ASML’s cutting-edge technology will capitalise on the growing demand for computer chips.
ASML has an enviable position as the key supplier to major companies that make the semiconductor chips that are supplying growing markets. The company makes the precision lithography systems that pattern transistors and other components onto chips.
These systems are continually developed to enable more components to be crammed onto a chip by creating finer patterns so that the size can shrink. This process is behind Moore’s law – the observation that the number of components on a chip doubles every two years.
This rule means chip power doubles (or cost halves for the same power) every two years, and has held since Gordon Moore of Intel predicted it in 1965. That’s why today’s smartphones are more powerful than the IBM360 used by Nasa for the Apollo programme and the Cray supercomputer of the 1970s.
Well placed to lead
The latest ASML systems are complex and sell for between €30m and €120m. The firm is the global market leader in a duopoly – the only other supplier being Nikon. It is well placed to maintain this position, as it led the world in developing extreme-ultraviolet (EUV) lithography, which enables the finest patterning available. EUV systems, which will enable the continuation of Moore’s law for the next decade, and other advances, are the result of years of ASML’s investments in research and development (R&D).
The firm’s R&D spending amounts to roughly 15% of sales each year. This has paid off. Results for 2017 showed record sales of €9.05bn (up from €6.8bn in 2016), net income of €2.12bn and earnings per share (EPS) of €4.93. The balance sheet shows solid net cash of €0.3bn. Shareholders benefited from capital return of more than €1bn in 2017 (dividends of €517m and share buybacks of €500m). The 2017 dividend is €1.40 per share, a rise from €1.20 in 2016, and the eighth consecutive increase since 2009.
Strong growth in sales
ASML forecasts sales of €11bn and EPS of more than €9 in 2020, with further growth potential into the next decade. Growth will be largely driven by EUV systems. In 2017, ten were delivered with an order backlog of 28 systems for six customers at the end of the year. ASML expects to sell 22 EUV systems in 2018, more than 30 in 2019 and substantially more in 2020. As more large chip-makers install multiple EUV systems, it becomes riskier for other chip-makers not to do so, since they risk being left behind with the older and less capable technology. (The box below explains the advantages of EUV for chip-makers.)
Benefiting from new trends
ASML is an example of a picks-and-shovels company that supplies essential equipment to a wide range of clients (I explained the appeal of this kind of investment in last week’s issue of MoneyWeek). The market for chips is set to increase because of demand from industries such as factory automation, consumer electronics, and artificial intelligence, as well as automotive and autonomous vehicles. For example, Audi estimates that semi-conductors now drive 80% of automotive innovations and will represent half the cost of a car by 2030.
ASML expects Moore’s law of continual improvements in performance and reduction in costs to continue to apply for at least the next decade, and it will provide the tools to allow that to happen. Its position as the leading company in a global duopoly makes it the preferred investment, and less risky than an individual chip-maker. That said, it would still be affected by a recession in consumer markets that reduced the demand for chips.
Why EUV will drive further growth
| ASML (Amsterdam: ASML) | |||
| Share price | €172 | P/E (est. 2019 EPS) | 22.5 |
| Market cap | €74bn | PEG 2019 | 0.9 |
| Cash/debt | €0.3bn | Dividend yield | 0.8% |
| Recent results | 2017 | 2016 | % change |
| Turnover | €9.05bn | €6.8bn | 33% |
| Operating profit | €2.5bn | €1.7bn | 47.1% |
| Earnings/share | €4.93 | €3.46 | 42.5% |
| Dividends/share | €1.40 | €1.20 | 17% |
The current precision lithography technology enables approximately 100 million transistors to be packed into each square millimetre, but EUV enables this density to be increased towards one billion per square millimetre. Further improvements in numerical aperture (NA) to enable High-NA EUV will allow increases well beyond a billion, but such systems could double the cost of standard EUV. ASML has just announced four orders for High-NA systems to be delivered in 2021. The reason EUV represents such a big advance is that current state-of-the-art UV lithography uses UV light of wavelength 193nm, but EUV has a wavelength of 13.5nm, more than 14 times smaller. Resolution scales linearly with wavelength, meaning much finer features can be patterned with EUV.
Each EUV system costs in excess of $100m and ASML is the only company selling these systems. Leading chip companies such as Samsung, TSMC, Intel and GlobalFoundries are all planning or introducing EUV technology, which will both enable finer patterning and simplify chip processing. Samsung expects to be producing chips for customers using EUV in the second half of this year.
ASML’s first research EUV system was made in 2006, so EUV has a 12-year development history from that first prototype to EUV’s expected use to produce customer chips later this year. The 30-plus EUV systems it expects to sell in 2019 represent sales of roughly €3.5bn, and there will be continuing service revenues from these systems once they are installed.
ASML’s 2017 results were strong, and the table above shows a healthy financial state. On the current share price of €172, the 2020 price-earnings (p/e) ratio would be 19 based on ASML’s target EPS of €9. The EPS growth rate from 2017 to 2020 would be about 22.5% per year, giving it a 2020 p/e-to-growth (PEG) ratio of under 0.8. After 2020, enhanced EUV will drive continued growth.