Artificial intelligence (AI) stocks have been all the rage on the stock market in 2023. The rapidly growing adoption of this technology has turned out to be a major catalyst for companies that are driving the AI revolution, making semiconductor companies solid investments this year.
The PHLX Semiconductor Sector index has jumped an impressive 36% in 2023, outpacing the S&P 500's gains of 12% by a massive margin. However, not all components of the semiconductor index have been on fire. ASML Holding (ASML 2.04%), for instance, is up just 5% in 2023.
It is worth noting that the Dutch semiconductor bellwether got off to a solid start and logged impressive gains until the beginning of July. It also delivered robust second-quarter results in July that saw ASML management raise its full-year guidance. However, shares of the company are down 25% since hitting their 52-week highs in mid-July.
Let's look at the reasons behind ASML's recent drop and check if this could be a buying opportunity for savvy investors looking to make the most of the proliferation of AI.
External factors have pulled the stock down
Though ASML has been delivering robust top- and bottom-line growth in recent quarters, investors seem to be worried about the potential impact of a slowdown in the smartphone and personal computer (PC) markets on its financial performance.
ASML Revenue (TTM) data by YCharts
For instance, PC sales are expected to drop almost 14% in 2023, according to market research firm IDC. The smartphone market has also been reeling under the impact of weak demand. Counterpoint Research estimates that smartphone shipments could drop 6% this year, which would be the market's worst performance in a decade.
The weak demand for chips from these two key markets explains why sales of chipmaking equipment are expected to decline in 2023. Industry association SEMI estimates that sales of semiconductor manufacturing equipment could decline almost 19% in 2023 to $87 billion. So, it was not surprising to see ASML CEO Peter Wennink strike a cautious note following the company's recent earnings as he warned that the broader chip recovery could be pushed out to next year from the end of 2023.
These potential headwinds are probably the reason TF International Securities analyst Ming-Chi Kuo expects ASML's customers to reduce orders for the company's chipmaking equipment. Kuo points out that ASML may have to face significant cuts in the range of 20% to 30% for its extreme ultraviolet (EUV) lithography machines that are central to the manufacturing of advanced chips.
The analyst believes that demand for advanced chips, which are playing a central role in the proliferation of AI applications, will not be as strong as expected in 2024 on account of soft sales of popular devices such as iPads and MacBooks. However, there are a couple of key points that could help ASML maintain the outstanding growth that it is currently clocking.
Why ASML could keep growing
The biggest reason ASML is unlikely to face a slowdown is its massive order backlog, which was worth 38 billion euros in the second quarter of 2023. That's a big number considering that ASML is anticipating a 30% increase in revenue in 2023 to 27.5 billion euros. So, ASML has a strong backlog that should help it deliver the 13.9 billion euros in revenue that it is anticipating in the second half of the year, and still be left with enough to deliver similar revenue in 2024.
However, don't be surprised to see ASML sustain a strong level of revenue growth in 2024 and beyond as well, thanks to the booming demand for AI chips. That's because ASML supplies the equipment that enables foundries such as Taiwan Semiconductor Manufacturing to make chips capable of tackling AI workloads.
Given that the demand for AI chips is expected to increase at an annual rate of 29% through the end of the decade, ASML should ideally witness stronger demand for its machines in the future. Investors should also note that sales of semiconductor manufacturing equipment are set to rebound from 2024, with SEMI forecasting a 14% jump in revenue next year to $100 billion.
By 2030, the semiconductor manufacturing equipment market could generate $150 billion in revenue as per third-party estimates, indicating that ASML's growth is here to stay for a long time. All this indicates why ASML's earnings are expected to jump at an annual pace of 23% over the next five years. The company generated $15.86 per share in earnings last year. So, ASML's earnings could jump to $44.65 per share in 2027.
Multiplying the estimated earnings with ASML's five-year average forward earnings multiple of 34.6 points toward a share price of $1,545 after five years -- a 170% jump from current levels.
With the stock currently trading at 30 times trailing earnings, which is a discount to ASML's five-year average price-to-earnings ratio of 41, investors would do well to buy this potential AI winner before it regains its mojo and starts rising again.
