ASML (ASML -1.99%) posted its first-quarter earnings report on April 19. The Dutch semiconductor equipment maker's net sales surged 91% year over year to 6.75 billion euros ($7.4 billion), which exceeded analysts' estimates by 360 million euros. Its net income jumped 181% to 1.96 billion euros ($2.15 billion), or 4.96 euros ($5.44) per share, which also easily cleared the consensus forecast by 0.80 euros per share.

Those growth rates were amplified by an easy comparison to its 19% revenue decline and 48% drop in net income a year earlier, which had largely been caused by the post-pandemic slowdown of the PC market, sluggish sales of smartphones, and other headwinds for chipmakers. So is it the right time to buy ASML and bet on its cyclical comeback?

A close-up shot of a silicon wafer.

Image source: Getty Images.

The bellwether of the semiconductor market

ASML is the world's largest producer of lithography systems, which are used to etch circuit patterns onto silicon wafers. It's also the world's only producer of extreme ultraviolet (EUV) lithography systems, which are used to manufacture the world's smallest, densest, and most power-efficient chips.

ASML's massive EUV systems cost about $200 million each and require multiple planes to ship, so it doesn't face any competitors at all in that capital-intensive market. Its top customers include Taiwan Semiconductor Manufacturing (TSM -1.14%), the world's most advanced contract chipmaker, as well as its competitors Samsung and Intel. It also sells its lower-end deep ultraviolet (DUV) systems to diversified chipmakers like Texas Instruments.

Since chip foundries can't produce chips without ASML's systems, it's often considered the bellwether and linchpin of the semiconductor market. It also represents an appealing way to profit from the market's growing demand for fresh chips without investing in individual chipmakers. But that also means ASML's growth is just as cyclical as the semiconductor sector -- which goes through boom and bust cycles every few years.

Will the current cyclical downturn end this year?

ASML endured two slowdowns over the past five years. The first one occurred in 2019 when the smartphone market cooled off and triggered a supply glut in memory chips. The second one started last year when PC sales cooled off as pandemic-related pressures eased. But through it all, ASML's gross margin continued to expand because it had near-absolute pricing power. 

Metric

2018

2019

2020

2021

2022

Revenue Growth (YOY)

22%

8%

18%

33%

14%

Gross Margin

46%

44.7%

48.6%

52.7%

50.5%

EPS Growth (YOY)

27%

1%

38%

69%

(2%)

Data source: ASML. YOY = Year over year.

In the second quarter of 2023, ASML expects its revenue to grow 20% to 30% year over year as its gross margin rises from 49.1% to between 50% and 51%. For the full year, it expects its revenue to rise by at least 25% as its gross margin slightly expands.

Those rosy estimates defy the recent rumors that suggest TSMC could slash or delay its EUV orders from ASML this year. That threat initially rattled investors, since ASML generated 38% of its revenue from Taiwan in 2022 and TSMC accounted for the lion's share of those orders. But it doesn't make too much sense if you review the facts.

While discussing its fourth-quarter earnings report in January, TSMC management predicted the semiconductor market would bottom out and stabilize in the second half of 2023 -- so it would be odd to abruptly reduce its EUV orders when it should be installing more systems to ramp up its development of 3-nanometer chips and stay ahead of Samsung and Intel. ASML's reiteration of its full-year forecast further backs that outlook and suggests the recent rumors regarding order reductions are unsubstantiated.

Over the long term, ASML believes it can generate 44 billion euros ($48.2 billion) to 60 billion euros ($65.8 billion) in revenue in 2030. The midpoint of that forecast implies its top line will still grow at a steady compound annual growth rate (CAGR) of 12% from 2022 to 2030. It also believes its annual gross margin will expand to between 56% to 60% by 2030.

ASML still deserves its premium valuation

ASML might seem a bit pricey at 32 times this year's earnings, but it deserves that premium because it's monopolized a crucial piece of chip-making technology. It could face cyclical headwinds and regulatory pressure (especially regarding its sales of DUV systems to Chinese chipmakers), but I believe it deserves that premium because it's still one of the best long-term plays on the secular expansion of the semiconductor market.