One of the worlds most important company with a machine so complex, noone can replicate it
Spectacular growth, fantastic future prospects, stellar fundamentals, competent management, good capital allocation, wide moat, low debt and doesn't need debt to achieve superior returns
ASML ASML 0.00%↑
The Business
ASML is a company from the Netherlands that produces photolithography which is an important step when producing semiconductors. ASML sells its products to major semi-producers and is considered one of the most important companies in the world.
The drivers for continued growth in the semiconductor market are essentially every technological category: smartphones, cloud computing, computing, 5G, AI/MR, and autonomous vehicles. ASML won’t run out of devices to create their photolithography for a long while.
ASML sells most of its products to Asia - specifically the big players from Taiwan, South Korea, and China - only 2% of the US. This creates a concentration risk, and political factors might affect ASML’s future earnings.
The Fundamentals
The company’s return on invested capital is 29.7% and has been consistently high for years, ranging from 14-32%. Their free cash flow per share has grown 22.73% CAGR over the last 5 years. ASML’s gross margins are currently at 50%.
The stock
The stock has been a big winner over the last 10 years, with a ~800% return (not including dividends). It has outperformed the S&P500 by a mile, and also other semiconductor companies like Texas Instrument and Taiwan Semiconductor.
The Growth
ASML has compounded revenue, cash flows, earnings, and dividends at a rapid rate for the last 5-10 years.
10-year CAGR:
Revenue: 14%
Earnings per share: 14.8%
Free cash flow per share: 27.5%
Dividends: 27,4%
Book Value: 6.1%
Sustainable Competitive Advantage
ASML’s EUV machines are so complex and effective in making microchips, that they can’t keep up with demand. Their backlog is large and growing, securing earnings even in a recessionary environment. ASML holds more than 90% of the EUW market and about 60% of the total lithography market:
Charlie Munger talks about the Lollapoloza moat, here are a few more points for ASML’s moat:
Complexity of their EUV machine (Almost impossible to recreate)
Capital intensive for new entrants creates a naturally high barrier to entry
Customer/client relationships, ASML has a tight relationship with its clients that has helped them financially to develop the EUV machine
ASML has more than 800 suppliers that all help support the creation of the EUV machine. This can’t be replicated in a few years, it would take years of building up a supplier network.
If you want to go deeper into the EUV machines and ASML’s competitive advantage I recommend this video:
Their VP of technology famously said that even with all the resources in the world, and 10,000 of the best engineers, you would not be able to recreate the EUV machine.
Why own ASML?
Strong future growth prospects
Wide (Lollapoloza) moat
Doesn’t need debt to achieve superior returns
Huge backlog (High demand for their EUV machine)
High return on capital
High FCF margins
Great capital allocation
The risk
The main risks I see for ASML
Disruption: New technology, substitutes, and competitors using e-beam lithography
Supplier dependency: ASML has supplier dependencies for the material required to make the EUV Machine
Political risk: ASML has the majority of its revenue from Asia, trade wars or political tensions could affect future earnings
Concentration on customer base, a few large companies make up almost all of ASML’s sales
For investors, there is also a risk of paying too much for a company with high concentration and risks that might impact future earnings
Valuation: At what price would I buy ASML?
ASML’s market cap is $250BN as of this writing. My DCFA suggests a weighted value of $350BN. Suggesting a ~30% discount and a margin of safety.
ASML can grow for 10% pa for the next 5 years, and 8% the following 5 years, and still, we can expect a 10% annual return. Given a terminal multiple of 30. I do believe there are high possibilities that ASML will do better than 10% pa. for the next 5-10 years.
From a valuation standpoint, ASML is providing a nice margin of safety, and an entry now would be a fine entry, suggesting a 15% pa return:
Conclusion
ASML’s earnings stability is riskier than other quality companies. This is because their revenue is concentrated in Asia, and with a few big players. It is also not clear whether technological changes could disrupt the need for their EUV machines. Their EUV machines look like an extremely strong asset that is protected by patents - but what if competitors could make a similar machine at a lower price or leverage other technology to get a similar result? This risk makes me set a higher requirement than for other more stable companies like S&P Global Inc. and L’oréal. Therefore I would like a ~40% Margin of safety.
My entry price would be ~£225BN - which is only a 10% discount from today’s levels. This means I might soon initiate a position in ASML.