ASML

Moat: 4/5

Understandability: 4/5

Balance Sheet Health: 5/5

ASML is a global leader in lithography, the technology used by chip manufacturers to produce semiconductors.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

ASML, a Dutch company, essentially holds a global monopoly in the market for EUV lithography systems, used to make the most advanced and cutting-edge semiconductors. This powerful position, built on unique technology and high barriers to entry, provides the company with a strong competitive advantage.

Business Overview

ASML’s core business revolves around the design, manufacture, marketing, and servicing of advanced semiconductor manufacturing equipment. Here’s a more detailed breakdown:

  • Lithography Systems: The core of ASML’s business. Lithography involves printing incredibly small patterns on silicon wafers to create semiconductor chips. ASML is the dominant player, with a near monopoly on advanced EUV (extreme ultraviolet) lithography, which is essential for producing the most advanced semiconductors. Their offerings also include DUV (deep ultraviolet) lithography systems.
  • Services: ASML also provides a range of services to its customers, including upgrades, installation, training, and ongoing support for their machines. These services are integral to maintaining a high level of performance for ASML’s complex systems.
  • Customers: ASML’s customers include leading logic, memory, and foundries which dominate the semiconductor industry worldwide. Names such as TSMC, Samsung, Intel, and SK Hynix are a few of their most important clients.
  • Geopolitical Influence: The semiconductor industry is subject to an increasingly complex geopolitical situation, with governments like the US and China looking at measures to protect supply chains and national interests. This creates uncertainty and volatility in the market.
  • Technology Advancements: Moore’s Law, which predicted the doubling of transistors on a chip every two years, is becoming harder to sustain, requiring even more advanced, and therefore complex and expensive lithography systems.
  • Increasing Complexity of Chip Manufacturing: As chip design grows more intricate, the demand for advanced, and more expensive lithography systems rises. This is particularly beneficial for ASML, which is the leader in providing cutting-edge EUV systems.
  • Supply Chain Challenges: Geopolitical events, trade tensions, and raw materials shortages are creating instability in the supply chain, and this is also impacting the chip manufacturing process.
  • Growth in Microelectronics: The need for more energy-efficient semiconductors and increased demand for AI applications is fueling semiconductor growth, increasing the relevance of the technology ASML provides.
  • ESG Awareness: There is increased pressure in the industry to improve on sustainability, which will impact supply chain management and the design of chips.

Financials

  • Strong Revenue Growth: ASML has demonstrated extremely strong revenue growth, particularly in the recent years. A testament to this has been a record Q4 2022.
  • High Profitability and Margins: ASML’s margins are high due to the lack of a direct competitor in its field. While profitability can vary somewhat depending on the business cycle, ASML continues to report very strong numbers.
  • Strong Order Book: The company has a record order backlog. This indicates that even if there’s a fall in demand, the company’s earnings will continue to be strong for years to come.
  • Continuous Investments into R&D: ASML spends a sizable portion of its revenue into R&D, to ensure it is always on the cutting edge of technology.
  • Financial Stability: Strong balance sheet with large cash reserves. The company has nearly €16 billion of cash and short-term investments at the end of 2023, reflecting excellent cash management.
  • Revenue Distribution by Geography: ASML has global sales, with Asia being their largest market followed by North America and Europe. They have 40+ manufacturing facilities in 16 countries, and nearly 100 customer sites throughout the world.
  • Revenue Split: The company sells both lithography systems, the DUV, and the highly advanced EUV, and also sells upgrade packages for its machines, which creates strong recurring revenues. However, EUV is significantly more profitable for the company than DUV due to the near monopoly that it has in this business.
  • Capital Expenditure: ASML spends a considerable amount of money to expand its manufacturing capacity, which will allow the company to increase output and fulfill its growing backlog.

ASML’s latest results have been very strong, although there has been some volatility in the sector. Its 2023 annual report and latest conference call showed strong demand for their systems, despite the cyclical nature of semiconductor sales, and the company’s focus has remained towards securing future returns.

Competitive Landscape

  • EUV Monopoly: ASML has a near monopoly on EUV lithography systems, which is a major competitive advantage. While competitors have developed their own versions of DUV lithography, no company has come close to achieving a similar position in EUV to ASML.
  • R&D Expertise: The company spends an outsized portion of their revenue in R&D, ensuring it is at the cutting edge of technology, this makes it harder for competitors to replicate its products.
  • High Barriers to Entry: The level of investment and technological know-how to operate in the lithography industry is very high, making it nearly impossible for smaller companies to enter the market.

Moat Analysis

I rate ASML’s moat at 4/5. Here’s the justification:

  • Wide Moat: ASML possesses the “wide moat” characteristics of the “inevitables,” as described by Warren Buffett. Their main moat drivers come from network economics, intangible assets in the form of highly specialized technology, patents, and first to market advantage.
  • Near Monopoly: The company’s leadership in EUV lithography is extremely strong with no current competition, and with long-term demand, as that technology is needed for high-end chips.
  • Technological Edge: The firm continues to improve its technology with continuous investments, ensuring it continues to stay at the forefront of the market for the long-term.
  • High Barriers to Entry: The sheer scale and complexity of manufacturing these incredibly complex systems is not easily replicated by a competitor.

Legitimate Risks

  • Geopolitical Risks: Increased tensions between the US, China, and other countries could hurt sales due to trade tensions, sanctions, or other restrictions that impact customers’ willingness to buy or prevent the sale of their products to China.
  • Technological Disruption: If new technologies emerge that can replace EUV or render it less relevant, that would make the current infrastructure of ASML obsolete.
  • Cyclicality of the Semiconductor Industry: The demand for semiconductors depends on larger macroeconomic conditions, and therefore is subject to peaks and troughs that may impact ASML’s earnings.
  • Dependence on Key Customers: ASML has a handful of clients, most of which are huge semiconductor firms, making them vulnerable if the demands of these clients change for whatever reason.

Business Resilience

Despite those risks, the company has a long-term sustainable competitive advantage with high margins, a very strong balance sheet and a lot of investment into R&D, positioning them for long-term growth.

Understandability

I rate the understandability at 4/5. ASML’s technology is complex to fully understand, and requires technical knowledge to fully appreciate, but the core business model of selling highly specialized equipment to a niche market is easy to understand, along with the concept that strong performance is linked with economic growth and the demand for chip manufacturing.

Balance Sheet Health

I rate the balance sheet health at 5/5. The company has very low debt, large amount of cash, and good financial indicators. They are very well-positioned to continue and improve their performance.