Chit Chat Stocks - ASML Holding NV (ASML) with Leandro

Episode Date: July 14, 2022

ASML develops and markets advanced semiconductor equipment systems. The company has the most advanced lithography systems in the world. Leandro does a great job breaking down the semiconductor industry into normal terminology. Listen as Brett and Ryan ask Leandro questions about the company, its business model, and valuation. Enjoy the show! ***************************** This episode is sponsored by Stratosphere. Get started for free at stratosphere.io to get the powerful software and research for informed investing decisions. ****************************** This episode is sponsored by Stream by AlphaSense, the highest quality expert network library. Sign-up here and get a 14-day free trial:  https://streamrg.co/CCM ****************************** Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Interested to see more of Leandro's work? Find him on Twitter here: https://twitter.com/Invesquotes?s=20&t=hiOfwwbFaD2MXngoNE9-AQ Contact us: [e-mail] Timestamps ASML Holding | (6:13) Value Chain | (17:31) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

This episode is brought to you by Stratosphere.io, the best web-based research terminal for company-specific metrics like KPIs and segment revenues. The service saves time, has a beautiful interface, and has the best data visualizations on the internet for equities. Now, our favorite features are the 10 years of data with data visualizations. This includes company specific KPIs, charts for all the financial metrics you might be interested in, and stuff specifically for that company. So for example, if you're looking at a payments company, you might have take rates, you might have GMV. If you're looking at a marketplace, you'll have GMV as well.

All that good stuff that can get you updated on your research process. If you want to get started today for free, go to stratosphere.io and start utilizing the powerful research terminal. Again, that is stratosphere.io. The link is in the show notes. We hope you'll join us on there today. Welcome to Chit Chat Money. This is our Thursday deep dive interview where we have on a single analyst or expert, and we discuss one stock. And today we're talking about ASML with Leandro. He has been on the show twice now. And just for some context, ASML is a semiconductor equipment provider and the leader or a leader in advanced lithography machines. If that sounded like a bunch of mumbo jumbo, don't worry, Leandro

gets into what that is, but he is the main contributor at Best Anchor Stocks, a Seeking Alpha service. I really do recommend checking that out. He does very thorough research. I think you'll see that today. But before we get to the interview, Brett, what were some of your highlights? My highlights were talking about the geopolitical relationships, talking about the competitive relationships? Is it someone able to copy what ASML does? And then their R&D relationship, not just with their own company, but with their suppliers, kind of getting everyone moving in the right direction so they can get these new machines to market in 2025 and how they are not the one company, but one of the companies, leading companies like Apple, Samsung, Intel,

nvidia to create the most advanced chips in the world and i guess you could say they're one of the companies that's contributing you able to be streaming this podcast from your phone uh just given how they've been able to you know keep moore's law going all that good stuff so you can thank them for the podcast industry indirectly uh but yeah we go in through all the details the cyclical parts of the semiconductor cycle, or excuse me, the cyclical threat that people are thinking about right now. I think anyone that's maybe knows ASM well, ASML well, will learn a lot from the show or maybe get some good thoughts going. And if you don't know them at all, it's also a good introduction. Yeah, I agree. And I was kind of a novice coming into this and

Leandro paints a really good picture of how the business works and sort of its moat within the industry, but we don't need to go any longer. Here's our interview with Leandro. Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chitchat Money by Ryan or Brett or any other podcast guest is not formal advice or recommendation.

Now, please enjoy this episode. Welcome in. Today, we're joined by Leandro. You may know him as InvestQuotes on Twitter. He has some really aesthetically pleasing one-page pictures on companies, like little note sheets. I recommend going and checking them out. But he's also the main contributor at Best Anchor Stocks.

And so for any listeners that are unfamiliar with what Best Anchor Stocks is, can you give sort of the elevator pitch? Yeah. So first, thanks for having me again. I think it's that. Well, I don't I don't think it's sure it's the second time after Constellation. so best anchor stocks is like the goal is to find follow and research a list of high quality companies that have low volatility okay so we don't aim directly for low volatility because it's almost impossible to do because the market like you don't control the market but by finding large established companies with predictable earnings we try to find like those companies that are not going to do a minus 60 percent or minus 70 percent because if 2020 and

2021 was a guide like people can find great companies but not many people can actually weather the volatility like that that you have to weather to to read the returns of those investments so the goal is basically to research uh largest at least and low volatility companies so that they help compensate for those investments that are more volatile i like that when when did you start best when was best anchor stock started january 14th it was not that it was not the best the best moment to start in hindsight no i think honestly it's gonna be the best like timing wise i think it's gonna be fantastic because when we launch something right near uh the top in february 2021 it's not the most fun

because you're anchoring back in your mind, even though you're trying not to have those high prices, you know? Yeah. Oh, sorry. Go ahead. No, no. Like it was a good time because the portfolio, like we're building it now. But if we would have come out with a portfolio already like built,

then in hindsight, it would be quite painful probably, although it's doing quite well, to be honest. All right. That's a good tease. Well, let's, let's talk about one company, ASML. I, I looked up the full name, but I don't, I don't feel like saying it because it's really long. And so it's just known as ASML. How'd you come across them as an investment? And can you describe briefly what they do? yeah so the the process was pretty simple because i knew that apple was designing some of the like most advanced dhl chips in the world for its devices like well now we have seen the m1 the m2 so i started getting interested in the semiconductor space and i then listened to a podcast about semiconductors and they spoke about asml and how it had one of the widest modes in the

in the industry so i thought well a wide mode in an industry that is that is expected to grow fast for many years to come like seemed quite compelling to me so that was like i was a bit worried at the start because i knew asml was a manufacturing company so i don't really love capital intensive businesses because for example for the what is happening now like all the inflationary pressures are going to give these businesses quite hard but for me it was quite surprising to learn that uh asml actually is not capital intensive is quite capital light and so we'll talk about that later but anyways after listening to the to the podcast i read the book fabulous it's not i think the book is dated 2014 and talks about the history of the semiconductor

industry and after reading the book i just like got more excited about the industry went to asml website and read the annual report i didn't understand a single thing so then i decided to to go deeper into the industry first because it was almost impossible to understand what asml did if you didn't understand the the ecosystem so started reading a lot about the industry until i think i grabbed i don't think i grabbed a pretty good understanding of all the technicalities in the industry, but I don't think it's necessary to understand where ASML fits

and how important it is in the industry. So that's how I started. The process took several months and then after knowing more about the industry, I actually reread ASML's annual report and that's when I understood everything and how the company fit in the industry and why it was so important.

And then, well, to give a brief introduction of what the company does asml is the uh it's not the the sole manufacturer but manufacturer but it's the main manufacturer of lithography systems for the semiconductor industry so these systems basically uh help uh foundries and idms which are the chip manufacturers to print the the digital chip patterns into the silicon wafer so asml is not alone in duv that is like the trailing edge system but it's the sole supplier of the euv system that is the most advanced lithography system in the world okay and i imagine we might have a lot of listeners that were in a similar boat to you when you first started looking into semiconductors so you mentioned fabless were there

any other resources in particular that kind of helped you learn about the industry it was it was actually quite hard uh that's why what i did the one pagers i did on the semiconductor industry because it was very very hard to find a place where they actually explained the semiconductor industry in a way that um everyone could understand it so i went for videos in youtube there's a channel that is called Asianometry he talks a lot about semiconductor like the semiconductor industry I think he's based in Taiwan so you could expect him to be a trusted source and then I saw different videos but it's actually very difficult to find a place where you can find a summary of the semiconductor industry and then the books that

are specific to the semiconductor industry most are like really expensive like 300 a piece because they're like very specialized and used for education more than laser reading right and i don't yeah that's probably a little bit beyond what we need to be as investors uh to get a to own the stock all right let's move into the business because we talked about the importance lithography um why are or what are the unit economics for asml and how is an equipment supplier to some of the largest manufacturers in the world able to achieve such large gross margins i believe if i looked at the range over the last 10 years it was about 40 to 50 percent yeah so i i'm gonna come up with this question from three angles first uh price then cost and

then software so when it comes to price uh obviously due to asml's importance and monopolistic position in euv and its oligopoly oligopolistic position in duv although it's also somewhat a monopoly asml has plenty of pricing power so then obviously you'd think that they'd sell these systems at a very acceptable margin um like each euv system the current ones are cost uh like are priced north of 150 million dollars and the new euv systems that are coming into high volume manufacturing in 2025 those are those cost around 300 million so that's the part of price they They actually can, being the sole supplier in EUV especially, they can price these systems at a very acceptable margin. And there's no one that is going to force them to lower this price.

Then from a cost perspective, I think it's not that intuitive, but ASML is actually capital light. So for the past 10 years, the average capex over revenue has been 5%. Like if you tell this to someone, like if you see an EUV system and how they build them and how many parts it has, and you tell the same person like, hey, this business spends 5% on Capex, it's like actually quite, for me, it wasn't intuitive. Like they are not spending anything compared to what they are producing. this is only possible because the capex is born by the supply chain so asml like each system has 100 000 parts or something like that and most of these parts are produced by third-party suppliers and they basically born all the capex to manufacture these these parts and also all the research and development uh obviously asml has to buy these parts so that's also a cost that

that is going into cogs but i would say that uh buying the parts has better economics than producing all of all of the parts in-house because it's there are a hundred thousand parts and most of them like are not related to each other so it's pretty difficult to have that in-house i would also say that besides the better economics it's also less risky to have to have it from a third-party supplier especially when you know that many of these suppliers depend on asml so that they cannot just run away um then when you are left with a like you said 50 40 50 gross profit and then this translates into a 30 net net profit margin uh and the so the like the flow through is quite high because i mean asml doesn't need to spend anything on

marketing i don't think tsmc inter or samsung need to see an ad or like to see a sales pitch so they buy an euv system like they they know they know it and they know who does it no facebook ads over in taiwan huh no no i don't think so like actually this has been a problem with asml because as they don't have a a strong brand towards the public they're actually struggling with brand like with um talent retention and talent acquisition because no engineer goes out and says hey i want to work for asml because probably like 90 doesn't know like what asml is right so they are trying to boost that they are actually investing in marketing there and so to put some numbers here sgna costs were less than four percent of revenue in 2021

so it's basically like a luxury company they don't spend anything and then the company does spend quite a bit on research and development like 2.5 billion that was 14 percent of sales it's not too high especially for a company that's so technologically advanced but this is also because what we said previously that most like some of the R&D is borne by the suppliers so if I'm making the optics for the EUV system, I'm spending there and the research and development to manufacture the optics. It's not, ASML can help me, but it's not ASML who is spending this money. And then obviously they don't have to, at their scale, a 40% of revenue equals 2.5 billion.

So it's quite hard to replicate for any competitor because they probably have to spend quite a bit more of as a percentage of revenue and then also important in the in the margin mix i would say is that people don't like people are not familiar with the company don't know that asml also has software products like if uh which obviously is a high margin business so when a customer receives an euv or duv system they can purchase a software upgrade so this system has more productivity um and this was very important during the semiconductor shortage because asml was telling customers like i'm gonna be able to give you this system but maybe in a year and a half so customers were saying okay well i'll buy the upgrade to the software so then it's

more productive probably not as much as the new system but it's something that can be deployed instantly and I can continue to produce more. So the software and all the field force that ASML puts in the customer's fabs, this made around 20% of revenue in 2021. So it's actually a significant portion that helps uplift margins. This episode is brought to you by Stream by AlphaSense. Stream is an expert interview transcript library with more than 10,000 interviews spanning across all industries, including tech, media, consumer goods, and plenty more. Not to mention 70% of these experts can be found only exclusively on stream. Thanks to many of the interviews that I've read on stream, I feel like I've gained a much more

intimate understanding of the companies that I cover. And at this point, it has become an integral piece of my research process. So if you want to check out some of their transcripts for yourself, you can go to streamrg.co slash CCM and sign up for a free 14-day trial. using the promo code CCM. Again, that's streamrg.co slash CCM, S-T-R-E-A-M-R-G dot C-O slash CCM. I want to try to get some context, some more context around like the value chain. So who are ASML's customers? Maybe what are some of the examples? And then what are their relationships like with suppliers um kind of what are the dynamics there yeah so the customers are basically the foundries and idms idms is integrated device uh idms integrated device

manufacturers yeah yeah and and the foundries that pure play foundries that don't do design just do manufacturing so that would be tsmc intel tsmc intel and samsung like asml doesn't disclose it but 60 percent of their revenue comes from this these three customers because they are the ones that are um that are actually buying the euv that is uh the higher price product so asml always had a like received a customer concentration risk but there's actually little that the company can do about it because these fabs are so expensive that the foundries have consolidated to large players that actually can do this can can spend the escapex like if you see i think tsmc or samsung they are spending north of 20 billion in some in some fabs

So this expenditure can only be made by big players. So I think it's obviously a risk, but it's not like ASML can diversify to more EUV customers because the pool is really slow, the pool of customers. ASML also sells to companies that, to memory fabs. And now these memory fabs are starting to purchase EUV also. But the bulk of the revenues is in those three customers. And also the DUV is sold more to trailing edge fabs, especially analog.

So when you do an analog chip, you don't need like a digital chip to the smallest features. So those are buying DUV. With EUV, you can do also advanced chips, but not so advanced as with EUV. So that on the side of customers, I would say that it's kind of a symbiosis relationship, like ASML knows that it depends on these customers, but these customers know that they depend on ASML. And both are actually trying to keep a healthy long-term relationship. So ASML in the cheap shortage could have probably hiked prices or doubled prices if they wished. Like people were going to still buy the systems or maybe not double, but hike prices 20%.

But they said that they were not going to act that way because that would damage the long-term relationship with foundries. So that's one part. like asml does hike prices and does have pricing power but they always do it looking at productivity so if my system is more productive then you're going to have to pay more for it probably what asml spends on making it more productive is less than what they are getting with the price hike but it makes sense for customers to see that a system is more expensive because it's producing more so that's i would say that's the relationship with with customers and then with suppliers it's much more complex because as we said it's like the the systems are the euv for example is

100 000 parts so there are hundreds and hundreds of suppliers i would divide them into two groups one is like the supplier that produces our commoditized product that it's not the sole supplier of that part so there i would guess asml has quite a bit of bargaining power because they actually probably that supplier is selling a lot of his output to asml and then you can you have the exclusive suppliers so for example the the company that makes the optics is called carl zeiss it's a german company and they are the sole supplier of this part so you would say okay so asml doesn't have too much bargaining power because they they need this part from that supplier but the thing is that asml has been intelligent in the sense that they have

participated like they have bought a participation in these companies or in some cases they have bought them in full so that reduces somewhat the bargaining power i think from carl's eyes if i don't remember incorrectly asml owns like 30 percent and of the company that does the light source uh for the euv system if i'm not mistaken asml owns a hundred percent of the company so this is this is why the moat is is much larger than many people think because you don't have only to replicate the technology but you have to replicate all the businesses that do the parts that go into the system so these companies have been decades investing in this technology so you have to replicate like 10 15 companies if you want to match an euv system so it's it's

obviously not easy all right so we cover the basics of the business and now the the latter half of the show we're going to cover kind of any nuances current news and then we'll get to the valuation of financials more specifically so first question i guess we're coming out with some negative stuff the there are rumors out there recently that the u.s and i guess u.s and allies want to convince asml to ban them from selling even its legacy equipment uh to china and i believe the EUVs are banned from China right now, but this would be the D-UV or the DUVs. Correct me if I'm wrong. How big of a threat to the business is this if they're excluded from China? Okay. So if we put numbers, it's not that big of a risk as someone without context would think

because China is the largest buyer of semiconductors, but it's actually not that important when it comes to manufacturing semiconductors. I think it's like the sixth country in semiconductor manufacturing. Obviously, the government is trying to boost that. So China makes around 14% of ASML's revenues. It's a pretty substantial part, but it's not something that would make ASML lose half of its business. As you said, EUV exports are already forbidden now they're talking about duv i think it's immersion duv because there are two types of duv one is dry duv immersion duv so immersion duv is used for more advanced chips than dry duv i think that they will not ban dry duv probably because probably china already has some domestic

copy of that so it doesn't make sense so from a quantitative point of view the impact would be significant but not that i don't know this is breaking probably especially i think that we have to take into account that there's another side of the coin to all this it's not that the us wants to get china away from manufacturing they want to take china away from manufacturing and they want to dominate manufacturing and europe also so at the same time that they are trying to do these moves they are doing what we said before of the cheap side that they are They're trying to subsidize other companies to bring manufacturing to their countries. We have seen TSMC is building a fab in Arizona.

And then I think it was Global Foundries that is now saying it's going to invest in France. Intel is also looking at Germany. So these subsidies are going to benefit materially ASML because ASML, like a FAB, is very expensive. And most of the cost of the FAB is equipment to build chips. And most of this equipment is our ASML systems. So as long as the US and the EU keep incentivizing domestic manufacturing, ASML is going to see a lot of that money flow to their financials. So that should help counteract the impact from a China ban. But to be honest, as an investor, what I don't like is not the fact that China is being banned from like DUV.

is the fact that the government is getting maybe uh too involved in the company like this is this is obviously something normal when you have a company that is the only one able to do the most like the machines that made the most advanced chips so i think it's it's a risk that is out there but i don't know i i don't think that the impact is that large as people think i don't know asml i think dropped eight percent on the news or something like that i actually contacted uh asml's investor relation department and they told me that they weren't like the logic like the answer i expected to receive that they were not going to comment on rumors but that that was a rumor that was like it was a rumor that had been there for quite a couple of years right so it's it's not

something that hasn't been thrown around before. Okay. Here's something that's maybe more positive, but I think investors maybe don't believe it as much anymore if we're kind of looking at what the stock price has done. On the last conference call, which I believe would have been Q1 in May or April, ASML execs said they had five years of demand already booked given their manufacturing capabilities. Because I guess they have a hard time ramping up given how complicated everything is. How reliable do you think that statement is? I think it's not 100% reliable, obviously. The net booking for ASML, I think last quarter were north of 24 billion. So that's basically telling you that they can put one year and a half of revenue just if they satisfy the demand that

they have already sold. I don't think it's like I said, 100% reliable, but I actually don't think it matters that much right now because like many people are talking about an incoming semiconductor bust and i think like that's why semiconductor stocks are doing so poorly everyone expects a down cycle now so even those that have demand book are doing poorly because investors think there's plenty of double ordering like customers putting on double order double orders because they have so much demand that they cannot need, that if a down cycle comes, obviously much of this demand they will not need.

So for sure, there's double ordering when it comes to DUV in ASML. I think that's probably the case. But DUVs right now is 40% overbooked. So you need 40% cancellations like for those cancellations to fly into the income statement. Right now, every cancellation is going to go to the net bookings metric and it's not going to impact the income statement.

So, and this is what management said in a recent conference, like imagine if demand goes down 20%, well, we still have a buffer of 20%. So if the down cycle is short-lived, maybe we will never see that lower demand going to the income statement because the orders would pick up in the coming months. Now, if the down cycle is, I don't know, one year or two years, probably you'd see an impact to the top line. and but i'm less worried about the euv side because these systems are key for for customers to remain competitive like intel didn't go to euv soon and it caused them a lot of trouble with tsmc that moved to to this technology so many actually it's like they need them to remain competitive Not investing in EUV means that maybe in five years you're going to regret it because you're not going to be manufacturing the same leading edge chips as your competitors.

So they are actually paying prepayments to receive this system. So Intel has booked the most advanced EUV system for 2025 and they have paid, obviously it's not disclosed, but they have paid a hefty amount to be the first ones to receive it. So saying no to EUV now means you're losing that prepayment, obviously. And secondly, you're saying I'm risking my competitive position over the long term. So I don't think that's happening. Like EUV, I don't see, will see meaningful cancellations if a down cycle comes. So this is obviously my opinion and things could go differently, but I actually think that ASML is probably the company in the semiconductor equipment space with the least top line risk in a semi down cycle. i i always like i guess i always struggle with whenever a company uh has a competitive advantage that's based on just being further ahead technologically because i can never like i feel like i uh it's maybe too complex for me to understand but do you think there's any

other company that could do what asml does okay so in there's definitely in duv and in metrology and inspection there's obviously companies that can do that because asml has competition there in dry duv uh canine does the the systems also and in immersion duv it's nikon which by the way the u.s is also pressuring japan to uh for like to prohibit the exports of nikon to china because they can get just to say nikon's the other big lithography company right from japan yeah okay yeah yeah and they do the immersion duv which is exactly what the u.s wants to like ban asml from exporting to china so my first thought was well but this is a bit stupid because china can get it from japan but then i read that they are also trying to pressure japan to ban it

so that it made it made more sense um so there there's there's competition there although asml is the the leader but asml is increasingly shifting to euv so actually their mode is getting stronger because the semiconductor industry is following morse law that for for people who don't have context, Moore's law states that the number of transistors that you can fit on a chip doubles every two years and the price is cut in half. It's the main reason why technology is deflationary.

I don't know if I should have said that word in the current environment. So as the semiconductor industry moves to EUV and is less reliant, like duv will will always be needed but asml is less reliant on duv so the mode is getting stronger around the business i don't think euv is replicable for at least i'm gonna be conservative i'll say for at least a decade because uh what we said before you have to first get the technology right like how do you want to assemble the system and then you also have to get the all the supply

chain which is probably the hard part like i don't think the hard part is knowing like how to assemble the system but the hard part is having all the pieces ready and all the companies that do the pieces like some of these companies have exclusivity agreements with asml so a competitor cannot come and start like buying parts from them um and also uh if someone tries to replicate this asml keeps evolving so low low ma euv is like the trailing edge euv so to say um and nobody has been able to replicate that and asml is already launching the next generation of euv which is high na so i think it's actually quite a strong mode i know in technology you like you can never never say never because technology comes at you fast but i think i'm i'm quite relaxed due to the supply

chain mode that the company has more than the technological mode which is also which is also wide in my opinion and then they also have metrology and inspection systems that are systems that are used to test how like the the the chips like to see if the patterns are have been printed correctly and here asml has competition and it's not and they are not the leaders so there's significant competition there too especially from kla gotcha um oh brian yes i'm just trying to think through it so that you said some of the more advanced systems are like 300 million dollars a piece and you might not have the answer in front of you but how many of these systems can they like produce i i imagine they can't i think it's that much i think it's

like 60 right unless you probably well that's like the the high na systems i think uh so the one that cost 300 million management was talking about uh building a capacity of 20 per year over the medium term so that would be like being able to produce these systems like in 2026 or 2027 and now they are also like trying to boost the the the capacity of all the other systems but that's sort of the preliminary numbers that that they gave like right now the not the 300 million one but the 150 million one like that uh trailing edge euv so to say the low last year if i'm not mistaken they shipped 42 and this year they expect to ship 55 so that's more or less like the the numbers behind it but it's also important to know that

when they ship 55 it doesn't mean that they are recognizing in revenue 55 they are probably recognizing less because with the chip shortage they what they have done is what they called fast shipments so they ship the product to the customer and then they cut all the testing of the system is done in the customer's fab because that like shortens the the sales cycle and and they cannot recognize it in revenue until the customer has has like tested the product and is already using it gotcha gotcha all right so we talked about this a bit but maybe can you quantify how the reshoring of manufacturing in america and europe can be for asml is there are you just tracking the capex announcements that you know intel and all the other companies are making

in the west or how can we understand like how important this is for someone like asml and the other equipment manufacturers? Yeah, so I think it's difficult to quantify exactly because you don't exactly know how much of each fab is going to be spent on ASML's products. But I think seeing the capex of the big players is quite a good sign. For example, I think TSMC spent last year uh 40 billion in capital expenditures and they are expected to spend this year 44 billion so it's already a high figure and it's increasing um i actually don't have a number behind it i don't think the when when i researched asml like the the chipset and everything was not like in the news every day or it was like i actually didn't think about it so um i think that there's enough

demand even without the chip stack because the the chips have to be have to be made and there's an increasing demand for chips and this is a long-term circular tailwind so um i don't know how to quantify it but i know it's going to be a very significant tailwind for the company because it's basically money that is flowing to them even and in a recent conference also the the head of euv said that even if these fabs are built but then they are not used at full capacity they actually don't care that much because they are putting the system on the floor So once the system is on the floor, they recognize the revenue and it's done. Obviously, there's more than just selling the system because as we said before,

ASML also has a portion of its revenue coming from software updates and from field force that the company is putting in the fabs to help the customers run these companies. So it's not the systems you sell, but as the installed base gets larger, it's also the money you're going to make with those additional services. I would say my number would be, it might be pretty significant. That's my number. It's high. It's high.

Given the numbers that everyone's throwing around, it's got to be high. All right. We got a few more questions. Last one specifically on the financials. How cyclical are ASML's margins? I know people worry about that in the semiconductor industry. Has that been smoothed out because of some of the things you've been talking about? Is that something you worry about when you're making an investment here?

Okay, so if supply would be equal to demand, I would tell you right now that ASML's margins are cyclical. Because I don't see their company spending less on research and development just because they are selling less. like it's part of the mode is spending that money so obviously under a low demand environment if sales go down the margins should compress but in the well like there's also some sort of pricing power you can do to try to uplift margins in that scenario but i don't think it would be enough especially because we talked about before that they are trying to keep the long-term relationships with customers healthy. So I don't think they would do like,

I don't know if it was Pepsi today that they high price at like 11%. I don't see ASML doing that. But in the case we are now, where supply is short of demand by a pretty substantial margin, I don't see margins being that cyclical because as we said,

the down cycle would impact net bookings, but not the financials directly. so i think asml would be able to to maintain its margins they are seeing a little bit of cost pressure due to inflation obviously but it's not that significant for um for a manufacturing company so i would say that right now i'm not worried about cyclicality in margins i would be very worried in case supply would exactly match demand okay last well second last question the i want to talk about the valuation so i think it's sitting around 175 billion dollar market cap today how do you go about valuing asml okay so if i were to simplify things a bit and just look at

multiples i would say that 29 times uh last 12 months earnings doesn't seem excessive for a monopoly in such an important industry obviously it's high it's richly valued that's uh especially when you consider it when you compare it to the peers but when you say peers well the peers are considered everyone that does like equipment for the semiconductor industry but obviously asml has no direct peer so to say because they have a product that nobody else has um if you do uh next 12 months the p i think stands around 22 times now a lot of arguments are being made yes but this is like artificially cheap because the e might contract and then the like it will it won't be that cheap next year but as we said before i don't think that asml has a

lot of risk in the e at least over the short term so i think they would they would be able to realize like most of the earnings that are expected for next year unless things turn really rough which could happen so 22 times next 12 months earnings doesn't seem excessive to me either so this is like the easy part but then if we do like more complex valuation method and we do an inverse discounted cash flow uh the current price assumes i'm gonna last year last year's free cash flow was nine billion but that's inflated so many people look at the free cash flow yield and say oh look uh asml is super cheap but that's not real because in those nine billion you have a lot of prepayments for euv that are not recurring like they made it once and they're not going to

make it again at least for the time being so if i reduce that nine billion to six billion for example like it's just i'm just trying to see what the price uh of the stock is assuming right now so if we bring like starting free cash flow to six billion um and we assume like the current price assumed that the company is able to grow 13% its free cash flow during the first five years, 10% from years five to 10, and using a terminal rate of 3% and a discount rate of 10%. And I'm not assuming here any reduction in shares outstanding, which I think probably is going to happen.

So I think ASML is capable of comfortably beating these estimates. Especially considering that the chip industry is shifting to EUV. So EUV is basically ASML. So they are shifting towards ASML and there's like, it's probably right now it isn't, but in the future, EUV will be a higher margin business than DUV. So I would say that based on this assumption, it's undervalued. And also we have to take into account that high quality companies are not perfectly represented in a discounted cash flow model

because from year 10, you drop the terminal rate to 3%. Obviously, it's stupid forecasting more than, well, even more than five years. It's a bit silly forecasting because you're probably going to miss even what the company makes next year. So I would assume that ASML from year 10 onwards

will keep growing at a faster pace that the terminal rate is portraying. so i would say that if it under a dcf it appears fairly valued for me if it's a high quality company it will be undervalued like imagine and i'm going to put another example but imagine um valuing google using a five-year discounted cash flow in the year 2013 and now you see after five years what google is google is doing and you're like well obviously like it grew past five years quite comfortably but obviously there are not so many companies that are able to grow past a 10th year like there's a lot of survivorship bias in this

assumption but i for me it's it's fairly valued using this these assumptions although it can be like the short term can be very tough like that's if we go into a down cycle and a recession It doesn't matter if ASML is more protected. Protected is going to go probably down with the rest of the industry. You talked about the share count reduction. I think I saw that they are returning capital to shareholders through both buybacks and dividends. Is that right? Yeah, they are doing both, but I actually don't like the company's buyback policy

because they are actually DCA-ing the dollar cost averaging their purchases. And I'm not a big fan of that, especially because what they had, I think they had $9 billion under the repurchase agreement and it's basically ending. Like they have spent 87% of that amount. And what if like now everything drops? Like they have to probably approve a new one or whatever. But I don't like the fact that they are making like recurrent purchases.

I would prefer like, I would prefer them to save it. And when things got really, really rough to buy back a large chunk. And if that does not happen, I would prefer to receive that money in a dividend, probably. Kind of be more opportunistic. Yeah, I'm going to say both. And then just to clear things up, did you say for your five-year assumption, was it 30 or 13, three, three, 13, 13, 13. Okay. I was going to say 30. That would be a, that'd be aggressive.

I was going to ask for a clarification there. All right. That makes sense. All right. Last question. What could go wrong? This is a little pre-mortem. We like to close things out here. Why would ASML be a poor investment say over the next five or 10 years? okay i think we've talked about the two main risks a bit over the like in the conversation the first one is that the government gets too involved that asml is some sort of like nationalized company and obviously that would be terrible for the stock in my opinion then the other risk i see is that asml is not able to expand supply to match demand like it's not

expanding demand supply for asml is not easy at all because they have to talk to all of their suppliers because you cannot say i'm going to do 30 more euv systems if cal size that does the optics cannot do 30 more optics like you need them to be on board too so uh if they cannot boost supply too much this demand is going to be like a cap on growth so to say um i'm not really worried over the short term because there's no competitor so even if you like take long to deliver the system you're not going to impact your customer relationships because there's not another supplier that is selling the same things as you in less time. But over the long term,

this should be the main focus for the company, in my opinion. They are already working on it. They said in the last earnings poll that they are looking to boost the capacity significantly. And they are talking to the suppliers and they'll say something in the investor date that I think is November or something like that. Is that where they could, I mean, could they just theoretically invest in some of their suppliers and give them some capital to boost their own supplier supply?

Yeah, they have said that where suppliers cannot invest all the CapEx needed to boost this capacity expansion, they'll help them. they have always done like they'll give them like loans or whatever or they'll acquire a participation and they'll give them money so they can boost the the supply okay perfect well i think that's all the questions we have uh thank you for joining us for a second time for any listeners that want to keep up with you where's the best place to do that and where can they find more of work well i think the best place is twitter at invest quotes and then also seeking alpha that i'm the main contributor of of may best anchor stocks so those two places would be the best well and also shout out here to common stock like i also find me on common stock

at InvestQuotes too. So the same as Twitter. Yeah, that's right. We've been all posting on there. It's gotten a lot. The activity on there is growing for sure. And we'll link in the show notes to the Twitter and the Seeking Alpha.

All right. Well, that's going to do it. We want to remind our listeners that Brett and I are not financial advisors. Anything we say or discuss here on Chit Chat Money is not formal advice or recommendation. We are, however, general partners at Archer Capital. so we may have positions in the securities discussed in this podcast.

Thank you all for listening. Thank you, Leandro, for coming on the show. We'll see you guys next time.