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Better Buy: ASML vs. Aehr Test Systems

Motley Fool - Wed Sep 20, 7:15AM CDT

ASML(NASDAQ: ASML) and Aehr Test Systems(NASDAQ: AEHR) represent two very different ways to invest in the booming semiconductor sector.

ASML is the world's largest producer of lithography systems, which are used to etch circuit patterns onto silicon wafers. It's also the only producer of high-end extreme ultraviolet (EUV) lithography systems, which are used to manufacture the world's most intricate, transistor-dense chips. Aehr is a much smaller company that produces testing and burn-in equipment for semiconductors. However, Aehr has notably established an early-mover advantage in testing equipment for silicon carbide chips, which can operate at higher voltages, temperatures, and frequencies than traditional silicon chips.

Over the past 12 months, ASML's stock has rallied by nearly 30% as Aehr's stock more than tripled. Let's see why Aehr outperformed ASML by such a wide margin -- and consider whether it will remain the stronger investment for the foreseeable future.

An illustration of a semiconductor.

Image source: Getty Images.

ASML expects to weather the cyclical slowdown

ASML has monopolized the EUV market and also dominates the market for older deep ultraviolet (DUV) lithography systems, so it's a crucial link in the semiconductor supply chain. Therefore, its growth usually mirrors the cyclical semiconductor market.

Its revenue rose 33% in 2021 as the post-pandemic rebound in chip sales drove its top customers -- including Taiwan Semiconductor Manufacturing, Samsung, and Intel -- to install more EUV systems. However, its revenue only rose 14% in 2022 as declining PC sales, slow smartphone sales, and other macroeconomic headwinds weakened the market's demand for new chips. Its gross margin also fell from 52.7% in 2021 to 50.5% in 2022 -- its first year-over-year contraction in gross margin since 2019.

However, analysts expect ASML's revenue and earnings to grow by 23% and 30%, respectively, in 2023 as it laps that slowdown. Based on those forecasts, it looks reasonably valued at 25 times forward earnings.

During its investor day presentation in November, ASML predicted it could generate 44 billion euros to 60 billion euros ($47 billion to $64 billion) in revenue in 2030. The midpoint of that long-term forecast implies its revenue will grow at a compound annual rate of 12% from 2022 to 2030. It also expects its annual gross margin will expand to between 56% and 60% by 2030.

That confident outlook, which is likely conservative based on ASML's track record of sandbagging its long-term guidance, suggests it will overcome its near-term challenges, continue to dominate the market for high-end lithography systems, and profit from the ongoing expansion of the global semiconductor market.

Yet investors should also be aware of ASML's two biggest weaknesses. First, it generated 38% of its revenue in Taiwan in 2022. Escalating trade and military tensions between Taiwan, China, and the U.S. could stir up unpredictable headwinds for its top market. Second, U.S. and European regulators could place additional restrictions on its sales of lithography systems to chipmakers in mainland China, which accounted for 14% of its revenue in 2022.

Aehr is generating volatile but impressive growth

The market's demand for silicon carbide chips has surged in recent years because their physical resilience makes them well suited for short-length LEDs, lasers, 5G base stations, military radars, and electric vehicles (EVs). That secular growth -- especially in the EV market -- is driving chipmakers like Wolfspeed, Infineon, ON Semiconductor, and STMicroelectronics to aggressively ramp up their production of silicon carbide chips.

That land grab lit a fire under Aehr's sales of silicon carbide testing and burn-in systems over the past two years. As a result, its revenue surged 206% in its fiscal 2022 (which ended in May 2022) and rose another 28% in its fiscal 2023 -- even as macro headwinds and supply chain constraints throttled the production of new EVs. But for fiscal 2024, it expects its revenue to rise "over 50%" as the EV market recovers. Analysts on average anticipate 58% growth.

That growth spurt also enabled Aehr to turn profitable on both a GAAP (generally accepted accounting principles) basis and a non-GAAP (adjusted) basis in fiscal 2022. Its non-GAAP earnings per share (EPS) rose 55% in fiscal 2023, and analysts expect 76% growth in fiscal 2024.

Those spectacular growth rates, along with its low enterprise value of $1.3 billion, suggest Aehr has a lot of upside potential. The global silicon carbide market should expand at a compound annual rate of 19% from 2022 to 2030, according to Research and Markets, so Aehr could still be a great takeover target for larger chipmakers.

Yet Aehr still has three glaring weaknesses as an investment: It generated 79% of its revenue from a single customer (likely one of the aforementioned chipmakers) in fiscal 2023, it could face a lot of competition from larger semiconductor equipment makers as the silicon carbide market grows, and its stock isn't cheap at 45 times forward earnings.

The better buy: ASML

Aehr might be the more exciting growth play, but its small size, narrow moat, and customer concentration issues are troubling. So in this volatile market, I'd stick with ASML for its market dominance, stable growth, and lower valuations.

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Leo Sun has positions in ASML. The Motley Fool has positions in and recommends ASML, Taiwan Semiconductor Manufacturing, and Wolfspeed. The Motley Fool recommends Intel and ON Semiconductor and recommends the following options: long January 2023 $57.50 calls on Intel and long January 2025 $45 calls on Intel. The Motley Fool has a disclosure policy.

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