ASML. EUV moves ASML closer to a monopoly. Target Price EUR Expected performance (12 mth) 18.2% BUY EUR (Closing price 20-Aug-13)

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Markets Equity Research INVESTMENT RESEARCH ASML Tech - Semiconductors / The Netherlands Company results Target Price EUR Expected performance (12 mth) 18.2% BUY EUR (Closing price 20-Aug-13)
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Markets Equity Research INVESTMENT RESEARCH ASML Tech - Semiconductors / The Netherlands Company results Target Price EUR Expected performance (12 mth) 18.2% BUY EUR (Closing price 20-Aug-13) EUV moves ASML closer to a monopoly 21 August 2013 Analyst: Robin van den Broek Tel: Analyst: Marc Hesselink Tel: Opinion on qualitative criteria Accounting IFRS 01/01/2004 Quality of track record High Solvency High Currency risk Neutral Risk of asset write-off Low Share price performance/eps revision (EUR) Price ABN AMRO EPS est We have more confidence in EUV At SEMICon West we have seen several indications that EUV acceptance has grown. EUV can handle situations far better when factory circumstances start to deviate from ideal circumstances, which should lead to superior production yields for next generation chips. With EUV it is possible to develop critical layers with a single exposure, allowing for a significant reduction in the number of non-lithography process steps. As a result, ASML will be in the position to claim more of its clients capex as it will have a monopoly on EUV. We believe ASML will demonstrate 80W source power with 3Q13, giving further backing to a scenario with strong EPS growth towards Expectation for the entire equipment market is positive as well Both SEMI and Gartner expect semi equipment spending to increase by some 20% in 2014, mainly as a result of a strong rebound in memory spending. Therefore, ASML s earnings momentum is likely to remain positive. Possible small delays on EUV will not be amplified by an economic downturn. In such a scenario, we believe investors should keep focus on EUV upside. As such, we do not focus on our EPS14 estimate which is 3% below the street. Valuation: reiterate Buy, target price up from EUR 60 to EUR 80 Based on increased confidence in EUV, we pull forward our EPS estimate of c. EUR 7.0 from 2018 to As a result, our EPS16 moves up from EUR 5.2 to EUR 7.1. We consolidate Cymer increasing margin potential as a result of vertical integration. Our DCF moves up to EUR 80. We reiterate Buy Aug Oct Dec Feb Apr Jun Source: FactSet, ABN Amro Equity Research Year to December e 2014e 2015e 2016e Sales (EUR m) 4, , , , ,884.0 EBITDA (EUR m) 1, , , , ,488.4 Net profit excl. extr. & amort. (EUR m) 1, , , ,131.4 Net profit (EUR m) 1, , , ,128.1 EBITDA margin (%) ROCE (incl. goodwill) (%) Net gearing (%) (47.3) (32.1) (43.5) (52.8) (60.5) Market capitalisation (EUR m) 30,248.9 No. of shares (m) Free float 71.1% 1/3/12 mth perf. (%) 0.0/9.1/40.0 High/low 52 weeks (EUR) 70.33/40.37 Next results due 16 October 2013 Price/book value (x) 4.2 Volatility (ß) (5yrs/DJ Euro Stoxx) 0.9 Reuters symbol ASML.AS Bloomberg symbol ASML NA Website EPS before extr. & amort. (EUR) EPS (EUR) DPS (EUR) % change sales (16.3) % change EPS (excl. extr. & amort.) (22.0) (18.4) EV/Sales EV/EBITDA P/E (excl. extr. & amort.) P/E PE/growth (excl. extr.) 2.1 nmf Free cash flow yield (%) IMPORTANT: PLEASE READ DISCLOSURES AND DISCLAIMERS BEGINNING ON PAGE 19 2 ASML 21 August 2013 ABN AMRO Bank Contents 1. Investment case Increased confidence in EUV Moore s law needs EUV Size of EUV market over time Holistic tool kit to push EUV price to upper-end of range Bump in EPS16 more certain Optimistic market outlook for SEMI and Gartner are positive on Both SEMI and Gartner see strong rebound in memory ASML s reliance on foundry, IDM and memory Other industry estimates Valuation ABN AMRO versus consensus Estimates revision table ASML is cheap compared to ARM DCF points to EUR ABN AMRO Bank 21 August 2013 ASML 3 1. Investment case We have more confidence in EUV At SEMICon West we have seen several indications that EUV acceptance has grown. Firstly, several EUV results showed that this technique handles situations far better when factory circumstances start to deviate from ideal circumstances, which should lead to superior production yields for next generation chips. Secondly, Nikon s presentation where it tried to push multiple patterning as a competitive alternative to EUV contained an unrealistic low throughput for EUV. We believe ASML will demonstrate 80W source power with 3Q13, giving further backing to a scenario with strong EPS growth towards With EUV it is possible to develop critical layers with a single exposure, allowing for a significant reduction in the number of non-lithography process steps. As a result, ASML will be in the position to claim more of its clients capex as it will have a monopoly on EUV. Expectation for the entire equipment market is positive as well Both SEMI and Gartner expect semi equipment spending to increase by some 20% in 2014, mainly as a result of a strong rebound in memory spending. ASML s earnings momentum is likely to remain positive. Possible small delays on EUV will not be enforced by an economic downturn. In such a scenario, we believe investors should keep focus on the upside EUV can still realise. As such, we do not focus on our EPS14 estimate which is 3% below the street. Pull EPS of EUR 7.0 forward from 2018 to 2016 On the back of increased confidence in EUV, we pull forward our EPS estimate of c. EUR 7.0 from 2018 to As a result, our EPS16 moves up from EUR 5.2 to EUR 7.1. We also include the Cymer acquisition in our model, which increases margin potential over time as a result of vertical integration. We illustrate that gross margin can move up to 50% over time, but pencil in a gross margin of 45% in 2016 and following years. We keep some slack in our gross margin in order to allow for additional investments to keep system requirements on track. Valuation: reiterate Buy, target price up from EUR 60 to EUR 80 As a result of the pull forward of EPS growth and the inclusion of Cymer our DCF valuation enhances from EUR 60 to EUR 80. Based on P/E14 ASML trades at 18.5x, which might seem rich. ARM, another near monopolist within the sector, trades at 35.2x P/E14. As such, ASML trades at a discount of almost 50%, while we show that our projected EPS growth is superior to ARM s consensus EPS growth in the next few years and ASML has a higher ROCE profile as a starting point in Furthermore, ARM s near monopoly position will be challenged by Intel, which to us seems like a stronger potential competitor than Nikon is for ASML. We raise our target price from EUR 60 to EUR 80 and reiterate our Buy rating. Summary: EUV will move ASML closer to becoming a monopolist Lithography has been the key driver of lower cost per semiconductor component. By introducing leading edge techniques and keeping a head start on cost of ownership compared to competition ASML has grown its market share to c. 75%-80%. At this point, ASML is the only company in the world developing EUV. With EUV the industry can continue Moore s law, while ASML can further increase its market share. ASML s biggest clients are large co-investors in the company, which will make it easier for them to accept a single supplier relationship. In our view, further proof of EUV getting ready for industrialization will come with the 3Q13 results, where the company will demonstrate 80W power source stability. We believe that will increase confidence in our 2016 EPS number, which diminishes valuation to 10x P/E16. 4 ASML 21 August 2013 ABN AMRO Bank 2. Increased confidence in EUV SEMICon West showed that EUV acceptance has increased. EUV increases possible shrinkage and production yields, while cycle time is reduced at the expense of non-lithography process steps. Since ASML has made significant progress on its EUV roadmap, we have more trust that it can roll-out EUV machines in As we have showed in our upgrade note of January that should facilitate an EPS of above EUR Moore s law extremely important for the industry 2.1. Moore s law needs EUV Lithography has been the driving force for Moore s law: doubling of components per chip every 12 months resulting in lower costs per component. For consumers Gartner has made Moore s law more transparent by showing the lithography costs of 1GB high quality Flash memory over time. At inception the costs were USD 1,162 per 1 GB. After 15 years the cost per 1 GB has dropped to only USD Figure 1: Price development high quality Flash EUV has more scaling advantages Source: Gartner Without EUV (Extreme UltraViolet) it seems difficult to continue Moore s law sub 20nm. Performance can be enhanced by adding more functionality to the chip by using a three dimensional gate structure (finfet). Technically speaking the lithography intensity of 14/16nm finfet is similar to 20nm. As such, the costs per gate are similar for 14/16nm finfet and 20nm. ASML showed that although multiple patterning can still facilitate some scaling from current leading edge logic nodes, EUV is the better alternative. Figure 2: EUV gives best scaling effects Source: ASML ABN AMRO Bank 21 August 2013 ASML 5 Nikon: multiple patterning is more than competitive... At SEMICon West, Nikon showed that it believes that triple patterning will be a more than competitive alternative to EUV for the production of next generation chips. It argued that in order to produce 50 wafers per hour the capital investment for equipment is far lower when using double (illustrated with 193 DP in the graph) and triple patterning ( 193i TP ) compared to EUV. For EUV Nikon used two scenarios, 1) a throughput of 20 wafers per hour ( slow ) and 2) a throughput of 50 wafers per hour ( fast ). With lower EUV throughput, more machines are needed to match the triple patterning solution and as a consequence also support and consumable costs are higher. Nikon also assumes that masks costs will be higher as mask degeneration is expected to be higher with EUV exposure. Figure 3: Overview of competitiveness of multiple patterning versus EUV Nikon s assumption on EUV throughput seems too low ARM design is more scalable with EUV Source: Nikon We note that Nikon does not have an active EUV programme. As such it is questionable how it derived its assumptions to illustrate the competitiveness of double and triple patterning. In our view, Nikon s assumptions for EUV throughput are too low. For previous experiments ASML used a NXE:3100 setup. For coming experiments ASML has updated its set-up to the NXE:3300B. As a consequence the demonstrated 55W source performance (communicated with the 1Q13 results) on the NXE:3100 set-up should already improve to 80W on the NXE:3300B set-up. 80W corresponds to a throughput of above 50 wafers per hour. We expect ASML to report this progress with the 3Q13 results. Therefore, ASML is already close to beating Nikon s EUV fast scenario. In our view, acceptance of EUV has clearly increased across the board. We believe the jump in progress to 80W with the 3Q13 will further increase EUV acceptance. Nikon did not pay much attention to production yields either. Several equipment users are coming up with arguments why EUV should have preference compared to multiple patterning. One big advantage of EUV compared to multiple patterning is that EUV has a wider process window. A technique that offers a wider process window can handle situations better when factory circumstances start to deviate from ideal circumstances. In other words, a wider process window will lead to higher production yields. In order to scale a 20nm ARM chip towards 10nm, immersion technology does not have a process window, while EUV meets all requirements. As a consequence, multiple patterning can only reach a 25% scaling effect given the ARM chip design. With EUV, 50% scaling can be achieved. 6 ASML 21 August 2013 ABN AMRO Bank Figure 4: EUV gives best scaling for 20nm ARM design towards 10nm Intel shows less risk of drain leakage with EUV Source: ARM, scaled N20 nm flip-flop design, ASML With multiple patterning all exposures have to match to each other to enable sufficient overlap, leading to tight overlay requirements. Intel showed at the SPIE conference in February that overlap at 10nm gridded SRAM designs is failing with multiple patterning at 3nm overlay, while EUV meets all requirements. In the picture below Intel shows that the chances of drain leakage is significantly lower using EUV compared to ArF/multiple patterning. In general, a more vertical line is better. EUV is clearly performing better than double patterning. Figure 5: EUV performance versus ArF EUV reduces cycle time mostly at the expense of other processes Source: Intel, SPIE, Feb 2013 ASML showed that EUV can reduce cycle times by 30% compared to double patterning and up to 75% compared to spacer defined quadruple patterning. A lower cycle time increases the output of a fab, which means lower costs per chip. With multiple patterning more lithography exposures are needed, also increasing needs for more strip/clean, etch, metrology and CVD process steps. With EUV it is possible to develop critical layers with a single exposure. As a consequence, the number of non-lithography process steps can be significantly reduced. As a result, ASML will be in the position to claim more of its clients capital expenditure programmes. ABN AMRO Bank 21 August 2013 ASML 7 Figure 6: Overview of process cycle time Besides throughput, mask blanks still need improvements ASML sees three EUV adaption scenarios EUV machine sales can show strong ramp up to 2016 Source: ASML At SEMICon West, Sematech presented that the main challenges for EUV are the source power and the readiness of mask blanks to support high volume EUV manufacturing. Sematech stated that the resist is in good shape. Additional investments are needed in order to get EUV mask blanks at the quality and volume needed for EUV high volume manufacturing ramp-up Size of EUV market over time ASML sees three scenarios for EUV adaption dependent on throughput: 1) clients will only adapt EUV for a limited number of layers (1 or 2) and get a scaling benefit of x compared to 1.5x with multiple patterning, 2) clients will adapt EUV for 5-7 layers and get a scaling benefit of 2.0x and 3) clients will use EUV for up to 17 layers. On multiple occasions ASML presented numbers on how many EUV machines the market could absorb. With a throughput of 70 wafers per hour, ASML expects that the industry will adapt EUV for 5-7 layers at 10nm logic nodes, which could lead to EUV machines being sold in 2016 with an average selling price of EUR m. Therefore, EUV revenues alone can add up to EUR bn in Figure 7: potential number of EUV machines sold Figure 8: potential EUV revenues 70 7, , , , , , , Bandwidth #EUV machines Revenue range for EUV Source: ABN AMRO Equity Research Source: ABN AMRO Equity Research 8 ASML 21 August 2013 ABN AMRO Bank Progress is expected to be exponential 70 wafers per hour has a power requirement of 105W. As said we already expect the source to perform at 80W in 3Q13. Looking at ASML s EUV throughput roadmap we conclude that it could be somewhat conservative, as the 80W level in the roadmap is set at YE13/BOY14. ASML uses a logarithmic scale on the y- axis as progress on new technique generally shows exponential progress once it is working. Figure 9: ASML s throughput roadmap If ASML lives up to its roadmap, more EUV machines will be sold Current design easily extendible to 81 wafers per hour throughput Speed of industry adaption is dependent on several factors Prisoners dilemma arises for clients to embrace EUV Source: ABN AMRO Equity Research, ASML Looking at ASML s roadmap and its assumptions for the given EUV machine sales in 2016 it seems that chances are increasing that we will move towards scenario 3. MOPA pre-pulse technology has been an important step in the industrialization of EUV. With the MOPA pre-pulse technology tin droplets needed to create EUV light are stretched before hit by the laser making the conversion to EUV light more efficient. With the current design ASML is confident to extend the source power to 125W or 81 wafers per hour. In order to increase throughput further, ASML will probably need to make some adjustments to the design. Although ASML is close to delivering a source power throughput equivalent of over 50 wafers per hour, the company remains dependent on the speed of EUV adaption at its clients. The speed of adaption will mainly be dependent on ASML s progress, client experience with the new technique, the availability of alternative techniques, potential cost savings for clients and the economic state of the world. We believe that continued progress will create a prisoners dilemma for ASML clients to embrace EUV once 80W source power is demonstrated. The competitiveness at next generation nodes will be highly dependent on the throughput of EUV and the number of layers produced with EUV. As such, high volume manufacturers such as Intel, Samsung and TSMC cannot risk to lose market share due to insufficient layers being built with EUV. ASML s order intake on EUV should further increase with progress as it has limited capacity to fill demand. ABN AMRO Bank 21 August 2013 ASML 9 Holistic tool packages will push APS up Changes increased of EPS16 above EUR Holistic tool kit to push EUV price to upper-end of range ASML has adapted a holistic tool package for immersion machines. This tool package adapts metrology and automatically adapts corrections for next wafer exposures. For layers where overlay is important, ASML s holistic tool package has shown strong added value for immersion machines already. As a result, client acceptance of ASML s holistic tool package has increased. For EUV layers overlay will also be very important. As such, the holistic tool package for EUV, which ASML is designing synchronically to EUV, is also likely to have added value for clients. We believe clients experience with the tool package for immersion machines will increase acceptance of similar added features for EUV machines. As a consequence, we believe it is more likely that the average selling price of EUV machines will move up to the upper-end of the range of EUR m Bump in EPS16 more certain We reiterate our EPS scenarios for 2016 we published in January We believe chances have increased that ASML will be able to demonstrate our EPS16 scenario of above EUR 7. In our previous valuation we factored in two years of delay, which we take out in our current model. Figure 10: EPS developments incorporated in our model Vertical integration of Cymer should improve margins EUV source cost price EUR 20m Source: ABN AMRO Equity Research In the following part we want to illustrate the potential effect of ASML s acquisition of Cymer on margins. With the vertical integration of Cymer, we believe ASML should be able to grow gross margins towards 50%. For our model we pencil in a gross margin of 45% in 2016 and following years. We keep some slack in our gross margin in order to allow for additional investments to keep system requirements on track. We believe that the selling price of ArF and KrF lighting sources are respectively EUR 2m and EUR 1.5m (or 12.5% of ASML s non-euv related machine sales), while an EUV lighting source is expected to costs around EUR 20m. 10 ASML 21 August 2013 ABN AMRO Bank Figure 11: Projection of stand-alone P&L Cymer in 2016 Bear Base Bull Light source price Revenue Cymer of non-euv litho COGS 12.5% 12.5% 12.5% Non-ASML market share 20% 20% 20% Gross margin 50% 50% 50% EBIT margin 15% 20% 25% Tax and financing 30% 30% 30% EUV related revenue 1,200 1,260 1,320 Non-EUV related ASML revenue Nikon related revenue Service related revenue Total revenue 1,649 1,819 1,989 Gross profit EBIT Net income Source: ABN AMRO Equity Research On gross margin we keep some conservatism Due to the acquisition of Cymer, we believe ASML can grow its gross margin towards 50% over time. In a base case scenario, we see an EPS16 of EUR Figure 12: ASML s pro forma income statement including Cymer ASML and Cymer Bear Base Bull Cost synergies 20% 30% 40% Revenue 8,589 10,663 12,798 COGS 4,536 5,527 6,472 Gross margin 47.2% 48.2% 49.4% R&D 1,000 1,000 1,000 SG&A Tax rate 13.0% 11.0% 9
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