Printing Innovation
In this edition of the Smart Investor newsletter, we examine the stock of an AI chip-printing machine monopolist. We are not selling any stocks this week but have three companies under review for possible deletion from the Portfolio. But first, let’s delve into the latest Portfolio news and updates.
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Portfolio Updates
❖ Alphabet (GOOGL) saw additional pressure last week, as concerns about a potential antitrust-related breakup weighed on the stock. The U.S. government expressed renewed interest in splitting up Alphabet’s advertising and Android businesses to reduce its market dominance. Alphabet will likely appeal any decision regarding the breakup, which could lead to a prolonged legal battle lasting years. Still, some analysts believe that the breakup might benefit Alphabet’s shareholders, as Android’s immense value could be better expressed through its monetization as a separate business.
❖ Taiwan Semiconductor Manufacturing (TSM) elevated investor expectations of its quarterly results scheduled to be published this week as it reported year-over-year revenue growth of 39% in September, far exceeding analyst estimates. In other company news, the foundry giant plans to expand its presence in Europe beyond its first fab on the continent, currently under construction in Dresden. TSMC is investing heavily in new sites across the globe to mitigate geopolitical risks. According to a senior Taiwanese official, additional plants in Europe will focus on AI chips.
❖ Amazon (AMZN) strongly rebounded in the past few days after its October Prime Day achieved record-breaking results, hitting new highs with both sales and items sold. In addition, following its third annual Amazon Day Symposium, Evercore ISI said it has “incremental confidence in AMZN” as its number one pick in “Net Long in the Large Cap space.”
❖ Texas Pacific Land (TPL) surged by over 10% in the past week after it announced the acquisition of Permian oil and gas mineral and royalty interests for $286 million in cash, a move that underscores its strategic expansion in the energy sector. This acquisition could potentially increase Texas Pacific Land’s revenue streams and asset base, contributing positively to its financial performance. Additionally, there was a notable increase in insider buying of the company’s shares.
❖ Interactive Brokers (IBKR) released its quarterly results on October 15th, with shares falling in after-hours trading due to a slight EPS miss, despite exceeding analyst revenue expectations. Commission revenue rose 31% year-over-year, while net interest income (NII) increased by 9%, and other fees and services saw a significant 38% jump. However, the EPS miss was likely attributable to higher general and administrative expenses, including a one-time $12 million charge related to the consolidation of IBKR’s European subsidiaries.
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Portfolio Stocks Under Review
❖ Super Micro Computer (SMCI) remains under review, although we begin to observe a tentative positive change in sentiment towards the stock.
The company’s shares strongly rebounded following the announcement of the release of a new liquid cooling solution for data centers, positioning Super Micro for further expansion in this rapidly growing market. SMCI is a leader in the direct liquid cooling (DLC) market; its competitors such as Dell Technologies (DELL) are just starting to ramp it up, while Super Micro is already churning out its offerings at a large scale. The company’s servers are designed to reduce power and infrastructure costs in data centers.
Still, SMCI is about ten weeks behind in filing with the SEC and over 50% below its March high. As a reminder, Super Micro underwent an extremely turbulent period, which included strong hits to investor sentiment stemming from a short-seller’s report and an SEC filing delay. The hit was exacerbated by media reports of a U.S. Department of Justice probe. Although many analysts have cut their ratings and price targets on SMCI, citing the heightened uncertainty, some remained bullish, seeing it as a major beneficiary of the rapidly accelerating investments in AI infrastructure due to its first-mover advantage in liquid-cooled rack-level solutions.
This advantage came into the spotlight earlier this month when SMCI surged by almost 16% after it disclosed shipments of more than 100,000 GPUs with its liquid cooling solution system to “some of the largest AI factories ever built, as well as other cloud service providers.” The announcement underscored surging demand for Super Micro’s servers, driven by AI data center proliferation, which could translate to billions of dollars in revenue.
We at Smart Investor see SMCI’s current difficulties as temporary, while its immense long-term potential remains intact. However, we are mindful of the risks faced by the company, particularly the fragility of investor sentiment due to its compliance issues, and hope that the company will soon shed some light on these questions. Doing so could help appease investors and analysts.
In addition, Super Micro is scheduled to release its FQ1 2025 earnings on October 30th, 2024. Analysts project that the company will see its EPS rise by about 115% year-over-year as the underlying demand for AI hardware remains strong and SMCI has demonstrated an ability to capitalize on this trend. If the company can meet or exceed analyst expectations, it could provide a catalyst for a further strong rebound in the stock price.
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❖ Adobe (ADBE) remains under review for now, despite a strong rebound in the last few days. The company’s stock has been under pressure after the release of its FQ3 2024 report on September 12th. Despite reporting strong FQ3 results that beat analyst expectations, ADBE provided weaker-than-expected guidance for FQ4 2024 (expected to be released on December 12th). Investors were concerned about signs of decelerating growth at Adobe, including projected FQ4 growth of only 9% year-over-year, which would be its lowest growth rate in nearly a decade. There were also worries about Adobe’s competitiveness in the rapidly evolving AI-powered software market. While Adobe remains a leader in its field with strong financials, these factors combined to create uncertainty about its near-term growth prospects, leading to the stock decline in recent months.
However, ADBE gained strongly in the past week, after the creative software maker unveiled the launch of Firefly Video, a new AI video-generation tool, at its annual Adobe Max conference. The announcement excited analysts and investors alike as it confirms that Adobe can continue to pose strong competition to OpenAI’s Sora, as well as generative tools offered by Meta Platforms, TikTok, Alphabet, and other current or potential rivals. Adobe’s generative video AI is differentiated by its integration into its creative tool suite, as well as by its focus on commercial safety (i.e., its models are trained on data to which ADBE has commercial rights). In addition to the Firefly Video, Adobe announced AI enhancements to its family of creative tools, including Photoshop, Illustrator, and others, and said it is working on developing AI models that can generate 3D graphics.
Most leading Wall Street brokerages were positive on the stock before the announcement, with several analysts positively opining on ADBE’s prospects after the details on the new tools were released. Thus, according to Goldman Sachs, the launch of Firefly Video underscores Adobe’s competitive edge in various creative domains, with AI technology expected to support its growth trajectory. Bank of America Securities added that Generative AI tools will be a meaningful component to Adobe’s growth. The average analyst price target for ADBE implies a potential upside of about 22% in the next 12 months.
While the recent developments around GenAI tools are positive for Adobe, we remain watchful as to whether they provide a sufficient catalyst to break the negative sentiment cycle and propel ADBE towards further gains.
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❖ We are placing Target Corp. (TGT) under review for a possible sale. The shares of the discount department store chain operator languished until last week when they staged a strong rebound. The stock was under pressure from concerns about consumer spending outlook amid worries about the slowing economy and weakening job market. The disruptions brought on by Hurricane Milton in Florida have added to reduced investor sentiment. However, the latest positive economic data, coupled with the expectations that the continued Fed rate reduction cycle will boost consumer spending, seem to have injected some positivity into TGT stock in the past week. Top Wall Street analysts are mostly optimistic towards the stock, rating it a “Buy” and foreseeing an average upside of 15% in the next 12 months. Bank of America Securities analysts have recently affirmed their “Strong Buy” recommendation, saying that Target’s unique positioning in the retail space and strategic sales initiatives provide a foundation for market share gains. In addition, Oppenheimer analysts listed TGT as one of the best retail stocks to own, pointing to its dominant market position, extensive investments in technology and logistics, and strong focus on high-growth offerings, which support TGT’s ability to thrive even in challenging retail environments. However, we will be checking the pulse on Target’s stock, focusing on its ability to sustain the positive turnaround of the past week.
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Portfolio Earnings and Dividend Calendar
❖ The Q3 2024 earnings season is in full swing, and several Smart Portfolio holdings are scheduled to release their quarterly results in the next few days. The reporting Portfolio companies are Taiwan Semiconductor Manufacturing (TSM), GE Aerospace (GE), Pentair (PNR), Alphabet (GOOGL), Verizon (VZ), General Dynamics (GD), and Amphenol (APH).
❖ The ex-dividend date for Pentair (PNR) is October 18th, while for Dell Technologies (DELL) it is October 22nd.
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New Buy: ASML Holding (ASML)
ASML Holding NV develops, produces, markets, and services advanced semiconductor manufacturing equipment, specializing in machines for chip production through lithography. ASML’s lithography machines are essential for the production process of a wide range of semiconductor products, including GPUs, memory chips, and other advanced semiconductors. Alongside Nvidia and Taiwan Semiconductor, ASML stands as one of the most critical firms operating today in the advanced chip production landscape.
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The Making of a Tech Monopoly
ASML traces its roots to 1984 when electronics giant Philips and chip-machine manufacturer Advanced Semiconductor Materials International (ASMI) created ASM Lithography to develop lithography systems for the growing semiconductor market. Building on R&D efforts initiated in the early 1970s, the newly formed company launched its first lithography system that same year.
The company grew rapidly, establishing new partnerships and expanding its innovative offerings. A breakthrough platform launched in the 1990s became a major steppingstone for ASML’s success. By 1995, ASML had become a fully independent public company, listed on the Amsterdam and New York stock exchanges, with an IPO providing the capital necessary for further growth.
Throughout the following decades, ASML maintained a substantial investment in R&D, typically allocating between 10% to 16% of its annual revenue to research and development activities. Along with capitalization on innovation, acquisitions have played a significant role in ASML’s growth strategy, contributing to both technological advancements and supply chain control. The company has focused on integrating crucial technologies and expertise needed to advance its lithography systems, vertical integration of its production processes, and innovation acceleration.
ASML’s technological prowess, combined with strategic acquisitions, solidified its market position, enabling it to deliver cutting-edge lithography solutions to major semiconductor manufacturers. In 2019 – nearly 40 years after the original theoretical concept – ASML revolutionized the semiconductor industry by introducing extreme ultraviolet (EUV) lithography.
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Indispensable AI Enabler
EUV lithography, using light of a shorter wavelength, allows the production of smaller chip features, resulting in faster, more powerful chips. These machines are immensely complex – often described as “the most complicated in the world” – requiring thousands of components from specialty providers and mastery of cutting-edge technology, as well as the ability to coordinate a vast, intricate supply chain.
The development of EUV technology took ASML decades of trial and error, numerous scientific breakthroughs, and $6.5 billion in R&D investment over 17 years. ASML didn’t do it alone: it relied on a strategic and financial alliance with Taiwan Semiconductor, Intel, and Samsung, which provided crucial financial and technological support and enabled ASML to overcome the challenges of EUV development. This foundation cemented ASML’s monopolistic position at the heart of the AI boom, as the only provider of EUV lithography machines.
Other lithography machine manufacturers cannot enter the high-end EUV market due to the prohibitive costs and complexity involved. As a result, ASML enjoys a unique position, providing indispensable technology for advanced chips used in smartphones, computers, and AI training. Each EUV machine costs between $200 million and $300 million, representing 20-25% of a semiconductor foundry’s capital expenditure. It is an essential outlay for producing cutting-edge semiconductor chips, including high-end GPUs. As AI demand accelerates, the need for ASML’s advanced chip-making technology is expected to rise, further strengthening its role in the semiconductor ecosystem.
With a market cap of $342 billion and annual revenues exceeding $27.5 billion, ASML is Europe’s second most valuable company (after Novo Nordisk) and ranks #28 globally by market cap.
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Challenges and Geopolitical Risks
Despite substantial R&D investments and acquisitions, ASML remains in robust financial health, with a negative net debt-to-equity ratio (indicating more cash than liabilities). It also boasts top-tier profitability metrics, with ROE and ROA ranking in the top 3% of the global semiconductor industry. Its gross and free cash flow (FCF) margins place it in the top 20% of its sector, while operating and net profit margins are within the top 5%.
ASML holds a 90% market share across photolithography machines. EUV systems accounted for approximately 33% of 2023 revenue, with DUV machines contributing similarly. Additional revenue comes from parts, upgrades, and services for installed systems.
The past five years have seen impressive growth, with revenues increasing by 133% at a CAGR of 23.5%, and EPS surging 223.5% with a CAGR of over 34%. However, 2024 has presented challenges. CEO Peter Wennink characterized 2024 as a “transition year” as the industry works through cyclical lows. In the first half of 2024, ASML faced slowing demand as chip producers managed excess inventories, particularly in consumer electronics and crypto mining markets. Additionally, Western export restrictions on China created further hurdles. Although ASML’s DUV equipment sales to China were initially unrestricted, new licensing requirements limit its ability to sell and service machines there.
The third quarter of 2024 reflected these challenges. Despite a 12% YoY increase in sales and a 10% rise in net income, order bookings were flat YoY and fell significantly short of expectations. Challenges at Intel and Samsung appear to have contributed to ASML’s weaker results, offsetting gains from TSMC, ASML’s largest customer and the world’s primary chip foundry.
According to ASML’s statement, while it continues to see strong and accelerating demand related to AI chip production, “other market segments are taking longer to recover,” i.e., it sees continued weakness in chip markets that are not direct beneficiaries of the booming demand for AI computing infrastructure. Based on this updated view of market dynamics, the company lowered its guidance for 2025 total net sales to the lower half of the previously provided range. However, ASML expects full-year 2024 revenue to come in at $30.5 billion, slightly above analyst estimates. The decreased 2025 estimate still implies solid annual revenue growth of 16.5%.
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Capitalizing on Megatrends
The negative bookings and guidance surprises have led to the sharpest daily drop in ASML’s shares in 26 years. Despite notable short-term headwinds, transpiring from the Q3 report, ASML’s long-term prospects remain exceptionally strong, supported by its unique market position expected to help it capitalize on global megatrends of AI, 5G, edge computing, and industry digitalization.
Basically, as economic activity is increasingly driven by technologically advancing chips, the only maker of the means of their production will undoubtedly ride this wave. ASML expects continued strong demand for its EUV and DUV equipment, driven by new fab expansions planned until 2030 and the growing need for high-performance memory chips and advanced logic processors. The long-term growth in semiconductors will require existing and new fabs to keep purchasing lithography equipment and servicing existing machines. In addition, ASML’s high-NA EUV technology is expected to enable even smaller chip features, playing a crucial role in the ongoing miniaturization and performance improvement of semiconductors across various applications.
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Growth at a Reasonable Price
Meanwhile, investors have a unique opportunity to acquire the chip production stalwart at a more than reasonable price, specifically after Tuesday’s share-price plunge. Analysts expect ASML’s earnings to grow at an annual rate of over 20% in the next couple of years, with a long-term EPS CAGR of around 21%. With the share price down to levels not seen since December 2023, its current PE has fallen below 40x, while its forward PE has tumbled to about 21x. These valuations place it at the bottom of the scale among its comparable peers, who are more replaceable in the industry. Moreover, based on future cash flows, ASML now appears undervalued by over 30%.
Surely, exposure to ASML at this point doesn’t come without risks, as the picture of further China restrictions is muddied by the nearing U.S. elections expected to affect the trade relations. In addition, the recovery in sectors nonrelated to AI, including automotive and industrial, is expected to continue being slow, depressing machinery orders. However, ASML’s dominant position in the crucial EUV lithography market, coupled with the long-term growth potential in AI and advanced semiconductor manufacturing, suggests that the current valuation presents a compelling opportunity for investors willing to look beyond near-term challenges.
In addition to the potential for stock-price appreciation, ASML is a dividend-paying company. Its dividend yield of 0.91% translates into a quarterly dividend of $1.41 per share. Coupled with the occasional buybacks of shares traded on both Euronext Amsterdam and NASDAQ, it adds to the total investor compensation.
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Investing Takeaway
ASML Holding NV is a critical player in the semiconductor industry, supplying advanced lithography equipment essential for chip production. With a monopoly on EUV lithography technology, ASML holds a unique position as the enabler of AI and high-performance computing advancements. Despite recent challenges, including reduced bookings and geopolitical tensions impacting sales to China, ASML’s long-term outlook remains strong. The company is well-positioned to benefit from the growing demand for advanced semiconductors driven by AI, 5G, and digital transformation. Currently trading at attractive valuations after a recent market correction, ASML offers a compelling mix of strong financial fundamentals, the widest possible economic moat, and innovation-driven, long-term growth. As such, we view it as a valuable addition to the Smart Investor Portfolio.
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Smart Investor’s Winners Club
The 30% Winners Club includes stocks from the Smart Investor Portfolio that have risen at least 30% since their purchase dates.
The strong jump in Pentair (PNR) in the past week has propelled it well above the 30% threshold and back into the Winners’ ranks. As a result, our exclusive club again counts 16 members: GE, AVGO, ANET, EME, ORCL, TSM, SMCI, TPL, CHKP, PH, HWM, ITT, APH, GD, AMAT, and PNR.
The next in line to join the lucrative club is now IBKR with a 27.8% gain since purchase. However, given a large after-hours drop it looks like the next in line – PYPL, with a 25.4% gain since purchase – has a better chance of catching up. Will it close the gap, or will another stock outrun it to the finish line?
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Disclaimer
The information contained in this article represents the views and opinions of the writer only, and not the views or opinions of TipRanks or its affiliates and should be considered for informational purposes only. TipRanks makes no warranties about the completeness, accuracy, or reliability of such information. Nothing in this article should be taken as a recommendation or solicitation to purchase or sell securities. Nothing in the article constitutes legal, professional, investment and/or financial advice and/or takes into account the specific needs and/or requirements of an individual, nor does any information in the article constitute a comprehensive or complete statement of the matters or subject discussed therein. TipRanks and its affiliates disclaim all liability or responsibility with respect to the content of the article, and any action taken upon the information in the article is at your own and sole risk. The link to this article does not constitute an endorsement or recommendation by TipRanks or its affiliates. Past performance is not indicative of future results, prices, or performance.
