Image Shown: ASML Holding NV effectively has a monopoly on the high-end space of the semiconductor equipment industry as the Dutch company sells the only lithography systems that can produce the most advanced cutting edge “chips.” We are huge fans of the company’s business model. Image Source: ASML Holding NV – Second Quarter of Fiscal 2022 IR Earnings Presentation
By Callum Turcan
Based in the Netherlands, ASML Holding NV (ASML) produces lithography systems that can produce all types of semiconductor components and effectively has a monopoly at the high-end part of this industry given its immense technological lead over its peers. The secular tailwinds driving up demand for “chips” across the globe such as the growing computing power needs of modern automobiles, cloud computing and AI activities, and the Internet of Things trend are in turn driving up demand for ASML Holding’s lithography systems.
Part of this expected demand growth is due to the need for the global semiconductor manufacturing industry to scale up their production capabilities to produce growing volumes of chips across all types of technological complexities. Furthermore, part of this expected demand growth is due to the need for semiconductor manufacturers to acquire the latest lithography systems to produce the latest edition of cutting edge chips. ASML Holding’s longer term outlook is incredibly bright, and the company benefits from a growing installed equipment base due to its sizable services business segment.
Before we dig further, some quick housekeeping items. ASML Holding reports its financial performance in Euros and in accordance with US GAAP account practices. The company’s dividend is paid out in Euros and recently ASML Holding implemented a quarterly dividend program. Its first quarterly dividend of EUR€1.37 per ordinary share will be made payable on August 12. ASML Holding’s fiscal year largely mirrors the calendar year, though not entirely. The firm has a dual listing structure with its ordinary shares listed on both the NASDAQ and the Euronext Amsterdam.
Earnings and Guidance Update
Image Shown: ASML Holding reported record net bookings last fiscal quarter. Image Source: ASML Holding – Second Quarter of Fiscal 2022 IR Earnings Presentation
On July 20, ASML Holding reported second quarter earnings for fiscal 2022 (period ended July 3, 2022) that beat both consensus top- and bottom-line estimates. The firm sold 91 lithography systems in the fiscal second quarter, up from 72 in the same period last fiscal year, which helped drive its net sales up 35% year-over-year to EUR€5.4 billion. ASML Holding noted that its ‘net system sales’ grew 40% and its ‘net service and field option sales’ grew 20% year-over-year in the fiscal second quarter. Its net system sales represented roughly three-quarters of ASML Holding’s total net sales.
Please note that if it were not for supply chain constraints and the related delay in the recognition of certain revenues, ASML Holding’s net sales performance would have been even stronger last fiscal quarter. The firm described these hurdles within its statutory interim update for the fiscal second quarter (emphasis added, lightly edited):
Due to current market conditions, characterized by high demand exceeding what we can manufacture given supply chain constraints, many customers are asking us to expedite certain deliveries of our systems by shipping the systems before the Factory Acceptance Test (‘FAT’). As a result of shipping without FAT, recognition of revenue for these systems is delayed until customer acceptance after successful installation. This resulted in 16 systems being shipped in the first half of [fiscal] 2022 for which revenue recognition is expected in the second half of [fiscal] 2022. The net sales value of our fast shipments not yet recognized in revenue in the first half of [fiscal] 2022 amounts to EUR€1.9 billion.
These supply chain constraints forced ASML Holding to reduce its full-year revenue growth guidance for fiscal 2022 down to 10% from 20% previously (both on an annual basis) during its latest earnings update, largely due to expectations that ASML Holding will recognize a significant amount of revenue for equipment shipped in fiscal 2022 next fiscal year. Please note that demand for ASML Holding’s offerings remains incredibly robust as it recorded EUR€8.5 billion in net bookings last fiscal quarter, a quarterly record. Here is what ASML Holding to say on its guidance revision within its statutory interim update for the fiscal second quarter (emphasis added, lightly edited):
Net sales are expected to grow around 10% in [fiscal] 2022 compared to last year. This growth is lower than previously guided as a result of supply chain constraints which drive an increase in the number of fast shipments expected in the remainder of [fiscal] 2022. The revenue in relation to fast shipments will be delayed into [fiscal] 2023 at an amount of around EUR€2.8 billion.
ASML Holding noted its gross profit margin fell ~180 basis points year-over-year to reach 49.1% in the fiscal second quarter “due to cost inflation, capacity increase and changes in product mix recognized in revenue.” The company offset those headwinds to a degree through higher selling prices of its extreme ultraviolet (‘EUV’) and deep ultraviolet (‘DUV’) lithography systems. For all of fiscal 2022, ASML Holding is guiding to generate a gross margin of 49%-50%, with pricing increases, revenue growth, and economies of scale helping maintain its margins in the face of sizable exogenous shocks.
In the fiscal second quarter, ASML Holding reported EUR€1.7 billion in operating income, up 33% year-over-year. The firm’s operating margin declined ~40 basis points year-over-year last fiscal quarter, falling to 30.4%. Economies of scale (for instance, its SG&A expenses as a percent of net sales declined moderately last fiscal quarter on a year-over-year basis) were key to offsetting headwinds negatively impacting ASML Holding’s gross margin performance. ASML Holding reported diluted EPS of EUR€3.54 last fiscal quarter, up 40% year-over-year.
The company’s headcount grew meaningfully from the second quarter of fiscal 2021 to the second quarter of fiscal 2022. On a full-time equivalent (‘FTE’) basis, the firm’s ‘number of payroll employees in FTEs’ rose 17% and its ‘number of temporary employees in FTEs’ rose by 67% year-over-year. ASML Holding needs to scale up its manufacturing capabilities given the robust demand for its offerings seen of late while also remaining competitive on the R&D front (R&D expenses represented ~15% of its net sales last fiscal quarter). We appreciate the company’s ability to accomplish these goals while largely maintaining its strong operating margin performance, keeping headwinds facing its gross margins in mind (which are largely due to exogenous shocks beyond ASML Holding’s control).
Financial Update
ASML Holding exited the fiscal second quarter with EUR€4.4 billion in cash, cash equivalents, and short-term investments on hand versus a negligible amount of short-term debt and EUR€4.4 billion in long-term debt. The company had a negligible net debt position at the end of the fiscal second quarter as ASML Holding has been aggressively buying back its stock of late while sharply boosting its dividend payouts in recent fiscal years.
Image Shown: ASML Holding has aggressively stepped up its capital return to shareholders in recent fiscal years via a combination of substantial dividend increases and large share repurchase programs. Image Source: ASML Holding – Second Quarter of Fiscal 2022 IR Earnings Presentation
During the first half of fiscal 2022, ASML Holding generated EUR€1.5 billion in free cash flow, though we will stress its net operating cash flows were held down by a large build in its working capital. In fiscal 2021 (period ended December 31, 2021), ASML Holding generated EUR€9.9 billion in free cash flow. ASML Holding spent EUR€1.5 billion covering its dividend obligations and an additional EUR€3.2 billion buying back its stock during the first half of fiscal 2022. We expect ASML Holding’s free cash flows will swell higher going forward.
ASML Holding intends to repurchase up to EUR€9.0 billion of its stock through the end of December 2023. Some of those repurchases will be used to cover employee share plans and the remainder will be cancelled.
We view ASML Holding’s stock buyback strategy quite favorably as shares of ASML have shifted materially lower year-to-date, and in our view, are quite undervalued as of this writing. The company’s dividend obligations have grown at a robust pace in recent fiscal years but remain manageable relative to ASML Holding’s stellar cash flow generating abilities. Shares of ASML yield ~1.3% as of this writing, though we caution that there are foreign currency movement considerations to be aware of here.
Longer Term Guidance Overview
ASML Holding laid out favorable guidance during its September 2021 Investor Day Event. Its guidance calls for EUR€24-EUR€30 billion in net sales by fiscal 2025 (versus EUR€18.6 billion in net sales in fiscal 2021) and a gross margin of 54%-56% (versus a gross margin of 52.7% in fiscal 2021) by fiscal 2025.
Image Shown: ASML Holding laid out a roadmap that called for strong revenue growth and gross margin expansion over the coming years during its September 2021 Investor Day Event. Image Source: ASML Holding – September 2021 Investor Day Event Presentation
During prepared remarks for its second quarter of fiscal 2022 earnings call, ASML Holding’s management team noted that (emphasis added, lightly edited):
“We are currently in discussions with our customers and suppliers to find a fair way to share in these inflationary cost increases. It is important to emphasize that the reasons for the lower margin guidance [for fiscal 2022] are a result of short-term shocks in our ecosystem and can be adjusted over time in collaboration with our ecosystems partners. Therefore, our longer term gross margin ambition of 54%-56% percent in 2025, as communicated during [our September 2021 Investor Day Event] is still valid.
Longer term, if we look at the secular drivers, the global megatrends driving our industry are still in place and fueling demand for both advanced and mature nodes. The expanding application space for semiconductors and secular trends are driving long-term structural demand.
The growth in the automotive market is very strong as semiconductor content scales with increasing automation and electrification. Customers are also indicating increasing demand for semiconductors as part of the green energy transition and build out of the smart grid. The demand for more mature technology nodes is furthermore driven by the internet of things fueling the demand for sensors, power IC’s and actuators.
Customers are seeing very strong growth due to demand from high performance computing applications. As applications require higher performance at a lower power, we see the energy efficient path to transistor growth driving the need for larger die sizes. Finally, there are a number of fabs being planned or already in progress driven primarily by technological sovereignty investments and subsidy schemes next to increased foundry competition.
Growth in semiconductor end markets and increasing lithography intensity are pushing the demand for our products and services. This is evident in our quarterly order flow of over EUR€6 billion the past five quarters and a record order intake of EUR€8.5 billion this past quarter. Our backlog has grown to over EUR€33 billion and we expect continued high order intake this quarter. Almost 85% of this backlog is for EUV and immersion which is planned for advanced nodes. Demand for our products this year and next continues to exceed supply.” — Peter Wennink, President and CEO of ASML Holding
We appreciate that ASML Holding is doing its best to scale up its manufacturing capabilities to set the stage for a robust revenue growth story over the coming fiscal years while preserving and potentially expanding its margins. In our view, ASML Holding should be able to navigate past near-term headwinds with its longer term growth runway solidly intact. Meaningful revenue growth and gross margin expansion should result in ASML Holding’s free cash flows swelling higher over the coming fiscal years.
Concluding Thoughts
ASML Holding is a tremendous enterprise with a bright growth outlook, a healthy balance sheet, and an impressive business model. The company’s management team is incredibly shareholder friendly. We view both ASML Holding’s dividend growth and capital appreciation upside quite favorably and think the market is “getting it wrong” on this company considering shares of ASML have sold off heavily year-to-date, even though its longer term free cash flow growth trajectory is as strong as ever.
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Callum Turcan owns shares of DIS, META, GOOG, VRTX, and XLE and is long call options on DIS, GOOG, META, MSFT, V, and VRTX and is long put options on RDFN and RKT. Apple Inc (AAPL), Cisco Systems Inc (CSCO) and Microsoft Corporation (MSFT) are all included in both Valuentum’s simulated Best Ideas Newsletter portfolio and simulated Dividend Growth Newsletter portfolio. Alphabet Inc (GOOG) Class C shares, Meta Platforms Inc (META), Korn Ferry (KFY), PayPal Holdings Inc (PYPL) and Visa Inc (V) are all included in Valuentum’s simulated Best Ideas Newsletter portfolio. Oracle Corporation (ORCL) and Qualcomm Inc (QCOM) are both included in Valuentum’s simulated Dividend Growth Newsletter portfolio. ASML Holding NV (ASML), Meta Platforms, Oracle, and Taiwan Semiconductor Manufacturing Company Limited (TSM) are all included in Valuentum’s simulated ESG Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.