When choosing a company to invest in, I always like to look for what Warren Buffett called a “moat” protecting it—a competitive advantage that allows the company to maintain pricing power and better than average profit margins.
When I’m considering an investment in the technology sector too, particularly in the semiconductor space, I am especially mindful of looking for those moats. That’s why I’ve always liked Taiwan Semiconductor (TSM), the world’s largest semiconductor contract manufacturer. Its leadership position in cutting-edge semiconductor technology is unchallenged at the moment.
The same also holds true for another company in the semiconductor sector that enjoys a dominant position, ASML Holding NV (ASML). The company’s extreme ultraviolet (EUV) technology, which uses light to etch integrated circuits on to silicon wafers at minuscule scale, is a miracle of modern engineering. Each EUV machine weighs 180 tons and costs more than $150 million.
ASML sells its machines to the likes of Taiwan Semiconductor, Samsung, Intel, and others. It dominates the global market for the lithography machines used to make advanced semiconductors. The company leads, with an 80%+ market share, in innovative extreme ultraviolet lithography systems, which utilize near-X-ray level wavelengths of 13.5 nanometers.
In effect, ASML is the printing press of silicon chips. I would call it the single most critical company in the global semiconductor supply chain. Its importance was already growing as the semiconductor industry accelerates investment in new production to meet a global shortage of chips and surging demand. Analysts expect the market to double to $1 trillion by 2030.
And now, thanks to the continuing global supply chain woes, the dominance of ASML will go on for many more years.
Chip Woes for Two More Years
In mid-March, Wall Street was breathlessly telling everyone how Intel’s (INTC) $88 billion expansion plan in Europe would turn the company around.
Well, guess what?
A shortage of critical equipment over the next two years will likely delay Intel’s multi-billion expansion plan, by as the supply chain struggles to step up production.
This warning came from Peter Wennink, the CEO of ASML, who told the Financial Times during an interview: “Next year and the year after, there will be shortages. We’re going to ship more machines this year than last year and…more machines next year than this year. But it will not be enough if we look at the demand curve. We really need to step up our capacity significantly more than 50%. That will take time.”
The reason ASML needs time to expand production lies in its own supply chain.
For example, the most complex component of ASML’s EUV equipment is the lens, which is made by the German manufacturer, Carl Zeiss.
In order for Zeiss to expand their production, a lot has to happen. First, the company would have to build more clean rooms. This involves asking for permits, and then actually building a new factory. Once a factory is ready, they need to order the manufacturing equipment needed and hire professionals to actually make the lenses.
Last, but not least, it takes more than 12 months to make the high-tech lenses needed for ASML.
I suspect Wennick’s estimate of a two-year period of shortages is too conservative. This shortage may last until the middle of the decade.
ASML’s Bright Future
To me, this means ASML will continue to dominate—it has no serious competitors in the EUV lithography machine space. Japan’s Nikon and Canon do not have the scale, nor the resources necessary to compete with ASML at the cutting-edge of technology.
And with Taiwan Semiconductor, Intel, and Samsung all vying for process technology leadership and trying to meet demand, ASML will be the primary beneficiary as it sells tools to all three chipmakers.
ASML shipped 26 EUV machines in 2019, 31 EUV machines in 2020, and 42 systems in 2021. Forecasts are for the company to ship about 55 EUV systems in 2022. By 2025, the sale of EUV systems will likely account for over 75% of ASML’s litho system revenue, compared with just 31% in 2019.
The company has proven its ability to keep increasing revenues and squeeze out bigger margins for many years now. For a linchpin in the semiconductor supply chain, even paying a premium for its shares looks more than fair.
But with the weakness in technology stocks in 2022, you will not have to pay a premium. ASML stock is trading around $665 a share. It’s down from its 52-week high of 895, making it a buy here.
