ASML is just a hold despite falling share price
As a dividend growth investor, I look for opportunities to increase my dividend income. I buy income-producing assets, mostly stocks in the United States. Sometimes I add to my existing positions when I think stocks are attractive. On other occasions, I initiate new positions in companies that can help me increase my diversification and have a decent valuation.
One of the most intriguing sectors right now is the technology sector. We saw a massive drop in the Nasdaq as sentiment shifted from growth to value. Therefore, there are opportunities for investors in this area. The semiconductor segment is fascinating because it includes companies that still benefit from long-term demand. ASML Holding SA (NASDAQ: ASML) is a leading supplier in the semiconductor industry, and I will analyze it in this article.
I will analyze the company using my dividend growth stock analysis methodology. I use the same method to make it easier to compare searched companies. I will examine the fundamentals, valuation, growth opportunities and risks of the business. I will then try to determine if it is a good investment.
Seeking Alpha’s business overview shows that:
SML Holding develops, produces, markets, sells and services advanced semiconductor equipment systems including lithography, metrology and inspection systems for memory and logic chip manufacturers. The company provides extreme ultraviolet lithography systems and deep ultraviolet lithography systems including immersion and dry lithography solutions to fabricate various ranges of semiconductor technologies and nodes.
Revenues have increased significantly over the past decade. Over the previous ten years, sales more than tripled as the demand for semiconductors grew and the demand for the devices needed to produce them increased. ASML’s growth is primarily organic as the company invests heavily to maintain its leadership position. Going forward, analyst consensus, as seen on Seeking Alpha, expects ASML to continue growing at an annual rate of around 11% over the medium term.
The company’s EPS (earnings per share) grew even faster. The reasons why EPS is growing faster than sales are company buyout programs and higher margins. Larger scale, as there were more orders, allowed ASML to become leaner and more efficient with its spending. Going forward, analyst consensus, as seen on Seeking Alpha, expects ASML to continue growing at an annual rate of around 15% over the medium term.
The company is a relatively new dividend payer. The company pays a 1% dividend, which seems safe and unlikely to be reduced, with a payout ratio below 40%. There are several nuances regarding the dividend. The dividend has increased on an annual basis for 12 years. However, there are two nuances. It wasn’t until 2022 that the company moved to a quarterly dividend, so the charts might look weird.
In addition, the company pays a progressive dividend in euros. Therefore, currency fluctuations may impact the dividend in USD. Investors can buy the shares in Europe and diversify their dividend payouts with a few euros.
In addition to the dividend, ASML Holding also returns capital to shareholders through buyouts. Buybacks are the main form the company chooses to return the money it bought back for more than 17 billion euros of shares in 2021 alone. Buybacks are incredibly effective when the company is growing because they supplement dividend growth. ASML has repurchased over 10% of its shares over the past decade. As the valuation becomes more attractive, the efficiency of the buyback will also increase.
ASML Holding’s P/E (price to earnings) ratio stands at 38.7 when considering 2022 EPS forecasts. This is a high valuation, even given the healthy growth rate. by 15%. It is therefore not surprising that the P/E ratio, which stood at 56 at the start of the year, has contracted. The current valuation is almost the lowest this year, but it is still an expensive stock.
The chart below highlights that while the stock isn’t as expensive as it was just a few months ago, the business is still expensive. The current P/E ratio is much higher than the average P/E ratio over the past two decades, which was around 28. ASML is never cheap, but the current valuation still makes it expensive , leaving investors little room for error.
To conclude, while ASML has excellent fundamentals, valuation is difficult. Even healthy double-digit revenue and net income growth can only justify the current valuation if the business is running smoothly. Therefore, the current valuation leaves investors with a minimum margin of safety.
The long-term story remains intact for the entire semiconductor industry. There are more smart devices, and each device requires more semiconductors. Semiconductors have become more complex and more powerful, driving the continued demand for high-end chips and machines capable of creating them like those sold by ASML. Short-term challenges will not change the long-term megatrend.
The most significant opportunity for ASML Holding is a competitive advantage that gives it a convenient monopoly. The company has a technological advantage that allows it to be the only company to sell EUV (Extreme ultraviolet lithography). As of 2022, ASML Holding is the only company that produces and sells EUV systems for chip production, mainly targeting 5nm. This is an important advantage because it is the only company to meet the most high-end needs.
A strong balance sheet is another opportunity for the company. The company’s interest coverage is greater than 100. Thus, the company has only a negligible risk regarding higher interest rates. In addition, the flexibility and high cash position with a low level of indebtedness allow ASML to be very active in the field of mergers and acquisitions if and when necessary. The lower valuation makes acquisitions more attractive in the current environment.
Weaker demand in the short term that could slide in the medium term is a risk for the current valuation. According to analyst consensus, as seen on Seeking Alpha, analysts expect EPS to decline 13% in 2022 and rebound 45% in 2023. This assumption is based on the recovery in demand. We see semiconductor companies like Intel (INTC) and Nvidia (NVDA) and Micron (MU) suffering from lower demand, and if this continues it will also hurt ASML in 2023.
It takes into account the risk of recession. Right now, the economy is technically in recession after two consecutive quarters of negative GDP growth. However, we are not feeling the recession so harshly. The job market is strong, unemployment is low, and people are still consuming. However, if the situation deteriorates, we could see more abrupt drops in demand. So, if there is a risk of a longer period of falling demand, there is also the risk of a deeper falling order during this period.
Competition is also a risk for ASML Holding. The company holds a monopoly due to its leading position and technological advantage in unique machines. However, the company competes with peers like Lam Research (LRCX) and KLA (KLAC) on other devices. Additionally, the company may not be complacent as other companies strive to disrupt its current position.
ASML is a high quality company. The immense growth in turnover and net income leads to a greater return of capital to shareholders. Long-term growth opportunities will serve the business as we move forward. Therefore, investors should follow this stock, which is suitable for a diversified dividend growth portfolio.
However, the company’s current valuation is too high. It does not reflect the possibility that the risks will materialize over a longer period. If 2023 does not show an extreme recovery, the stock price will likely fall further. Therefore, I think the stock price should be around $350-$400 in the current environment. A price of $500 will only be plausible when we see more assurance for a recovery in 2023.