With only three orders received in the third quarter, ASML couldn't hold on
ASML has been in big trouble lately.
The president of ASML has been warning since August that the Chinese market, which has the fastest growth rate and the most stable demand, has been closed due to the bans in the United States and the Netherlands, and this behavior will hurt ASML's healthy development.
Then, the prophecy turned out to be unfortunate.
According to the latest earnings report, ASML received only three EUV orders in the third quarter, well below analysts' expectations of nine orders. It is also disappointing that the backlog of unfulfilled EUV orders is also experiencing customer requests for shipment delays.
ASML's weak fundamentals are complemented by a gloomy outlook. The company now expects its total revenue in 2024 to be essentially flat year-on-year, followed by a recovery in sales in 2025. However, analysts have concluded through calculations that the company's 2024 forecast is disappointing, and confidence in its 2025 is also affected by uncertainty and some speculation.
The current weak demand environment for ASML's semiconductor manufacturing equipment means that the company's ability to generate cash flow will be weak not only in 2023 but also through 2024. As a result, the company's buybacks totaled only €100 million in the third quarter, a significant drop compared to the €900 million buybacks in the first half of the year.
Notably, including buybacks and dividends, ASML's equity yields have now compressed below 2%, down from about 3% in fiscal 2022 and less than half of the returns on short- and long-term US Treasuries.
This is a red flag.
Plummeting orders and lost markets
ASML's president is now one of the most uncomfortable people. Unlike Nvidia, which is banned and can still produce low-frequency computing cards to sell to China, the Chinese market for DUV lithography machines is almost saturated, and the EUV lithography machine it urgently needs is not allowed to be sold in the United States.
According to previous financial reports, the revenue of EUV lithography machines accounts for 40% of ASML's total revenue, but the profit accounts for more than 50%. The biggest problem for ASML is that the profitable business is not allowed to be sold, and the other business markets are becoming saturated.
What makes ASML even more uncomfortable is that many orders that have been completed by EUV cannot be shipped, and a large number of customers have written to request the postponement of the delivery of relevant equipment. In fact, this has taken up a large amount of ASML's capital, which has affected its liquidity a lot.
Of course, there is an inevitability to emerge in this situation.
Looking at the data, the equipment capex investment cycle of most foundries has peaked sometime in the last 12-18 months. This may be due to a combination of factors such as intensified market competition, accelerated technological upgrading, and changes in the global economic environment.
In the case of Samsung, the company expects capital expenditure in fiscal 2023 to be 54 trillion won, essentially unchanged from the same period last year. However, semiconductor capex is expected to decline by 5% year-on-year. This suggests that while Samsung has remained stable in terms of capital expenditures, its investment in semiconductors is decreasing. This may be due to the weakness of the semiconductor market demand and the uncertainty of the overall economic environment.
At the same time, ASML faces a number of headwinds. First, the delay in fab construction may have affected the production and delivery of its equipment. Second, weak demand for semiconductors could lead to a decline in customer demand for ASML equipment. Finally, the overall economic environment is weaker and may also have a negative impact on ASML's business.
In a sense, the dynamics between ASML and the OEM seem to have shifted in favor of buyers. In the past, ASML equipment was in short supply, but now it is starting to appear in stock.
ASML's top management is well aware of this, and they have set their outlook for 2024 very low.
ASML President and CEO Peter Wennink said in a recent earnings briefing that 2024 is expected to be a transition year as customers remain uncertain about the recovery of demand within the industry. ASML is conservative about 2024 and expects annual revenues to be broadly in line with 2023.
ASML CFO Dasse said 2025 will be an important year of growth. First, the growth momentum is significant and very strong, secondly, 2025 will be in an upward cycle, and ASML believes that the share of lithography machine investment in total fab investment will continue to be strong. As previously mentioned, there are also a significant number of fabs that will come online in 2024 and 2025.
The core of ASML's executives' speeches was actually the hope that investors would abandon their better expectations for 2024 and instead hope that the industry will turn around in 2025 and bring opportunities.
But will it really work?
Financial reports that are influenced by the Chinese market
According to the third quarter of 2023, ASML achieved net sales of 6.7 billion euros, which is in the middle of the forecast revenue range. Sales under management amounted to EUR 1.4 billion. Gross margin for the quarter was 51.9%, exceeding the expected target.
According to the report, the company's sales performance in the current period benefited from two main factors: first, the high proportion of infiltration equipment sold in the current period, and second, some non-recurring one-time expenses. Together, these two factors drove ASML's sales performance in the current period.
In the quarter, ASML posted a net profit of 1.9 billion euros and new orders of 2.6 billion euros, which was lower than in previous quarters but remained at a high level. The main reason for this phenomenon is that in the current economic environment, customers are cautious about cash flow and capital expenditures, and therefore relatively conservative about new orders.
Looking further at the types of lithography machines sold by ASML in the third quarter, a total of 105 new lithography machines were sold, including seven used lithography machines. The specific product categories are as follows: 11 EUV lithography machines, 32 ArFi (immersion DUV lithography machines), 9 ArF dry (dry DUV lithography machines), 44 KrF lithography machines, and 16 I-Line lithography machines.
In terms of end applications, 76% of the shipments were made of lithography machines for the manufacture of logic chips, while 24% of the shipments were used to manufacture memory chips. In terms of sales, ArFi immersion lithography machines account for 48% of sales, and EUV lithography machines account for 35%.
Crucially, Chinese mainland customers accounted for 46% of the equipment sold in the third quarter, followed by Taiwan (24%) and South Korea (20%). The high proportion of sales in Chinese mainland this quarter is attributed to ASML executives as two reasons.
First of all, the equipment shipped to Chinese mainland is mainly for mature process customers, which means that these equipment are mainly used to produce mature process products. The majority of shipments in the quarter were based on orders from 2022 and beyond, suggesting that demand for these devices was identified at an earlier point in time.
Secondly, the timing of other customers' needs has changed, which has enabled ASML to deliver more equipment to customers in China. This change may be due to economic conditions, technological developments, or other factors in other regions. As a result of this change, ASML was able to adjust its production schedule to meet the needs of its customers in China.
As a result, deliveries in China are increasing while others are decreasing, which has led to a relative increase in the share of the Chinese market. This change may be due to the intensity of competition in the Chinese market, market demand or other factors.
Recently, it has been rumored that due to TSMC's reduction of capital expenditures, ASML has also suffered a large cut in orders, and some of its equipment orders in 2024 have been cut by TSMC by about 40%. ASML did not respond directly to the rumors of a cut, but the company's treasurer, Roger Daasen, admitted that some large companies are "delaying the need for certain equipment".
However, TSMC reported that President Wei Zhejia said that due to the continued weakening of the overall economic situation and the weak overall demand in the end market, customers are more cautious and intend to further control inventory, including the fourth quarter of 2023. This means that the postponement of ASML's orders may extend into the first half of 2024.
This is really not good news.
Another situation is formed
As the world's largest chip market, in fact, China is not incapable, but relies on openness to establish market guidelines. But the competitive landscape of the global lithography machine market is changing profoundly after the United States introduced new chip control rules in October last year, prohibiting the sale of 14nm and higher-level chips or related equipment to China, including restricting Americans from providing any help to the development of China's semiconductor industry.
On the one hand, the Chinese government has attached great importance to and strongly supported the chip industry, and has introduced a series of policies and measures to promote the development of the industry. For example, the establishment of a national integrated circuit industry investment fund to encourage innovation and technology research and development, and cultivate outstanding enterprises and talents.
On the other hand, China has established a relatively complete chip industry chain, covering multiple links such as design, manufacturing, and packaging. Domestic companies have made certain breakthroughs in these fields, making China's chip industry have a certain ability to innovate independently.
To a certain extent, in this technological blockade and market competition, Chinese local companies are gradually emerging and becoming important competitors of global lithography machine giants such as ASML.
In an interview last September, ASML CEO Peter Wennink expressed his views on China and the export controls and protectionism the company faces. He made it clear that completely isolating China through export controls is not a viable solution.
In fact, he argues, these restrictions are pushing China to redouble its efforts to innovate and accelerate its pace towards self-sufficiency. Huawei, for example, has its latest Mate 60 Pro smartphone powered by a Chinese-made chip. Although the performance of this chip is slightly inferior to TSMC's 5nm chip, due to the large enough order volume, Chinese foundries have a "golden opportunity" to improve yield. It is estimated that the yield has increased from 15% to 50%.
At the same time, global lithography giants such as ASML are facing competitive pressure from local Chinese companies. China's lithography machine industry chain has taken initial shape and has made breakthroughs in some key areas. For example, Shanghai Microelectronics' leading position in ArF lithography machine technology, and Keyi Hongyuan's breakthrough in independent research and development of high-energy excimer lasers all show China's technical strength and market potential in the field of lithography machines.
First of all, Chinese mainland has a foundation for rapid development in the field of lithography machines, and the lithography technology industry chain has been initially formed. Shanghai microelectronics lithography machine technology is leading in China, and the ArF lithography machine with 90nm resolution can be mass-produced, and the lithography machine with 28nm resolution is also expected to make a breakthrough. The domestic lithography machine is still in the DUV stage, but it has made a major breakthrough in immersive technology. Once the breakthrough is achieved, it will enter the high-end ranks of DUV lithography machines.
In addition, the first high-energy excimer laser independently developed, designed and produced by China Keyi Hongyuan Company has filled the gap in the field of excimer laser technology in China.
Secondly, in terms of gluing and developing equipment, Xinyuan Microelectronics has launched the first immersion high-capacity gluing and developing machine, which can meet the requirements of T RACK for domestic production lines of all process nodes of 28nm and above, and can cooperate with the mass production of various mainstream lithography machines.
Therefore, in the face of the rise of China's local competitors, global lithography machine giants such as ASML need to re-examine their market strategies and technical routes. In this competition, whoever can maintain the leading position in technology and products, and continue to expand the market share, is likely to achieve greater success in the future. However, this also requires companies such as ASML to continue to innovate and invest more R&D resources.
In the eyes of Wall Street analysts, ASML shares are currently trading at 33 times earnings based on expected earnings in 2024 – which is much higher than the 24 times earnings of some of the most promising tech stocks, such as Meta. In fact, even Apple's stock is cheaper than ASML, with the former trading at 29 times earnings.
The main reason analysts feel that ASML should not trade at a higher price than companies such as Meta is that ASML is relatively more susceptible to economic cycles. In addition, in contrast to some tech giants, ASML's business fundamentals are not protected by network effects or brand values.
As a result, multiple Wall Street analysts agree that the recent bullish trend in ASML stocks does not coincide with the overall fundamental recovery in the semiconductor industry. In fact, the capex cycle for foundry equipment investment appears to have peaked around last year, and the market should not expect a rebound in the global economy until 2025.
For ASML, lower-than-expected EUV orders, coupled with delays in the shipment of existing orders, are clear headwinds. This weak demand scenario has impacted the company's free cash flow and buybacks, and ASML's share yield has compressed below 2%.
While ASML has a bright long-term structural outlook due to its dominance in the lithography machine space, the company's stock valuation may not be worth investing in at this time.
In order to solve the impact of the decline in chip equipment shipments, ASML must open up new markets in time and strive for the right to ship chip equipment freely.
However, it is difficult to implement such a decision.
[The analyst is an investment consultant and well-known analyst of Wall Street investment bank. 】
作 者 | Khen Elazar 张津京