The semiconductor equipment maker ASML Holding (ASML) has recovered slightly following its slump in July, when investors, worried about the company’s exposure to China and potential new export restrictions, pulled back from the Dutch company. While the stock is no longer at its July nadir, I don’t believe the opportunity has slipped away to buy ASML stock. Despite unfavorable valuation metrics, this company is a kingpin of the technology sector.
ASML’s Earnings Surprise
Let’s start by taking a closer look at ASML’s Q2 2024 earnings report, released on July 17. ASML, which essentially has a global monopoly on advanced lithography machines used to make semiconductors, painted a picture of resilience amid market uncertainties.
Net bookings impressed at €5.6 billion, with €2.5 billion attributed to their flagship extreme ultraviolet (EUV) technology, underscoring ASML’s dominance in advanced chip manufacturing equipment. Moreover, the company reported a better-than-expected gross margin of 51.5% and net income of €1.6 billion.
Despite these solid figures, ASML stock took a hit on July 17, dropping by as much as 12% and continuing to decline further in subsequent days.
This downturn was primarily driven by investor concerns over potential U.S. restrictions on advanced technology sales to China. This was compounded by the results, which showed that almost half of ASML’s revenue from the first half came from China. As such, further restrictions could impact both new equipment sales and service revenues from existing installations.
The company expects 2024 full-year sales to align with 2023 levels, with a stronger performance anticipated in the latter half of the year. However, it’s important to remember that geopolitics has a profound impact on the semiconductor industry and, consequently, ASML’s business performance.
A New Catalyst For ASML Stock
This improved outlook is partially due to a new catalyst. ASML’s high numerical aperture (NA) EUV machines represent the next step in chip manufacturing technology. NA is a measure of an optical system’s ability to capture fine detail, and as such, these EUV machines offer improved precision for crafting smaller and more complex chip structures.
Although these machines are incredibly expensive, with a price tag of around $380 million, and require significant investment in both money and time to become fully operational, ASML’s key customers are actively moving to adopt them.
That’s because new technologies increasingly require smaller and more intricate chip designs that only high NA EUV can produce efficiently. Chips with finer features are crucial for advancing computing power, energy efficiency, and overall performance. This is particularly important given the rise of artificial intelligence (AI), which has a demanding workload.
Interestingly, Intel (INTC), which has fallen behind its peers in the chipmaking world in recent years, is leading the way in terms of orders. The company received its first unit in April 2024 and has placed orders for additional machines. Meanwhile, Samsung (GB:SMSN) plans to install its first machine by early 2025, aiming for 2027 production. Also, TSMC (TSM), initially reluctant due to costs, has now decided to start ordering this year.
Looking forward, these machines will likely be central to the company’s ongoing success. They offer higher margins and reinforce ASML’s technological dominance over its peers, thanks to the extreme barriers to entry in the sector. The company has around 82.9% market share, making it a kingpin of the tech sector.
ASML’s Valuation Issue
While investing in companies with dominant market share may often feel like a shrewd move, it’s only worth it if the company’s valuation data remains attractive. And for some investors, ASML’s current forward price-to-earnings (P/E) of 42.2x is simply too expensive.
However, as always, we have to consider earnings growth. Analysts believe that ASML will grow earnings by 22.3% annually over the next three to five years. In turn, this leads to a price-to-earnings-to-growth ratio (PEG) of 1.86.
Typically, a PEG ratio above one doesn’t indicate that a stock is undervalued. However, ASML is a unique case, given its technological dominance, long-term earnings tailwinds, and its strong balance sheet. This can make it hard to value, but I personally believe the stock will push higher over the medium and long term.
Is ASML Stock a Buy?
ASML stock is a Strong Buy, according to analysts, with five unanimous Buys assigned in the past three months. The average ASML stock price target of $1,172.25 implies 31.99% upside potential.
The Bottom Line on ASML Stock
So, what’s the bottom line on ASML stock? Well, the stock is expensive, but the company’s high NA EUV machines are a crucial element in the technology sector, given their ability to produce smaller and more complex chip designs. Also, the barriers to entry in this specialized field reinforce ASML’s technological leadership. While the stock has seen a modest recovery since its July lows, I still believe it represents an attractive opportunity for investors.
