ASML Holding N.V. - A Q4 earnings review
Whereas our Market Insight post usually focuses on multiple stocks, this one will focus entirely on ASML and its Q4 earnings due to the significance and brilliance of these.
ASML shows why it deserves its premium valuation
After TSMC was the first large-cap semiconductor company to report earnings last week, ASML followed Wednesday, and just as we saw with TSMC, the results spurred a run on semiconductor stocks, with the SOXX ETF rising another 2%. Meanwhile, ASML shares gained over 10% on the Nasdaq, getting awfully close to a new all-time high. For reference, this means that shares have more than doubled from an October 2022 low.
Luckily, this has not been without reason. Looking at the Q4 earnings report, we can safely say the jump in share price is at least partially justified, and I’ll show you why.
ASML delivered very impressive Q4 results, beating the consensus and its own guidance. Revenue rose 12.5% YoY in Q4 to €7.2 billion, ahead of a consensus of $6.9 billion and management’s own high end of guidance at €7.1 billion. A very strong performance by a company that still faces an environment in which large customers are pushing out deliveries (ASML only realizes revenue after orders are installed at the customers). Yes, it is a slowdown from prior years and quarters, but this is as expected.
In recent quarters, the company has been facing some demand issues as customers are postponing deliveries. Crucially, this does not mean ASML is seeing cancellations, but due to a low-demand environment for semiconductor manufacturing over the last year and lower capex levels by the likes of TSMC, Intel, and Samsung, these customers simply are not looking to have new equipment delivered. On top of this, many new manufacturing sites are facing a shortage of specialized personnel, which means fab construction is delayed, further adding to this demand headwind for ASML.
However, once again, let me clarify that ASML is seeing no cancellations, and all this revenue is simply being postponed. This is what impacted growth in H2 and will impact growth in 2024, but more about that later.
Nevertheless, ASML delivered a very decent Q4, shipping 10 EUV systems and realizing €5.7 billion in system sales. Yet, the revenue beat was primarily driven by higher revenue from its installed base. Installed Base Management sales for the quarter came in at €1.6 billion, which was higher than guided due to additional service and upgrade sales.
The higher installed base revenue also drove a margin beat due to higher revenue levels than anticipated, and these service revenues carrying higher margins. The gross margin was 51.4%, sitting above management’s guidance of 50% and 51%, but still slightly down from 51.9% reported in Q3. Net income was up 12.7% YoY to just over €2 billion, reflecting a net income margin of 28.3%, which is perfectly in line with our expectations and above the Wall Street consensus. This translated into an EPS of €5.21.
For FY23, ASML reported 30% YoY revenue growth to €27.6 billion against a 2% contraction in the semiconductor industry and a double-digit contraction in the foundry industry, which is still an insanely strong performance. Worth pointing out while we are at it is that ASML has grown revenue at a CAGR of 23.5% since 2019, the number of lithography machines shipped at a CAGR of over 18%, and EPS at a CAGR of 23.5%, which are incredible numbers, justifying its premium valuation.
The gross margin in 2023 was up 80 bps to 51.3%, and the net income margin was up 180 bps to 28.4%, driven by the improvement in gross margin and costs like SG&A and R&D growing slower than revenue at 17% and 22%, respectively. This led to a full-year EPS of €19.91, up 41% YoY.
Furthermore, FCF was up to €3.2 billion and was able to almost completely offset the shareholders returns of €3.3 billion through both dividends and share buybacks. This allowed it to maintain its pristine balance sheet with €7 billion in cash, cash equivalents, and short-term investments.
The order intake was the absolute highlight
However, even though these results were impressive, this was not the reason for the investor optimism. What caused the enthusiasm was the order intake reported by ASML, which blew past the consensus.
Even as ASML continues to operate in a challenging environment with the industry navigating its way through a bottom, the company reported an incredible record high order intake of a staggering €9.2 billion in Q4, blowing away the Wall Street consensus, which expected a number closer to €4 billion. This means the order intake tripled from Q3 levels.
Of the €9.2 billion reported, €5.6 billion came from EUV orders, including new orders for the next generation of high NA EUV systems, of which ASML delivered the very first one to Intel before the end of the year. The rollout of this new generation of EUV equipment could potentially spur a new investment cycle as foundries look to upgrade to satisfy the demand for advanced 3nm and 2nm node manufacturing. Therefore, we do not see this quarter’s order intake as a standout and expect this to remain high throughout the next couple of years.
Last quarter’s incredible order intake brings the total backlog to a massive €39 billion, showing the company still has plenty of growth ahead while regularly reporting a positive book-to-bill.
I can’t stress enough just how incredible this is – the fact that ASML reported a record high order intake at this time shows investors how incredible demand for its equipment really is and points to significant growth ahead for ASML.
Not only this, but it also indicates that foundries are scaling up investments again, indicating a return in demand for semiconductors, confirming what we heard from TSMC management last week. This is why other equipment manufacturers like AMAT, KLA, and Lam also picked up a couple of percentages on Wednesday. Clearly, the outlook for the semiconductor industry is rapidly improving as we enter a new growth cycle. This is why we remain very bullish on the semiconductor industry.
The near-term outlook is a stain on an otherwise brilliant report
However, while everything sounds brilliant so far, there was a small stain on the Q4 earnings report, which was guidance. ASML now guides for Q1 revenue of between €5 billion and €5.5 billion, which points to a revenue contraction of 18% YoY. Management expects lower EUV volume in Q1 and lower revenue from the installed base compared to Q4, reflecting that the industry is still navigating its way through the bottom. Furthermore, as revenue is expected to contract in Q1, the gross margin is also expected to fall to a range of 48% to 49%.
Revenue and margin guidance for FY24 isn’t much better, with management guiding for revenue levels similar to 2023. Even as demand improves for its customers, ASML sees weakness with logic customers after 60% growth in 2023, partially offset by a rebound in demand from memory customers.
The company also warned that sales to China, its third-largest market, would be impacted in 2024 by new U.S. and Dutch export curbs. Whereas ASML earlier guided for 10 to 15% of its China sales to be affected by export restrictions, the partially revoked licenses in December for less advanced equipment now means ASML expects this number to be closer to 15% in 2024, adding an additional near-term headwind.
As management has guided previously, 2024 will be a transition year in which it prepares for the next wave of growth.
Turning to margins, for 2024, management expects the gross margin to also come in lower compared to 2023. This is driven by several factors, including the expected higher costs in 2024 from introducing high-NA EUV equipment and production capacity expansion plans.
All in all, it was not quite the outlook investors and analysts were looking for. Yet, while this might sound somewhat bearish, we know ASML management has been historically very conservative with its guidance, so it is safe to assume this time is no different. Furthermore, we have known for a few months now that 2024 was going to be a flattish year for ASML, so there are not any surprises there.
Furthermore, management clearly pointed out that investors don’t need to worry about the impact of the Chinese export restrictions in the long run, as demand for the company’s equipment remains incredibly high. According to ASML, this 15% loss in its Chinese business will be quickly filled in with demand from other customers once demand recovers in 2025. Therefore, we should expect sales from China to drop to the mid-teens in 2024 and single digits in 2025.
Concluding thoughts
The most important for investors is to shift their view past 2024 and look ahead to 2025 and beyond. Positively, management still maintains its long-term growth targets laid out in 2022, guiding for 2025 revenue of between €30 billion and €40 billion and 2030 revenue of between €44 billion and €60 billion.
Moving to margins, ASML continues to aim for a 2025 gross margin of between 54% and 56%, indicating that margin pressure is expected to be only temporary. Driving this margin expansion into 2025 is expected to be higher sales volumes (obviously), the move to higher margin system sales, and reduced headwinds from growing costs. By 2030, ASML aims for a gross margin of between 56% and 60%.
Considering the expected upcycle in the semiconductor market, which management expects to kick in in 2025, and ASML’s incredible backlog and order intake, these targets seem very much achievable, and this is where investor enthusiasm following its Q4 results came from.
ASML points to several secular growth drivers in its end markets to drive sustainable long-term growth, including trends like the energy transition, electrification, and AI. Furthermore, the current expectation is for a significant number of new fabs to open between 2025 and 2028 globally, which will require substantial numbers of ASML equipment, driving a robust new demand wave.
Following these expectations, developments, and management’s commentary, we now expect ASML to report the following financial results through 2027.
Based on these estimates, shares now trade at almost 42x this year’s earnings, which is an incredible premium over the sector average of 25x and its own 5-year average of 38x. As a result, we believe shares are now somewhat overbought following the earnings release. We believe that a long-term multiple of closer to 32x earnings will offer much better long-term potential and downside protection, leading to a 24-month target price of €916, leaving us with just 13% upside over two years.
Therefore, we believe shares aren’t an attractive buy at this point, and investors are best off looking for a share price below $750, which shares traded on as recently as two days ago. This results in a “Hold” rating.
However, this does not mean we are not bullish on ASML, as we very much are. ASML shares remain prominent in our portfolio, accounting for 6% of current value, making it the second largest holding for us, and we are happy to keep holding these for many more years.
The company operates a very powerful monopoly and technological advantage, which will not be challenged any time soon. Meanwhile, demand is expected to grow rapidly from 2025 onward, resulting in strong growth for ASML. Meanwhile, the company pays a rapidly growing dividend and is committed to returning excess cash to shareholders through share buybacks.
All in all, this company remains one of our favorites, and we are happy to keep buying on any share price weakness ahead. This is a true one-of-a-kind.
Just a couple of other things…
Coca-Cola CEO James Quincey recently indicated that he does not view GLP-1 weight loss medications as a serious threat to the business. According to the CEO, Coca-Cola sells a variety of beverages, including low-calorie drinks, which should insulate it from the impact of lower calorie consumption expected from mass adoption of these weight loss drugs. We share this view and don’t believe it should be a reason for investor worries.
Piper Sandler calls Celsius the best growth story in the consumer sector. According to the analysts, the company should be able to keep driving sustainable volume-driven growth driven by its international expansion. The firm put a $76 price target on the shares, leaving approximately 40% upside, despite these already trading at a 70x P/E multiple.
eBay announced plans to cut 9% of its full-time workforce to ensure long-term sustainable growth in the face of increasing competition and growth struggles. Shares gained slightly on the news. Meanwhile, shares remain attractively valued at below 10x earnings.
German software company SAP shares reached an all-time high following a strong quarterly earnings report, plans to cut 8,000 jobs, and a push into AI. Revenue was up 5% in Q4, and shares have gained 50% in 2023, the best performance since 2012.
The world’s largest luxury fashion brand – LVMH – yesterday reported FY23 earnings. Revenue was up 9% for the full year to $86 billion, while net profits increased by 8% to €15.2 billion. Most business groups and regions drove growth, as demand has held up really well in 2023. Meanwhile, shares are attractively priced at around 20x earnings.
Comcast reported its Q4 and FY23 earnings yesterday, and shares were up 4% in response, even as the company continues to lose broadband subscribers. Luckily, Q4 results beat estimates as domestic wireless line additions were strong, and the company’s streaming service – Peacock – crossed the $1 billion revenue mark. The service added 3 million subscribers in Q4, bringing the total to 31 million, up 50% YoY, which is a respectable performance considering that competition in streaming is intensifying. On top of this, the company also raised the dividend by 6.9% and announced a new $15 billion share repurchase program, which satisfied investors. Meanwhile, shares trade at just 11x this year’s earnings, a 21% discount to its 5-year average. For reference, the company is expected to report high mid to single-digit EPS growth in the medium term.
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Disclosure: I/we do have a beneficial long position in the shares of ASML and LVMH either through stock ownership, options, or other derivatives. This article expresses my own opinions and we are not receiving any sort of compensation for it.
No recommendation or advice is being given as to whether any investment is suitable for a particular investor. The information provided in this analysis is for educational and informational purposes only. It is not intended as and should not be considered investment advice or a recommendation to buy or sell any security.
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