chip manufacturers' capital spending goes toward buying chipmaking tools, Taiwan Semiconductor cutting back on spending was taken as bad news by investors. And ASML's stock dropped approximately 8% on the news.
But despite recent investor angst, there are still great reasons to invest in the company for the long term. Here are three of them.
1. The impact of China export rules is limited for ASML
ASML is a European company with very little U.S. technology in its tools, enabling it to ignore many U.S. rules. Therefore, management expects to continue shipping the less-advanced deep ultraviolet (DUV) lithography systems to China.
In an interview, chief financial officer Roger Dassen said that although the direct impact of the export limits on China should be minimal, there could be an indirect effect. For example, China could fail to get other equipment that it needs for advanced chipmaking from U.S. manufacturers, rendering ASML's equipment useless.
Dassen then said that even if ASML failed to ship products to China, its capacity is so far below demand outside of China that other customers would quickly replace any loss of Chinese sales. Dassen's commentary soothed investors' fears over the issue.
2. Tailwinds from the adoption of new technologies
Innovations like 5G, artificial intelligence, mobile devices, cloud computing, and other modern technologies are driving the need for smaller, faster, and cheaper semiconductors. This sparked a race among semiconductor manufacturers to be the first to mass-produce chips as small as 2 nanometers. And since ASML is the lone maker of machines using extreme ultraviolet (EUV) lithography, a technology that reduces the size of semiconductors better and more cheaply than any other current technology, there is high demand for the company's EUV system.
Moreover, since there is a long lead time to receive an EUV lithography machine, it can severely hurt a chipmaker's long-term competitiveness to cancel an order.
During the third-quarter 2022 earnings call, Dassen said that for the first time, the company is seeing some customers delaying the time that they would prefer to take delivery of ASML's tools. Still, most customers prefer to receive those tools sooner rather than later, and will take the place of any company that wants to delay delivery . So while ASML is not immune from the effects of a downturn reducing demand, it is highly resistant to it.
The company's record order intake of 8.9 billion euros ($8.8 billion) in the third quarter shows high demand for its products, despite a possible recession.
3. The push for technological sovereignty
Technological sovereignty is the idea that a country should control its information and communications infrastructure. For instance, the U.S. government created the CHIPS and Science Act of 2022 to jump-start domestic semiconductor manufacturing capacity, reducing reliance on Asian chipmakers.
Based on third-party data, ASML believes that this push for technological sovereignty will result in the U.S., China, the E.U., Japan, and South Korea nearly doubling the industry's 2021 annual capital expenditures of $150 billion. Consequently, these countries' push to create a homegrown semiconductor industry will likely drive additional demand for ASML's tools.
While some worry that the recent technological sovereignty trend could create an oversupply of chips, ASML believes that the semiconductor industry requires substantially more capacity over the long run. Moreover, the company expects this trend to play out over multiple years, generating long-term demand for its entire product portfolio.
What could go wrong?
ASML uses more than 100,000 parts from approximately 4,700 global suppliers to manufacture an EUV system. So you can imagine that the pandemic delivered a significant gut punch to the company's supply chain. And an ailing supply chain continues to be a considerable investor worry.
But the good news is that ASML is progressing in recovering from this pandemic-induced shock. And despite this risk and a terrible macroeconomic environment, it still generated solid net sales of 5.77 billion euros and gross margins of 51.8% in the third quarter of 2022, soundly beating its guidance. Moreover, the report calmed market fears of a potential slowdown.
Investors looking for a solid growth investment in an uncertain environment would be hard-pressed to find a better option than ASML Holding.