ASML's (ASML -0.14%) stock plunged 13% on July 17 amid three major developments for the Dutch semiconductor equipment maker.
First, it followed up its second-quarter earnings beat with soft guidance for the third quarter. Second, several reports indicated the Biden administration would further tighten its restrictions on semiconductor equipment sales to China. Lastly, former President Donald Trump commented that Taiwan -- the world's largest producer of chips and ASML's biggest single market -- should pay the U.S. for military protection against China.
These developments sent shockwaves through the semiconductor sector and sank ASML, the world's leading producer of lithography systems. Let's review the bear and bull cases to see if that pullback represents a buying opportunity.
Image source: Getty Images.
The key facts and figures
ASML's lithography systems are used to optically etch circuit patterns onto silicon wafers. It's the largest producer of deep ultraviolet (DUV) systems, which are used to produce older and larger chips, and the only producer of extreme ultraviolet (EUV) systems, which are required to manufacture the smallest and densest chips.
All of the world's top foundries -- including Taiwan Semiconductor Manufacturing, Samsung, and Intel -- use ASML's EUV systems to produce their most advanced chips. ASML's monopolization of that crucial technology gives it plenty of pricing power and makes it a linchpin of the global semiconductor market. However, that dominance also makes it a top target for government regulators in the escalating chip war between the U.S. and China.
The Dutch government already barred ASML from shipping its EUV systems to China in 2019, and it expanded that ban to include its newer DUV systems in 2023. If the U.S. pressures the Dutch government to pass even harsher export curbs, ASML could be banned from shipping any of its systems to China, which still accounted for 26% of its revenue in 2023. Taiwan, which accounted for 29% of its sales, is also heavily exposed to the escalating tensions between the U.S. and China.
ASML's growth is cyclical, but it's grown at an impressive clip over the past five years as its gross margin consistently improved. Most of its recent growth has been driven by the expansion of the artificial intelligence (AI) market and the "process race" between the world's top foundries to manufacture the smallest and most advanced chips.
|
Metric |
2019 |
2020 |
2021 |
2022 |
2023 |
|---|---|---|---|---|---|
|
Revenue growth |
8% |
18% |
33% |
14% |
30% |
|
Gross margin |
44.7% |
48.6% |
52.7% |
50.5% |
51.3% |
|
EPS growth |
1% |
38% |
69% |
(2%) |
41% |
Data source: ASML. EPS = earnings per share.
The bear case vs. the bull case
The bears will note that ASML expects to generate flat revenue growth this year as it deals with the export curbs in China, laps the AI market's initial growth spurt, and gradually transitions from its EUV systems to its newer high-NA EUV systems.
Analysts expect ASML's revenue to stay roughly flat this year as its EPS dips 6%. The bears will claim those are dismal growth rates for a stock that trades at 44 times forward earnings. They'll also warn you that tighter export curbs against China could make it challenging for ASML to even match those conservative estimates.
In a worst-case scenario, a military conflict between China and Taiwan would instantly wipe out more than half of ASML's revenue. But if that black swan event happens, the entire stock market -- not just ASML or TSMC -- would likely crash.
The bulls believe ASML's growth will accelerate in 2025 and beyond as it ramps up its shipments of EUV systems for producing even smaller and denser chips. The stabilization of the PC and smartphone markets should complement that growth. ASML expects those tailwinds to pick up in the second half of 2024, while analysts expect its revenue and EPS to grow 32% and 62%, respectively, in 2025. Based on those expectations, ASML's stock trades at just 27 times next year's earnings.
Which argument makes more sense?
The bears make some good points about ASML's challenges, but I'm still bullish on this stock for three reasons: It has monopolized an indispensable chipmaking technology, it's tightening its grip on the world's leading foundries with its high-NA EUV systems, and it's a balanced way to profit from the secular growth of the semiconductor market without putting all of your eggs in a single chipmaker's basket.
ASML stock might remain under pressure as investors focus on its lackluster near-term growth and regulatory headwinds, but I believe it can overcome those challenges and set new highs in just a few years.
