Improved Semiconductor Inventory: ASML versus Applied Materials
Improved Semiconductor Inventory: ASML versus Applied Materials
ASML (ASML 1.99%) and Applied Materials (AMAT 3.78%) are two prominent players in the global semiconductor equipment manufacturing sector. ASML is recognized as the world's primary producer of lithography systems, employing optics to etch circuit designs onto silicon wafers. It's the sole supplier of high-end extreme ultraviolet (EUV) lithography systems, crucial for manufacturing the world's smallest, densest, and energy-efficient chips.
Applied Materials, on the other hand, offers a broader spectrum of semiconductor manufacturing equipment, services, and software catering to the foundry, logic, and memory chip markets. It also provides equipment for LCD and OLED display production. Both firms are considered vital cogs in the semiconductor industry's machinery.
However, during the past three years, ASML's stock has witnessed a 5% decline while Applied Materials' stock surged by 15%. Let's explore why this disparity occurred and determine whether Applied Materials remains a stronger semiconductor equipment play compared to ASML.
ASML confronts macro and regulatory challenges
ASML, headquartered in the Netherlands, holds a significant position in the semiconductor market's supply chain with its EUV systems. Leading chipmakers like Taiwan Semiconductor Manufacturing (TSMC), Samsung, and Intel rely on ASML's EUV systems to manufacture high-end chips.
These systems cost over $150 million each and require multiple cargo planes for transportation. ASML's next-gen high-NA EUV systems, needed for the creation of even smaller chips, currently set you back about $380 million. The company took decades to develop EUV technology, so it won't encounter substantial competition in the near future.
Nevertheless, ASML's growth is influenced by the cyclical semiconductor market. It's also vulnerable to the ongoing tech and trade conflict between the U.S. and China, which has prohibited it from selling EUV systems and certain DUV lithography systems to Chinese chipmakers. Half of its revenue was sourced from mainland China in 2023.
ASML's revenue increased by 33% in 2021, 14% in 2022, and another 30% in 2023. This growth was primarily attributed to robust PC sales during the pandemic and the 5G upgrade cycle in the smartphone market, alongside the flourishment of the AI sector.
However, analysts predict a 2% increase in revenue for 2024, due to the implementation of tighter export restrictions against China and the market's lapsing of the initial AI market growth surge. Earnings per share (EPS) is anticipated to decrease by 4%.
In 2025, analysts anticipate a 15% rise in revenue and a 27% surge in EPS for ASML. Its stock appears relatively priced at 28 times future earnings and offers a forward yield of 0.9%, although it's yet to be considered an attractive buy at these prices.
Applied Materials tackles more significant issues in China
Applied Materials' revenue increased by 12% in the fiscal year 2022 (ending October 2022), but saw a marginal 3% growth in fiscal 2023 and only 2% in fiscal 2024. Its growth declined as the broader economic headwinds negatively impacted the PC, smartphone, industrial, and automotive markets. Additionally, the tightened export regulations obstructed sales to China, which contributed to 37% of its total revenue in fiscal 2024.
Furthermore, the U.S. Department of Justice (DOJ) has been investigating Applied Materials' prior equipment sales to China's largest chip foundry, SMIC, for the past year. Reports suggest that Applied Materials' heavy reliance on China led to its unsuccessful application for CHIPS Act funding (for a $4 billion R&D center) in July 2023.
Nonetheless, Applied Materials expects a revival of its growth as the demand for more powerful AI chips, energy-efficient chips, and denser memory chips rebounds. It aims to gradually diminish its exposure to China while developing integrated solutions by merging multiple production steps like material deposition, etching, and material modification into a single system. It also anticipates a resurgence in its smaller LCD and OLED businesses.
This explains why analysts anticipate a 9% rise in revenue and an 11% increase in adjusted EPS for Applied Materials in fiscal 2025. Based on these projections, its stock seems reasonably priced at 17 times forward earnings and yields a forward dividend yield of 0.9%.
Which stock should you buy?
ASML's underperformance relative to Applied Materials can be ascribed to its overvaluation in comparison to its growth potential around that period. ASML's bulls believed its EUV market dominance justified its premium valuation, but its growth stagnated in 2024, and its fiscal outlook for 2025 was subdued. However, its current valuation appears a bit more favorable relative to its long-term growth potential.
Meanwhile, Applied Materials' valuations were pushed down by concerns surrounding its future in China. But if you believe it can navigate these challenges and compensate for the pressure with growth in other markets, it might be undervalued at current prices. While I recommend caution before investing in either company, ASML's monopoly in the EUV market, lower overall exposure to China, and stronger growth rates position it as a more potential investment compared to Applied Materials.
Given the text, here are two sentences containing the words 'finance', 'money', and 'investing':
- Investors looking to finance their semiconductor equity portfolio might consider the performance of both ASML and Applied Materials, as they are critical players in the industry's machinery.
- With the disparity in the stocks' performance over the past three years, those interested in investing in the semiconductor sector might ponder whether to allocate more money towards the higher-performing Applied Materials or consider if ASML's potential growth justifies its premium valuation.