What happened
Shares of lithography giant ASML Holdings (ASML -1.60%) were down in Wednesday trading following its second-quarter earnings report, falling 5.1% as of 2:56 p.m. ET.
ASML broadly beat consensus figures while raising its full-year guidance. However, management's commentary was more subdued, and some of the guidance raise was due to an accounting change regarding its fast shipments to customers. Furthermore, the quarter's strength appeared concentrated in the China market, which may be at risk of further sanctions.
So what
In Q2, ASML posted revenue growth of 27.8% to 6.9 billion euros ($7.3 billion) compared with expectations for 6.74 billion euros ($7.6 billion), and net-profit growth of 35% to 1.9 billion euros ($2.13 billion) compared with analyst expectations for 1.82 billion euros ($2.04 billion). Furthermore, management raised its full-year revenue-growth guidance from over 25% to around 30%.
So, what exactly was the problem here? Well first, ASML has recovered nicely this year from last year's sell-off, posting a 31% gain year to date, even factoring in today's sell-off. So it may have been due for some profit-taking.
Second, the composition of revenue gains and commentary from management might have given investors pause.
In the video interview with CEO Peter Wennink, Wennink noted that while many chip markets are bottoming out, a recovery may be pushed out from later this year to next year. This is in spite of generative AI growth, as larger and more mature markets like PCs and smartphones are still feeling economic pressure from high interest rates and recession fears. Furthermore, Wennink noted some customers are pushing out extreme ultraviolet (EUV) orders, as new semiconductor fabrication plants (fabs) aren't yet ready due to the lack of expertise needed to get leading-edge fabs up and running.
So where did the strength come from? Actually, it wasn't with ASML's high-priced proprietary EUV tools on which it has a monopoly, but rather trailing-edge deep ultraviolet (DUV) tools, which are less sophisticated lithography tools for trailing-edge applications.
Demand for DUV is booming right now, as these are needed for power, sensor, and other trailing-edge chips needed for electrification. That's especially true of demand from Chinese customers. In fact, in the quarter, Chinese system sales made up a whopping 24% of sales, up from just 8% in the year-ago quarter.
However, the durability of those sales may be in question, as the U.S. and its allies are contemplating further restrictions on some DUV sales to China going forward. Wennink maintained that any new restrictions would not have a material impact on the company's sales this year or its long-term targets given at its Capital Markets Day. However, the new concentration in Chinese sales may be giving investors pause.
Finally, ASML's full-year guidance was also boosted by an accounting change, not entirely excess demand. During the period of supply-chain shortages since 2021, ASML adopted a "fast shipment" policy where it would ship tools to customers before final testing at the customer site. That got tools in the field faster, but ASML couldn't recognize revenue until final testing, delaying recognition. However, Wennink noted it had agreed on a reduced-testing protocol with customers for DUV tools, allowing DUV machines to be qualified faster and revenue recognized quicker. Management noted that would increase this year's revenue by about 700 million euros ($784 million).
Now what
It's not surprising to see ASML investors taking some profits amid cautious commentary from management and uncertainty over China. However, ASML seems like a stock to buy on any material dips and a hold for the long term, given its monopoly on crucial technology for advanced semiconductor manufacturing.
The stock is not cheap at around 37 times earnings, but it has never been particularly cheap, and lithography should have strong growth through the end of the decade.