Business Breakdowns
· Matt Reustle, Tom Walsh
[00:00:00] S0: Back to the financials, for reference some of the investment that they're making into manufacturing capacity, what does the cash flow stream look like as an investor, when you look at the business, you have a certain margin profile? How much of that is just immediately getting plowed back into the business in the form of capital investment or some other form of investment? And how much is either being returned to shareholders or doing something different? [00:00:00] S1: The company's cash generation is actually pretty fantastic, not least, it's helped because customers pay a down payment. They pay for this equipment often there's only the development machines that are able to take deposits upfront. So that's been helped to support as they've had to spend heavily on R&D and building out capacity. So the cash generation of this business has actually been fantastic over the years. So pretty much net income converts to free cash flow generation. And that free cash flow generation has generally been recycled either into dividends, which is highly unusual for a company that is growing as rapidly as it is, all share buybacks, which the company has been pretty consistent about doing at modest levels, if you go back 10 years or more. But at fairly substantial levels over the last 5 years or so. So the company is able to continue to invest. It spends every year about 15%, 16% of revenues on R&D. It's investing as heavily as it ever has on CapEx, but it's still able to pay a dividend and give its cash back to shareholders through buybacks.
· Tom Walsh, Matt Reustle
[00:00:00] S1: The company's cash generation is actually pretty fantastic, not least, it's helped because customers pay a down payment. They pay for this equipment often there's only the development machines that are able to take deposits upfront. So that's been helped to support as they've had to spend heavily on R&D and building out capacity. So the cash generation of this business has actually been fantastic over the years. So pretty much net income converts to free cash flow generation. And that free cash flow generation has generally been recycled either into dividends, which is highly unusual for a company that is growing as rapidly as it is, all share buybacks, which the company has been pretty consistent about doing at modest levels, if you go back 10 years or more. But at fairly substantial levels over the last 5 years or so. So the company is able to continue to invest. It spends every year about 15%, 16% of revenues on R&D. It's investing as heavily as it ever has on CapEx, but it's still able to pay a dividend and give its cash back to shareholders through buybacks. [00:00:00] S0: You mentioned capacity expansion, having leading-edge technology, these seem like drivers of the business over the next several years. Is there anything else when you think about a bull case from an investor's perspective that stands out as an opportunity for ASML or anything else we didn't talk about in that category?
· Tom Walsh
[00:00:00] S1: The opportunity really is the history of the company has been about small images, better resolution, faster throughput. That's what we do, make things smaller, make them sharper and make them faster. And that's going to be the core of this business for a very long time because that in itself is just this massive structural growth story because the number of transistors we need, the number of chips we need in the world is going to keep growing, unless something very dramatic happens, it's going to keep growing for a very, very long time. So simply delivering on that, I think, will be -- is a massive opportunity ahead of them. There are aspects that they are able to leverage more and more beyond the simple manufacturing, but I say simple, beyond the manufacturing of lithography equipment. And that comes around some of the computational stuff that's done around what they call holistic lithography. You can't use an optical examination technique on leading-edge semiconductors anymore because the feature size is so small, and you just -- you can't see them. So nowadays, you need to fire electrons at the surface of a semiconductor to identify where the defects are arising. And they're able to do this down to a resolution of a single nanometer. That's four silicon atoms. And that's not a marketing spin that is actually four silicon atoms why they're able to measure. So the better they get to doing that at and the faster they can do that with their E-Beam metrology equipment, the better information they can feed into the computers, the better they can adjust the manufacturing or the actual lithography machine, the better the semiconductors coming out the other side will be. And really, that's the cycle they will go through. They'll keep working on that until Moore's Law runs on it.
· Matt Reustle
[00:00:00] S0: I guess in terms of monitoring that as an investor, I can make the extreme comparison to something like biotech, where you have a drug and there's very clear stages of FDA approval, where you get to a point where you know whether this is going to be an economically viable product. Here, there's some level of technology that's being tested. How do these milestones get measured or the events that determine which, yes, this has been a success and we're able to go on and sell this. How has that been announced historically? Is it something that's coming from the company or from customers? And how do you expect that to evolve in the future? I'm just curious with something like a drug approval, these are kind of big announcements that have major impacts. What does that look like in this market?
· Tom Walsh
[00:00:00] S1: It's quite different. I think it will be short form. The one thing that was made closest to say, a biotech process would be maybe the development of EUV, which was a major generational shift in manufacturing. It was give or take 20 years on from the previous generation machine and took a fundamental design of machine. And there was a lot of uncertainty as to whether it would work because you were changing so many different things. You were changing the way that the light was focused. You're going from using lenses to using mirrors to focus the light. We have an entirely new light source that needs to be invented and created and powered up. And you had to do everything inside the machine in a vacuum because the light that we're using was so delicate that it got absorbed by air particles. So that was a massive risk, we hope and actually they would report to the market on terms of test achievements. They had achieved a certain amount of power and light source. But one of the, I think, strengths again of the ASML business is a lot of the improvements are incremental and they're able to do this because they have a modular approach to design. Again, something that dates back right at the beginning of the company's history. It had to take an approach that enabled it to get something to market quickly. And it worked rather to trying make machine as one piece. They just break it down into components and they make each of those in parallel and then put them together. And the great thing about that is it means that they can take the current machine and they upgrade a single part of that, take one of the modules and upgrade that. And there's a risk, obviously, in upgrading that module. But if it doesn't work, it's not as if the whole machine falls over, they'll be working on another part of the machine as well. So a lot of the technological development, though incredibly high risk in the sense that you are pushing the boundaries of physics and boundaries of what most people would think was physically possible. The actual process they've developed for introducing each of these new improvements is as derisked as I think you can possibly do it. So yes, it's about monitoring it. It's about seeing this come through.
· Tom Walsh, Matt Reustle
We'll be able to get some readouts on how things are going with the mirror development for high NA, which is the next generation of EUV equipment down the line. But a lot of the continuing improvement in terms of existing stuff that's in the market, that's pretty gradual and incremental. It's happening all the time. And it's as low as because everything could be when it's as complex as what they're doing. They have derisked it to a certain extent. [00:00:00] S0: That's actually incredibly helpful explanation. I did appreciate the incremental progress you can make on the various components of the overall machine. So that makes sense. When you do think about the risks to the business, what stands out the most to you?