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Tickers in this Article: ASML, MU, TSM, CAJ, AMAT, CYMI, AEIS
Whither ASML (Nasdaq:ASML) goest? The answer is "more or less wherever memory is going." For now, that means bad news for ASML as companies have significantly pulled back on their capex spending. Eventually, though, these manufacturers will come back and ASML will see the order book swell again.

A Third Quarter That Was Slightly Better Than Expected
Analysts had been looking for a fairly unimpressive quarter from ASML and they were basically right, though ASML did do a little better than hoped. Revenue rose 24% from last year, but fell 5% on a sequential basis. Shipments fell 13% sequentially, with new unit shipments down about 21%.

ASML boasts significant operating leverage and that profitability cuts both ways. Gross margin slid about three full points from the second quarter, while operating income fell 18%.

Looking ahead, ASML management seemed cautiously optimistic that this is about as bad as conditions are likely to get in this cycle, but gave relatively few specifics. Orders about a third from the second quarter and the backlog (measured in Euros) dropped about 28%.

It's About Memory
While the fab giant Taiwan Semiconductor (NYSE:TSM) is not surprisingly a major customer of ASML, memory giants like Samsung and Hynix are high on the list as well. Simply put, the memory chips made by the likes of Samsung, Micron (NYSE:MU) and SanDisk (Nasdaq:SNDK) are the bulk of the semiconductor industry, even if names like Broadcom (Nasdaq:BRCM), OmniVision (Nasdaq:OVTI) and Atmel (Nasdaq:ATML) generate more excitement. So, for so long as the outlook for major memory players like Micron isn't so good, so too is the outlook for ASML.

Longer term, though, there is no choice but to upgrade the chips and the equipment that makes them. As ASML is the leader in the lithography space, that means solid long-term prospects. At this point, ASML remains the technology leader while Canon (NYSE:CAJ) and Nikon (Nasdaq:NINOY) compete more on price. What's more, as technology is moving forward, the prospects are good that ASML will be able to drive increased spending on next-gen lithography and increase the percentage of fab spend on lithography from its traditional range in the high teens to low 20's - perhaps even into the high 20's.

Always Other Plays
A large percentage of ASML's cost of goods go to Zeiss (which makes the lenses) and Cymer (Nasdaq:CYMI) (which makes the light sources). Forget about Zeiss, it's private, but Cymer is an investment option with many similar characteristics - it sells key equipment and has minimal competition.

Beyond that are the usual roster of other options to play the semi capex cycle. Applied Materials (Nasdaq:AMAT) is the big dog in the space, involved in so many aspects that it's basically a proxy for the market. But then there are other, more focused, options to consider - Advanced Energy (Nasdaq:AEIS) and its power conversion products, Lam Research (Nasdaq:LRCX) and its etching equipment, and MKS Instruments (Nasdaq:MKSI) and its various pressure, gas and vacuum measurement and control products.

The Bottom Line
ASML is proof that market leadership is not worth as much in the wrong market; semi equipment ordering patterns are so brutally cyclical that although ASML has done better than many other chip equipment stocks, it's still too volatile for many investors. It also happens to be a difficult company to value - cash flow modeling is just guesswork wrapped in pretty paper and ultimately it makes just as much sense to watch fundamental metrics like price/book, EV/EBITDA and EV/revenue.

All in all, ASML is not dirt-cheap and certainly not the cheapest stock in this sector. But what it lacks in discount to fair value it makes up in the likelihood of realizing that value. It is hard to imagine a cyclical recovery in chips that doesn't bring ASML along for the ride. What's more, there's still the possibility that it attracts a bid from the likes of Applied Materials. Accordingly, this is a quality name for investors who want to play a recovery in the chip sector, but it is not likely to be the best performer when that recovery comes. (For additional reading, take a look at A Primer On Investing In The Tech Industry.)

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