The Dutch Investors

ASML | Risks and the role of cyclicality

• The Dutch Investors • Episode 2

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In this episode, we’re taking a deep dive into the uncertainties ASML faces and how the semiconductor industry’s cyclical nature impacts its future. We break down the key risks ASML encounters, the role of cyclicality and what it means for investors.

Join us to understand why investing in top companies isn’t just about the upside, but about smartly managing risks. Whether you’re curious about ASML’s technology or want a clearer perspective on the role of cycles in markets, this episode will help you.

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Disclaimer:
Nothing in this podcast can be considered financial advice. This is for educational purposes only. We may hold positions in the businesses discussed. Do your own research.

Siem:

Welcome to episode 2, cyclicality and risk. Last week we took a closer look at ASML's role in the global semiconductor industry. We went over some key traits and shared why we believe ASML has a solid competitive edge, and the response was great. But I realized there's still more to cover. As you know, investing is really about managing risk minimizing the downside while maximizing the upside, and we didn't fully address that last time, I believe. So today let's dive deeper into the risks ASML faces and discuss cyclicality, breaking it all down so you understand what it means as an investor. Ready, let's get started. All right, everybody, welcome back to episode two. I am Sim, your host and one of the four members of the Dutch investors.

Siem:

Now, before we jump into all the risks and perhaps even opportunities, we had to stop and ask ourselves what actually makes ASML's technology so unique, and we believe the secret is the precision of ASML's machines. Their EUV machines make chip patterns at scales smaller than 13 nanometers. At that size, just the speck of dust or the slightest vibration can ruin an entire batch. To put this into perspective, 13 nanometers is actually smaller than most viruses. Let me give you a sense of how extreme the precision is. Imagine a sharpshooter hitting a pinhead-sized moving target from 10 kilometers away, with each shot timed within a nanosecond of the last. Or picture ASML's laser as someone throwing darts every few nanoseconds hitting a dust-sized target moving at nearly 360 kilometers an hour, every throw timed perfectly. With that kind of visualization, you start to see how tough this process actually is. And in chip manufacturing, accuracy is everything, and we believe ASML has this down to a science. And, before we go into the risks, asml's financial performance is nearly as impressive as its technology. Since 2018, asml has achieved an annual revenue growth of 15%, driven largely by the rising global demand for semiconductors, and what is even more impressive is that they've managed to grow their earnings per share at an average rate of 21% over the past decade.

Siem:

When we look at the company's revenue streams, asml is pretty well diversified, with 80% coming from machine sales which is to be expected, I guess and 20% from service contracts. And this service component is particularly valuable because it provides a steady recurring income stream from clients who depend on ASML for, say, upgrades and maintenance. And the more machines they sell you guessed it the more service contracts are needed, and it's a pretty smart setup. It reminds me a bit of the elevator industry, where companies sell elevators relatively inexpensively but earn high margins from essential service contracts. Most are obligated to have them Very smart.

Siem:

As investors, we're always focused on the opportunities, but as mongers famously said, invert always invert. So let's flip the perspective and focus especially on the risks, to assess the reward ratio. Especially monopolistic businesses like ASML face challenges and competition. Everyone and their mother is looking at ASML trying to find the secret sauce Well, maybe I mean secret blueprint in ASML's case.

Siem:

The first big risk here are export restrictions. Under the pressure from the US, the Dutch government has already stopped ASML from selling its EUV also stands for extreme ultraviolet machines to China. Now the US is doubling down, trying to restrict export of ASML's less advanced DUV machines too. Technically, china can still make 7nm chips using DUV machines, but the yield is so low it's not really worth it for them financially. Considering China makes up about 10-20% of ASML's total revenue, these restrictions could actually take a big chunk out of their earnings. Then there's the knock-on effect China's push for chip independence. They're pouring resources into building their own semiconductor industry, which honestly kind of makes sense. I mean, with all the limitations from the West, it's no surprise that they want to make their own chips. This is the classic second order effect. The West is hoping to keep China dependent on foreign tech, but by blocking chip exports, they're practically nudging China towards self-sufficiency, something they may end up regretting. Actually, for now, chinese companies still rely on ASML's DUV machines, but if China manages to build this technology domestically, asml could lose a big piece of its market share.

Siem:

Then there's another big one, of course the risk of conflict between China and Taiwan, because China claims Taiwan as its own territory, while Taiwan sees itself as independent. And there's a lot to this. But here's the bottom line. Tsmc and other chip producers depend heavily on ASML's equipment for their manufacturing, and switching suppliers isn't really an option. It's also hard to imagine Taiwan relying on Chinese-made machines for its chip production, given that China claims ownership of Taiwan. If conflict breaks out, it could hit TSMC's operations and mess with the global supply chain, which would hurt ASML and a ton of other companies. The impact would be massive, not just for TSMC or ASML, but also for China, taiwan, the West and everybody else, but also for China, taiwan, the West and everybody else. Chips power everything we use, from phones to cars, so prices would likely skyrocket and industries like automotive, healthcare tech, cloud providers and AI would definitely feel the pain In the end. It's probably in everyone's interest aside from, maybe, china, to keep Taiwan independent.

Siem:

Right, maybe I got a bit carried away with the last risk, but thinking through these scenarios is kind of fascinating to me. Of course, asml faces plenty of other risks too. Of course ASML faces plenty of other risks too, but I wanted to focus a little bit more on China in this episode. Think of risks like losing key engineers, spies falling behind on innovation, accidentally leaking technology, a cyber attack or even new competitors stepping up Just some food for thought.

Siem:

So what's the takeaway from all of this? The bottom line everything is cyclical Markets, economies, nature, politics, markets, economies, nature, politics. Asml might be at the top of its game now, but staying there means facing cycles that influence everything from competition to regulation. Nothing lasts forever, not a company's market dominance, nor the challenges it faces. When we look closely, we see that these cycles are shaped by human behavior, like the push for control, self-sufficiency or the swings of policy and investment. Recognizing these cycles can help us keep perspective. It stops us from getting caught up in extremes, whether that's becoming overly confident when times are good or overly cautious when things seem uncertain, companies like ASML that sit at the top have to adapt constantly because inevitably, challenges will come up that shake up their current position.

Siem:

But successful investing, long-term investing is about engaging in smart, calculated risks rather than reckless bets. Intelligent risk taking means understanding what you're up against, analyze risks, spread them out, ensure that the potential returns justify what you're putting on the line. This kind of disciplined approach is how you maximize gains while keeping the downside in check. Well, in theory, I guess we are still human. I guess we are still human.

Siem:

Remember, investing isn't about predicting one single future. It's about preparing for a range of possibilities. Or, as Elroy Dimson said, much better than I ever can. Risk means more things can happen than will happen. Beautiful, and I think that's a good quote to end this episode on. That's it for today. I hope you enjoyed this episode as I did preparing it. Thanks for being here. We really do appreciate it. If you'd like even more content, consider following us for free over at the sub stack at the dutch investors. You can also find us on x at dutch investors or, if you'd like to join our premium service, check out the dutch investorscom. And, like I said, nothing lasts forever, not even this episode. So until next week, stay curious, be patient and happy investing.