Semiconductor Industry Update: DQ's Value Proposition and ASML's Earnings Outlook

Daqo New Energy Stock: Oversold Status Triggers Compelling Value Growth Story (NYSE:DQ)

We will also highlight a few metrics to look out for in the upcoming FQ2'24 earnings call in early August 2024 (estimated), with it underscoring DQ's near-term prospects. We previously covered Daqo New Energy (NYSE:DQ) in April 2024, discussing why we had upgraded it to a Buy, despite the declining spot prices, the growing pessimism surrounding Chinese-based ADS, and the (potentially) intensified solar tariffs on foreign made solar panels. With the stock is still trading way below its book value per share, aided by the long-term electrification story, we believe that it continued to offer a compelling investment thesis for value-oriented investors. Since then, DQ has further pulled back by -30.2%, well, underperforming the wider market at +11.8%. Even so, we are maintaining our Buy rating here, thanks to the robust electrification prospects through the second half of the decade and the bottoming polysilicon spot prices over the past six weeks. We will also highlight a few metrics to look out for in the upcoming FQ2'24 earnings call in early August 2024 (estimated), with it underscoring the health of DQ's business and near-term prospects, namely the polysilicon spot prices, the average cash costs, the ongoing solar trade war, and the results of the US election. By July 10, 2024, the global polysilicon spot prices have seemingly stabilized at $5.57 per kg over the past six weeks (-20.3% from April 2024 levels of $6.99/ -85.7% from 2022's peak of $39/ -38.1% from 2019 averages of $9.00), as the supply glut continues. Even so, it is undeniable that these low prices do not bode well for polysilicon producers such as DQ, attributed to the narrowing profit spread at approximately 26.7% in FQ1'24 (-1.5 points QoQ/ -49.5 YoY/ -55.1 from FQ4'22 peak of 81.8%). This is based on DQ's moderating average cash cost of $5.61 per kg (-1.9% QoQ/ -15.1% YoY/ -17.2% from FQ4'22 levels of $6.78) and the much lower realized ASPs of $7.66 per kg (-3.8% QoQ/ -72.4% YoY/ -79.5% from FQ4'22 peak of $37.41). Based on the spot prices above, it is not overly bearish to assume a further QoQ decline in DQ's realized ASPs in FQ2'24, implying that its profit spreads may further narrow while impacting its near-term prospects. At the same time, the management continues to reiterate the FY2024 production of 290K MT polysilicon (+46.5% YoY) at the midpoint, further underscoring why their capacity expansion is likely to further impact the near-term spot price movement. This is on top of the potential expansion of its ambitions in numerous overseas locations, including the US, Middle East, and Southeast Asia, potentially to bypass the ongoing US and EU trade ban. As a result of the lower realized prices and intensified capex plans, it is unsurprising that DQ has guided a suspension in its shareholder return program through share repurchases and dividends, as "the Board does feel that it's more prudent to conserve capital for now to weather the market downturn." Even so, we remain optimistic about the long-term electrification trends, significantly aided by the ongoing generative AI and data center capex boom, with Goldman Sachs Research already estimating data center power demand growth by +160% by 2030. As data centers increase their power consumption, it is unsurprising that more have turned to greener and sustainable power generations to better comply to their 2030 Environmental, Social, and Governance [ESG] commitment, though renewable energies while opting for efficient power management/ liquid cooling systems. Renewable Electricity Capacity Additions By Technology, 2016-2028 With the International Energy Agency [IEA] still expecting solar PVs to comprise the lion's share of renewable energy capacity additions through 2028 (either in base or accelerated case), it is undeniable that polysilicon producers such as DQ will remain highly relevant over the next few years. This is especially since the increasingly cheaper polysilicon may potentially trigger accelerated PV adoption, partly digesting the supply glut. The same has been observed in the consensus forward estimates, with DQ's top/ bottom-lines to drastically improve from FY2025 and FY2024 likely being a trough year. Most importantly, the polysilicon company is expected to remain highly profitable on an adj EPS basis, further underscoring why its low-cost operations in China/ Mongolia have worked out in its favor during the supply glut. And this is the reason why we believe that DQ has been oversold here, with the FWD P/E valuations of 3.31x extremely cheap compared to the previous article at 5x, the 5Y average of 5.67x, and the sector median of 24.17x. Even when compared to its silicon solar peers, including Canadian Solar Inc. (CSIQ) at 7.56x with a projected adj EPS CAGR of +14.9% through FY2026 and its cadmium telluride solar peer, First Solar (FSLR) at 16.59x at +55.7%, respectively, it is apparent that DQ is not expensive here - offering interested investors with an excellent margin of safety. For now, as a result of the near-term headwinds, we can understand why DQ has further pulled back after our April 2024 coverage while temporarily bouncing of its previous support levels of $14s. For context, we previously offered a fair value estimate of $28.10, based on DQ's FY2023 adj EPS of $5.62 multiplied with the discounted FWD P/E valuations of 5.00x. This is on top of the long-term price target of $46.50, based on the consensus FY2026 adj EPS estimates of $9.31. It is apparent from the valuation segment above, that those estimates have temporarily underperformed as DQ's FWD P/E valuations continue to decline to new lows compared to its historical levels. Even so, we believe that its investment thesis remains robust, with the stock still trading at a massive discount to its book value of $71.78 in FQ1'24 (-1% QoQ/ +10.9% YoY). While it is undeniable that there has been ASP headwinds thus far, the polysilicon spot prices have seemingly stabilized over the past six weeks, implying that the bottom may already be here. Combined with DQ's oversold status and extremely cheap valuations, we believe that its investment thesis looks very compelling for value and growth oriented investors looking to ride the great upside to our reiterated long-term price target of $46.50, upon its successful turnaround. Does this mean that we are maintaining our Buy rating for the DQ stock? Yes indeed, though with three caveats. One, while the risk/ reward ratio is skewed to the attractive, investors should size their portfolios according to their risk appetite attributed to the ongoing EU and US trade ban surrounding Chinese-made polysilicon products. Two, the ongoing US election is also likely to trigger near-term uncertainties, since President Trump has "said he'll dismantle the Inflation Reduction Act, which includes an estimated $370 billion for clean energy," naturally triggering further stock price volatility over the next six months of election campaign. Three, this Buy rating does not come with a specific entry point since it depends on individual investors' dollar cost average and investing style, with the stock likely to continue underperforming the wider market, prior to the reversal of market sentiments surrounding Chinese ADRs and solar industry in general.

ASML Q2 2024 Earnings Preview And 2024-2025 Tailwinds

I knew when I took on this assignment to write about ASML Holding N.V.'s (NASDAQ:ASML) upcoming Q2 2024 earnings call on July 17, 2024, that it would be exceedingly difficult. By all metrics, ASML's Q1 2024 results were disastrous, as shown in Table 1. According to ASML, every metric was down QOQ, by double-digit percentages. However, CY 2023 was an exceedingly strong year for ASML. In a February 13, 2024 Seeking Alpha article entitled "ASML Led Global WFE Equipment Market In 2023 As China's Naura Maintains 9th Position," ASML overtook Applied Materials (AMAT) as the top WFE (wafer front end) Semiconductor Equipment supplier in 2023. My dilemma is how to formulate an in-depth dive analysis on ASML when revenues increased 50% in 2023, as shown in Chart 1, only to drop 27% in Q1 2024 and a linear regression analysis is virtually impossible. Sure, I can report consensus earnings for Q2, which is based on ASML's guidance during the Q1 earnings call. But that's a trailing indicator for the company and, as I suggested above, not sufficient to do an in-depth dive analysis for the rest of 2024 and for 2025. ASML's guided Q2 2024 total net sales between €5.7 billion and €6.2 billion, with a gross margin between 50% and 51%. These figures reflect QoQ increase of 12.3% from Q1 2024 sales at the midpoint, reported in Table 1 above. The consensus among analysts suggests that ASML will achieve EPS of approximately €3.7 for Q2, 2024, strengthened by strong demand for its EUV and DUV systems. For the full calendar year 2024, ASML expects total net sales to be similar to 2023 levels, which were €27.6 billion. I expect sales of €37.2 billion for 2025 (34.8% YoY). Taiwan Semiconductor (NYSE:TSM) (or TSMC) is a leader in semiconductor manufacturing known for its advanced technology and strong market position. TSMC growth continues to be strong. The company just announced its net revenue for June 2024: On a consolidated basis, revenue for June 2024 was approximately NT$207.87 billion, a -9.5% MoM change from May 2024 and a +32.9% YoY increase from June 2023. Revenue for January through June 2024 totaled NT$1,266.15 billion, a +28.0% HoH increase compared to the same period in 2023. In Q1 2024, TSMC's most advanced 3nm process contributed 9% of its revenue. While the 5nm and 7nm processes contributed about 56% of its revenue, as shown in Chart 2. But the sweet spot for ASML is the 2nm node, since ASML's lithography systems are just being delivered and will represent a large percentage of revenues in 2025 and 2026. Shown in Chart 3 is pricing for each node by year, illustrating the ASPs (average selling price) of the 2nm node, which will be introduced in 2025. I discussed this pricing in a March 5, 2024 Seeking Alpha article entitled "Taiwan Semiconductor Raising Prices 8.7% In 2024 As Revenue Growth Underperforms Customers." "N2 technology development is progressing well with device performance and yield on track or ahead of plan. N2 is on track for volume production in 2025. We start the N2 production in the second half of 2025, actually in the last quarter of 2025. And because of the cycle time and all the kind of back-end process, and so we expect the meaningful revenue will start from the end of the first quarter or beginning of the second quarter of 2026." According to AnandTech, TSMC is gearing up to construct two fabrication plants capable of producing N2 chips in Taiwan. The first fab is planned to be located near Baoshan in Hsinchu County, neighboring its R1 research and development center, which was specifically built to develop N2 technology and its successor. This facility is expected to commence high-volume manufacturing (HVM) of 2nm chips in the latter half of 2025. The second N2-capable fabrication plant by is to be located in the Kaohsiung Science Park, part of the Southern Taiwan Science Park near Kaohsiung. The initiation of HVM at this plant is projected to be slightly later, likely around 2026. TSMC's 2nm fabs are located in Hsinchu and Kaohsiung, Taiwan. Table 2 presents my analysis of ASML sales of DUV and EUV equipment to TSMC for its 2nm production in its two fabs in Taiwan. Table 3 shows revenues from sales of semiconductor equipment to China by company, between 2022 and 2024. In Q1 2024 ASML generated 49% of revenues from China. Significantly larger than the 17% in 2022, it peaked at 46% in Q3 2023, slowed in Q4 2023, before increasing again in Q1 2024, according to my report entitled Mainland China's Semiconductor and Equipment Markets: Analysis and Manufacturing Trends. This high percentage of revenues is not only benefiting ASML but all the top companies shown in Table 1, despite U.S. Government sanctions on sales of equipment to capable of making sub 12nm node chips. As the U.S. Government continues to tighten sanctions, Chinese semiconductor companies have gone full board in purchasing as much non-Chinese-made equipment as they could, to the point of hoarding anticipating deeper and broader sanctions. This equipment is allowed to be shipped under U.S. sanctions, for the processing of mature and mid-critical nodes, i.e., >12nm, to China, as most vendors except for possibly Applied Materials complied with export control regulations. It must be remembered that ASML's flagship EUV (extreme ultraviolet) lithography system, priced exceeding $250 million, has been sanctioned for sales to China since the Trump administration. I will discuss EUV later in this article in an analysis of sub-5nm chip tailwinds for ASML. But immersion DUV systems have been largely exempt from U.S. Sanctions, except for a few of ASML's high-end systems. And the growth of DUV sales results in growth of other processing types of equipment. KLA Corporation (KLAC) is the biggest beneficiary of DUV systems in China (and, of course, other regions) because the smaller the technology node, the greater the need for KLAC's inspection/metrology equipment demanded to maintain high manufacturing yields. I discussed this issue in detail in my May 15, 2024, Seeking Alpha article entitled KLA: Benefiting From The Need For High Yields In Sub-5nm Chip Production. Equally important, DUV has been able to pattern 7nm and below chips in China, which I first brought to investors' attention in my May 18, 2022, Seeking Alpha article entitled "Applied Materials: SMIC Move To 7nm Node Capability Another Headwind." But to get there, semiconductor manufacturers must employ multi-patterning processes with DUV lithography. Why? Because DUV lithography on its own only works up to the 39nm technology node. Lower than that, multi-patterning processes need to be used, and these processes use deposition and etch equipment from companies like Lam Research (LRCX) or Tokyo Electron (OTCPK:TOELY). As an example of the synergy between lithography and multi-patterning equipment, even when hamstrung by U.S. Sanctions to limit production of chips in China to mature and mid-critical nodes: At the end of Q1 2024, ASML had a backlog of 75 EUV systems with an ASP of €180 million, as show in Chart 4. I also estimate 160 DUV systems in backlog with an ASP of €77 million. Unlike memory IC companies, logic/foundry semiconductor companies are not likely to cancel orders despite the downturn and oversupply of chips as leading foundry companies migrate to smaller technology nodes. In addition, ASML received acceptance from its customers on DUV tools to recognize revenue upon shipment. This resulted in €700M of revenue recognized in 2023 and no longer deferred into 2024, as a result of screaming demand for DUV systems coming from China. ASML's upcoming Q2 2024 earnings call on July 17 should provide investors with insight on its performance and future direction. Despite a disappointing Q1 2024, where every financial metric was down by double digits QoQ, ASML overtook Applied Materials as the leader of the Global Semiconductor Equipment market in 2023. ASML's guidance for Q2 2024 suggests net sales between €5.7 billion and €6.2 billion, a 12.3% increase from Q1 at the midpoint, with a gross margin of 50-51%. I expect ASML to report an EPS of approximately €3.7, up from €3.1, reflecting strong demand for ASML's EUV and DUV systems. This recovery sets a positive tone for the rest of 2024. In the near- and midterm, ASML's strategic focus will be on high-volume manufacturing for TSMC's 2nm nodes - one of the three biggest opportunities I detail in this article. I estimate WFE spend for 2nm manufacturing will entail the purchasing of 16 EUV and 10 DUV systems in 2024, followed by 38 EUV and 22 DUV systems in 2025, highlighting the critical role of ASML's lithography equipment in advancing semiconductor manufacturing. These purchases are expected to generate €3.5 billion in revenue in 2024 and €8.19 billion in 2025. Additionally, ASML's extensive order backlog of 75 EUV systems and 160 DUV systems highlights continued robust demand. ASML's significant revenue from China, where it generated 49% of its Q1 2024 revenues, should continue through 2024 as its DUV technology is recognized by Chinese semiconductor manufacturers as the leading lithography product. ASML's share price over the past 1-year period has underperformed other equipment companies Applied Materials and Lam Research, as well as TSMC, as shown in Chart 5. Despite is poorer stock performance, ASML's forward P/E is 53.58x, nearly twice that of the other semiconductor companies in Chart 6. Choosing a rating on ASML is difficult in light of its high forward P/E ratio. Looking a Seeking Alpha Quant ratings of a Hold in Chart 7, this is based on its F rating on high valuation. But this is a problem with looking at charts and not having intimate knowledge of ASML, its management (fortunately new), market dominance, and momentum including the driving force behind AI chip production with its DUV systems. U.S. Sanctions have had minimal negative effect on the company as it is production limited on EUV systems and can sell as many as they can make to TSMC, Samsung (OTCPK:SSNLF), Intel (INTC), SK Hynix, and Micron (MU). Until China's SMEE can produce a production-worthy DUV system, ASML has minimal competition from Canon (CAJ) and Nikon (OTCPK:NINOY). I rate ASML a Buy, despite historic issues with supply chain and inability to ship completed EUV systems to customers, which I have written about extensively on Seeking Alpha.