Page 32 - DIY Investor Magazine - May 2019

THE ANATOMY OF A GOOD COMPANY: ASML
Jamie Ross, Fund Manager of Henderson EuroTrust, provides a snapshot of the typical analysis undertaken on every company considered for the portfolio. In this case, he explains the rationale behind the inclusion of the Dutch technology company ASML.
When considering an investment for the Henderson EuroTrust portfolio, we tend not to focus on market noise or any technical factors; the main thing we are doing is trying to establish whether what we are looking at is a good company or not. This is a key part of the research process.
There tend to be many features that most good companies have in common, but there are myriad characteristics and features to analyse that will be unique to each and every business.
By undertaking detailed analysis of the 50 or 60 companies we have on our radar (a portfolio of ~40 positions and a watch list of 10-20 names) we try to ascertain whether a business is a good business and if so, whether now is the right time to be invested or not. In this article we will highlight aspects of our process using one of our portfolio companies, Dutch lithography tool manufacturer ASML.
WHAT DOES THE COMPANY DO?
Based in Veldhoven, Netherlands, ASML is the global leader in the production, sale and aftermarket care of lithography tools. Lithography tools are used by semi- conductor manufacturers to etch 3D patterns onto silicon wafers; an essential part of the complex process of building up a transistor.
Over time, ASML has built up an extremely strong market position. Historically, it has had two competitors (Nikon and Canon), but the huge investment burden (capital intensity and research & development intensity) has taken its toll on its competitors, leaving ASML with a market share of roughly 85% (80% share in immersion technology ‘DUV’ and 100% market share in next- generation EUV technology).
Without significant technological change, it is very difficult to see ASML’s market share being challenged
‘THERE TEND TO BE MANY FEATURES THAT MOST GOOD COMPANIES HAVE IN COMMON’
in the medium term. Crucially, ASML’s strong market position has been partly created through the support (equity investments) of their main customers (Samsung, Intel and TSMC).
DOES THIS COMPANY GENERATE STRONG RETURN ON INVESTED CAPITAL (ROIC)?
The firm’s gross margins (total revenue minus cost of goods sold) are high at 47%; and are expected to climb to more than 50% by 2020. The high overall gross margin is driven by the company’s market position and ensuing pricing power.
‘THE ABOVE FINANCIAL CHARACTERISTICS RESULT IN A BUSINESS GENERATING STRONG DOUBLE DIGIT ROIC, WELL ABOVE’ ‘MARKET/INDUSTRY AVERAGES
Research and development (R&D) costs are relatively high at about €1.5bn per annum making up around 14% of sales - the equipment used in the lithography tool-making process can be the size of a bus and cost several hundred million Euros; so the R&D burden is a big barrier to entry.
Other operating costs make up only a few percent of sales leaving an operating margin of around 28%. In terms of invested capital, most is tied up in working capital and in fixed assets used in the production process.
Whichever way you cut the numbers, the above financial characteristics result in a business generating strong double digit ROIC, well above market/industry averages.
DIY Investor Magazine | May 2019 32