ASML Impresses With EUV Growth as Price Remains Stretched

ASML Holding NV (ASML, Financial) – the manufacturer of extreme ultraviolet lithography equipment for semiconductor fabrication – reported the results of its second quarter on Wednesday, beating both the top and bottom line consensus.

Revenue came in at $3.2 billion, up more than 30% on a year-over-year basis. Wall Street was modeling for revenue of $3.05 billion for the second quarter. Earnings reached $1.61 a share during the quarter, translating into approximately 26% year-over-year growth. Earnings per share were also ahead of analyst consensus of $1.42.

For the third quarter, the Netherlands-based semiconductor company is guiding for midpoint revenue of $3.2 billion, slightly below the analysts’ consensus of $3.27 billion. The company expects earnings to be $1.85 per share, ahead of the Street’s consensus of $1.74. The market reacted positively to the results as the stock gained nearly 6%.

Extreme ultraviolet lithographyis boosting revenue growth

Revenue was supported by better-than-expected shipments of extreme ultraviolet lithography equipment, which is used to manufacture semiconductor chips. The company projects it will sell 20 EUV systems in 2018 and a total of 30 EUV systems in 2019.

In a statement, CEO Peter Wennink commented on the company's performance.

“In Q2 we shipped four EUV systems, one more than we forecasted, as Logic customers prepare for the ramp of next node devices starting later this year. We recognized revenue for seven EUV systems.”

During the quarter, the semiconductor equipment manufacturer generated most of its revenue from argon fluoride immersion – a resolution enhancement tool for integrated circuits using an ArF laser source – followed by extreme ultraviolet lithography. The company generated more than 80% of its revenue from ArF immersion and extreme ultraviolet lithography during the quarter.

What lies ahead for EUV adoption?

ASML is hoping for widespread adoption of extreme ultraviolet lithography equipment in the semiconductor industry as circuit features continue to shrink. Most of the semiconductor companies, including Advanced Micro Devices (AMD, Financial) and Apple (AAPL, Financial), have 7-nanometer products in the pipeline, which is good news for ASML. Samsung’s (SSNLF, Financial) foundry is also deploying EUV to churn out its first 7-nm semiconductor chips.

The extreme ultraviolet lithography market is set to reach $10.3 billion by 2023, translating into a compound annual growth rate of 28.3% between 2018 and 2023. ArF immersion, on the other hand, is expected to witness single-digit growth over the same period. As ASML generates most of its revenue from these two areas, it’s safe to say that the Dutch semiconductor equipment manufacturer will continue to experience growth in its revenue going forward.

What are the hurdles?

Although the company is selling EUV equipment to semiconductor manufacturers, it should achieve 90% uptime for its devices to be optimally deployed for mass production. The company is hoping to reach greater than 90% uptime by 2019. Note that ASML has already crossed the 250 Watts power source barrier, which was critical for making the systems viable for mass production. In short, there seems to be no major hurdles left to prevent the mass adoption of EUV for semiconductor manufacturing except costs.

Unless an alternative technology surfaces – a highly unlikely scenario as the semiconductor industry has largely focused its time and money on EUV – it is difficult to see a replacement for the fabrication technology.

In summary, ASML is set to benefit from the adoption of EUV, which is evident from the company’s healthy quarterly growth, favorable industry forecasts and the fact the company is successfully crossing barriers in the way of mass production.

Valuation is a tricky business

It is unclear, however, how the company will benefit monetarily from the adoption of EUV going forward. The company itself is modeling for “a 2020 annual revenue opportunity of $12.8 billion with an EPS greater than $10.5, with significant further growth potential into the next decade.” The problem, however, is the stock is trading higher even after adjusting for this growth. Based on the revenue forecast provided by management for 2020, the stock is trading at a price-sales ratio of 7.3, which is high for a growth stock. The forward price-earnings ratio is around 20, which isn’t very cheap.

Let’s take a look at the economic value added approach to see how ASML stands from a valuation perspective.

Capital value

Note, this valuation projects the total market value of ASML’s stock, excluding dividends. Approximately 16% per annum growth in earnings is assumed between 2020 and 2023, in line with the EUV and ArF immersion forecasts discussed above. Analyst consensus for 2018 and 2019 was used for valuation.

Value of dividends

As ASML is paying dividends, the valuation of these dividends is separately gauged. The company is planning to pay $1.72 per share in 2018. Assuming a 5% per annum growth rate over the next five years, the value of dividends amounts to $33.5.

The valuation reveals that a rough fair value of ASML should be around $200. It is important to note this valuation assumes a 16% growth rate for the company. As the stock is already trading around $217 and is also priced expensively based on price-sales and price-earnings multiples, the price seems to be a bit stretched.

Takeaways

As ASML reported healthy revenue growth, especially on the extreme ultraviolet lithography front, mass adoption of EUV equipment might be a reality in near future. In addition, since the company is the only supplier of this equipment, it should benefit even more.

Regardless, the valuation seems a bit stretched and the stock doesn’t offer much value to investors.

Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours