Rather than investing in a company that makes products, it is sometimes better to invest in a company that provides the tools needed to make products. In the world of chips, ASML Holdings (ASML 0.58%) that is that’s all (More on that later) A company that provides the machinery needed to manufacture chips with as many transistors as possible.
However, recent patent filings by Chinese tech giant Huawei threaten ASML’s monopoly. Is this a potential sell signal? Or is ASML still an investable company?
The competition is close, but it’s far
ASML’s extreme ultraviolet (EUV) machine allows users to etch the world’s smallest transistors onto a chip. If you’ve heard of a 7nm (nanometer), 5nm or 3nm chip, it was created using ASML machines. ASML has very few customers, only companies such as: samsung, taiwan semiconductorWhen intel buy that product.
Huawei’s potential entry into the EUV game is a problem for ASML’s technological monopoly. However, filing for a patent and building his EUV machine are not the same. There is still plenty of time before Huawei’s machines are up and running. What’s more, given how exclusive the technology is, it’s unlikely the Chinese government will allow it to be sold to foreign companies, who would prefer to buy from Chinese chipmakers. The real problem is Huawei’s ability to make these tiny chips, so if ASML’s customers have to compete with Chinese products, they could be hurt.
Still, while the threat is still small at this point, it is a risk that investors must understand. If ASML can maintain its dominance, its impressive financial position combined makes it an excellent investment.
ASML Holdings is in a strong financial position
EUV machines are not cheap. One estimate puts the EUV machines costing him about $150 million each, about the size of a school bus. As a result, ASML revenue can be very large. Producing a handful of additional machines in a quarter could result in a failed quote. To understand how your business is doing, it’s worth looking at metrics like net bookings (amount of sales orders accepted). In the third quarter, this he reached 8.9 billion euros, a new record.
ASML also generated a net profit of €1.7 billion from a turnover of €5.8 billion, a profit of 28%.
With its impressive margin profile, ASML can generate staggering amounts of cash. ASML has free cash flow of $9.6 billion over the past 12 months, which will allow it to buy back its own shares. On IR Day in November, ASML announced a new buyback program to buy back €12 billion worth of his shares (about 5% of market capitalization). The following graph shows the effect of these buybacks over the past five years.
The program isn’t as aggressive as some companies, but it’s better than nothing.
However, the biggest indicator for buying ASML is the free cash flow yield. Free cash flow yield, like dividend yield, is a measure of how much free cash flow a company generates relative to its market capitalization. ASML yields 4.4%, higher than 10-year government bonds. This shows that the stock is currently undervalued. ASML is approaching its highest free cash flow yield in 10 years, so I think now is a great time to take a position in ASML.
Huawei may be close, but ASML has a big head start. Moreover, with a stock at a reasonable valuation and a record backlog of new business, buying ASML is the best way to invest in the chip space without chip maker cyclicality.
Keithen Drury has no positions in any of the mentioned stocks. The Motley Fool US headquarters recommends ASML, Intel and Taiwan Semiconductor Manufacturing. The Motley Fool’s recommended options are Intel’s Jan 2023 long call at $57.50, Intel’s Jan 2025 long call at $45, and Intel’s Jan 2025 short put at $45. The Motley Fool’s U.S. headquarters has a disclosure policy.