ASML Holding: More HBM Equals More EUV

seekingalpha03-27

ASML's stock price has surged by 42% since July 2023, driven by their monopoly position in Extreme Ultraviolet (EUV) technology and strong growth in wafer demands.The growing demand for high-bandwidth...

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Since then, the stock price has surged by 42%. With the rising AI demands, I argue ASML will continue the rapid growth momentum in the near future, driven by explosive demands on high bandwidth memory (HBM) in AI computing. I reiterate with ‘Strong Buy’ with a one-year price target of €1,238 per share, or $1,340 in USD. HBM Growth Drives EUV Demands In FY23, ASML delivered 42.2% net system sales growth, with logic growing by 60.2% and memory increasing by 9.2% year-over-year. They finished the year with a record backlog of €39 billion.   ASML Annual Reports My biggest takeaway from their FY23 result is their tremendous growth potential in the HBM market, driven by AI computing. High-bandwidth memory devices are required to pair with GPUs in order to process vast amounts of data in generative AI. Let’s start with the three main suppliers for HBM: In the most recent earnings call, Samsung Electronics (OTCPK:SSNLF) indicates that the market has huge demands for HBM, and the majority of their capital expenditure will be focused on expanding HBM manufacturing capacity. In Q4 FY23, Samsung Electronics’ HBM sales increased by more than 40% quarter-over-quarter. Additionally, they expect the next generation of HBM3 product to begin mass production later this year. According to EDN, SK Hynix’s sales of HBM3 chips have increased by more than fivefold in 2023 compared to 2022, and they plan to proceed with the massive production of HBM4. SK Hynix has ambitious plan to increase their HBM capacity to capture the increasing demands on GPUs. Micron (MU) released their Q2 FY24 result on March 20, indicating their HBM has been sold out for calendar 2024, and the overwhelming majority of 2025 supply has already been allocated, as detailed in the slide below.   Micron Investor Presentation According to the outlook provided by the three companies, it appears that the industry demands for HBM is quite high. These memory companies plan to increase their manufacturing capacity to meet the rising demands and capture the notable growth opportunities from AI computing. For ASML, the benefit is quite obvious: more HBM manufacturing means more EUVs demands. Over ASML’s earnings call, their management expressed optimism regarding the EUV demand from memory market. I anticipate that the expansion of HBM manufacturing could contribute significant growth to ASML in the near future. China: Export Restrictions The U.S. government has been increasingly controlling ASML’s exports to China. Dutch and Japanese governments also implemented export restrictions to China due to pressure from the U.S.. Over the earnings call, ASML indicated that the impact of the Dutch and U.S. export control regulations would affect 10%-15% of their China system revenue. Given that China accounts for 26% of total revenue in FY23, the impact on group revenue could be 2.6%-3.9%, as per my calculation. Enterprises in China have made many pre-purchases before the regulation became effective, as shown in the chart below. In FY23, ASML’s China revenue grew by 148% year-over-year.   ASML Annual Reports ASML has not gained the export license approval for their NXE:2000 products, and the regulatory approval is granted on a case-by-case basis. It is quite uncertain whether ASML can obtain the regulatory approval. According to tom’s Hardware, the latest U.S., Dutch, and Japanese export rules restricted the sales of tools and technologies that can produce logic chips with non-planar transistors on 14nm/16nm nodes and below, 3D NAND with 128 or more layers, and DRAM memory ICs of 18nm half-pitch or less. The export restriction is expected to pose some growth challenges for ASML; however, based on my calculation, the overall revenue growth impact is in low-to-mid single digit range. Recent Result and FY24 Outlook In Q4 FY23, ASML achieved a record high of net bookings, amounting to €9.18 billion, as depicted in the chart below. The revenue grew by 12.6% year-over-year. The company expects FY24 net sales to be similar to FY23. It worth nothing that ASML achieved 30.2% total net sales growth in FY23, and the muted growth outlook for FY24 reflects the strong comparable as well as the impact of China export restrictions. In FY23, they generated €3.28 billion FCF, paid out €2.34 billion in dividends, and repurchased €1 billion of own shares.   ASML Quarterly Results Over the past six years, ASML has achieved an average of 20.9% net revenue growth. As such, the growth rate in FY23 was quite abnormal and well-above historical average. The rising demands in AI and numerous pre-purchases in China attributed to the high growth in FY23, in my view. Investors should be mindful that ASML’s growth is tied to fab’s manufacturing expansion cycles; therefore, ASML’s growth rate can be quite volatile. For instance, their logic revenue grew by 60% in FY23, and they anticipate a slow year of manufacturing expansion for FY24. Consequently, I think their FY24 guidance is reasonable. As discussed previously, I anticipate the rising demands for HBM will emerge as a structural growth driver for ASML in the near-term. Valuation As discussed, I forecast flat revenue growth in FY24, reflecting the growth headwinds from China, and some normalization of wafer manufacturing capacity expansion. For normalized growth, I anticipate ASML will deliver approximately 20% revenue growth, a level consistent with their historical average level. The rising demands for HBM will create long-term growth tailwinds for ASML, in my view. ASML achieved 32.8% operating margin in FY23, and I anticipate their future margin expansion will be driven by gross margin improvement as well as operating leverage from R&D expenses. New product innovation is crucial for ASML, as these offerings carry much higher ASP and gross margins. For instance, on March 12, ASML announced that the first TWINSCAN NXE:3800E is now being installed in a chip fab, and the NXE:3800E is aimed to make chips on 2nm and 3nm-class technologies. I anticipate their consistent R&D innovation could drive their gross margin expansion in the future. In the model, I assume 10bps margin expansion from gross margin, and another 10bps from R&D operating leverage.   ASML DCF - Author's Calculation I calculate their free cash flow to equity by adjusting their net income with depreciation/amortization, change in working capital and net borrowings.   ASML DCF - Author's Calculation The cost of equity is estimated to be 13.5% with the following assumptions: -Risk free rate: 2.99%. 10-Year Eurozone Central Government Bond Par Yield Curve -Market risk premium: 7% -Beta: 1.51. SA’s 24-month data After discounting all the FCFE at a discount rate of 13.5%, the one-year price target is calculated to be €1,238 per share, or $1,340 in USD, as per my estimates. Other Issues I think the biggest risk for ASML is their export to China, as discussed previously. The current export restriction rules from Dutch, U.S. and Japan could have some meaningful impact on China’s advancement in chip developments. However, I believe Chinese government would pour tremendous capitals to their own EUV developments. I acknowledge there is a considerable gap between ASML’s leading EUVs and Chinese local players; however, don’t forget that ASML is just one company, whereas China is an entire country. Investors should not underestimate the speed at which China can progress in this area. In addition, ASML repurchased €8.85 billion of own shares in FY21, followed with another $4.64 billion in FY22. However, they only bought back €1 billion of own stocks in FY23, which could indicate that the management might believe their stock price is overvalued, or less attractive compared to that in previous years. Conclusion I think the rising demands for AI computing necessitates more memories in GPUs, which would stimulate memory/logic capacity expansion over the near future. ASML stands to benefit from the industry-wide capacity expansion in my view. I remain optimistic about their long-term growth potential, despite uncertainties surrounding their exports to China. I reiterate with ‘Strong Buy’ with a one-year price target of €1,238 per share, or $1,340 in USD.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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