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Go With Uncommon Sense On ASML
Normally it would not take much work to justify buying the stock of a company whose revenue grew 43% in the last quarter and trades at a reasonable valuation. But ASML (Nasdaq:ASML) is a semiconductor equipment company, and this is a sector where investors' heads are always twisted to the future - a future that looks to have significantly fewer orders in the short term. Still, long-term investors who can weather a down period in the cycle should seriously consider adding shares of one of the best-positioned equipment companies in the space.
TUTORIAL: The Industry Handbook: The Semiconductor Industry
A Good Second Quarter, But Nobody Cares
ASML reported that second quarter revenue rose 43% from the year-ago level and a little over 5% from the first quarter, a level of performance that exceeded the consensus analyst guess. While shipments were basically flat, the company did see an uptick in the average selling price (both on a sequential basis). Better still, margins were solid - the company saw gross margins improve 40 basis points sequentially and the operating margin improved by more than a full point as the company logged close to 10% sequential growth. (For related reading, see Analyzing Operating Margins.)
The problem this quarter was in the bookings. ASML booked 840 million euros in orders, which means about a 1% sequential decline and well short (about 12%) of prior guidance. Worse yet, management indicated that bookings in the third quarter would be no better than 500M euros, almost half the prior level of expectation. Not surprising, backlog is also weakening as foundries and chipmakers hold off on committing to new equipment.
Back To the Lows, Then Back To the Future
The fact of the matter is that semiconductor equipment is a cyclical business - always has been, probably always will be. To that end, though, it is hard to see a level of orders approximate the lows seen in the credit crisis and not believe that that will be at or near the trough of this cycle. Sure, companies like Microchip (Nasdaq:MCHP) are announcing weak results and seeing harder times in the consumer, auto and PC markets, but this too shall pass (or at least it always has before). (For related reading on cyclical stocks, see Market Cycles: The Key To Maximum Returns.)
ASML is still the 800 pound gorilla in lithography (with about 80% share) and lithography is still about 15 to 20% of total semiconductor capex spend. What's more, not only are Nikon (Nasdaq:NINOY) and Canon (NYSE:CAJ) hampered somewhat by disruptions due to the earthquake in Japan, they are also not technology leaders in the space.
Speaking of technology, extreme ultraviolet (EUV) is the latest new thing in the space for ASML. Some analysts are skeptical that ASML can reach its throughput goals with EUV, but the rewards will be substantial if they can. Maintaining Moore's Law basically forces chip companies to spend on ever more sophisticated equipment and the ramp-up of chips on smaller nodes from companies like Qualcomm (Nasdaq:QCOM) and Broadcom (Nasdaq:BRCM) (in partnership with foundries like Taiwan Semiconductor (NYSE:TSM), Intel (Nasdaq:INTC), and Texas Instruments (NYSE:TXN) should support the eventual recovery.
The Bottom Line
Investing success in chips usually requires that investors swim against the tide, buying when everybody hates the sector and vice versa. Ironically, that may a bit of a problem today with stocks like ASML and KLA-Tencor (Nasdaq:KLAC), another equipment company that is well-positioned with the fabs - these stocks are still relatively more popular in the analyst community.
Still, current valuation does not seem to account for the potential of this company over the length of a cycle. Buying ASML today (or Cymer (Nasdaq:CYMI), a key supplier) will take some courage and patience, but so long as investors believe that consumers will demand ever more performance from Intel/ARM Holdings-based (Nasdaq:ARMH) devices, that eventual demand for better production equipment should emerge. (For more, see A Prime On Investing In The Tech Industry.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
TUTORIAL: The Industry Handbook: The Semiconductor Industry
A Good Second Quarter, But Nobody Cares
ASML reported that second quarter revenue rose 43% from the year-ago level and a little over 5% from the first quarter, a level of performance that exceeded the consensus analyst guess. While shipments were basically flat, the company did see an uptick in the average selling price (both on a sequential basis). Better still, margins were solid - the company saw gross margins improve 40 basis points sequentially and the operating margin improved by more than a full point as the company logged close to 10% sequential growth. (For related reading, see Analyzing Operating Margins.)
The problem this quarter was in the bookings. ASML booked 840 million euros in orders, which means about a 1% sequential decline and well short (about 12%) of prior guidance. Worse yet, management indicated that bookings in the third quarter would be no better than 500M euros, almost half the prior level of expectation. Not surprising, backlog is also weakening as foundries and chipmakers hold off on committing to new equipment.
Back To the Lows, Then Back To the Future
The fact of the matter is that semiconductor equipment is a cyclical business - always has been, probably always will be. To that end, though, it is hard to see a level of orders approximate the lows seen in the credit crisis and not believe that that will be at or near the trough of this cycle. Sure, companies like Microchip (Nasdaq:MCHP) are announcing weak results and seeing harder times in the consumer, auto and PC markets, but this too shall pass (or at least it always has before). (For related reading on cyclical stocks, see Market Cycles: The Key To Maximum Returns.)
Speaking of technology, extreme ultraviolet (EUV) is the latest new thing in the space for ASML. Some analysts are skeptical that ASML can reach its throughput goals with EUV, but the rewards will be substantial if they can. Maintaining Moore's Law basically forces chip companies to spend on ever more sophisticated equipment and the ramp-up of chips on smaller nodes from companies like Qualcomm (Nasdaq:QCOM) and Broadcom (Nasdaq:BRCM) (in partnership with foundries like Taiwan Semiconductor (NYSE:TSM), Intel (Nasdaq:INTC), and Texas Instruments (NYSE:TXN) should support the eventual recovery.
The Bottom Line
Investing success in chips usually requires that investors swim against the tide, buying when everybody hates the sector and vice versa. Ironically, that may a bit of a problem today with stocks like ASML and KLA-Tencor (Nasdaq:KLAC), another equipment company that is well-positioned with the fabs - these stocks are still relatively more popular in the analyst community.
Still, current valuation does not seem to account for the potential of this company over the length of a cycle. Buying ASML today (or Cymer (Nasdaq:CYMI), a key supplier) will take some courage and patience, but so long as investors believe that consumers will demand ever more performance from Intel/ARM Holdings-based (Nasdaq:ARMH) devices, that eventual demand for better production equipment should emerge. (For more, see A Prime On Investing In The Tech Industry.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
by
Stephen D. Simpson, CFA
Stephen D. Simpson, CFA, is a freelance financial writer, investor, and consultant. He has worked as an equity analyst for both sell-side and buy-side investment companies in both equities and fixed income. Stephen's consulting work has focused primarily upon the healthcare sector, while he has also written extensively for publication on topics pertaining to investments, security analysis, and healthcare. Simpson operates the Kratisto Investing blog, and can be reached there.
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