Disconnect Between AI Deals and Spend: Citi’s Gardiner

Key Concepts

• ASML (ASML Holding N.V.): A Dutch company that is the sole supplier of extreme ultraviolet (EUV) lithography machines, crucial for manufacturing advanced semiconductor chips.
• EUV Lithography: A cutting-edge technology used in semiconductor manufacturing to print extremely small and complex patterns onto silicon wafers.
• Artificial Intelligence (AI): A field of computer science focused on creating intelligent machines that can perform tasks typically requiring human intelligence. AI drives significant demand for advanced chips.
• Data Centers: Facilities that house large numbers of computer servers and networking equipment, essential for supporting AI and other data-intensive applications.
• Order Flow/Order Intake: The process by which a company receives and records customer orders for its products or services.
• Lead Times: The duration between placing an order and receiving the product or service. For ASML's EUV tools, this is approximately 12 months.
• Backlog: The accumulation of unfulfilled orders.
• Supply Chain: The network of organizations, people, activities, information, and resources involved in moving a product or service from supplier to customer.
• Revenue Exposure to China: The portion of a company's sales generated from customers in China.

Bullish Outlook on ASML and Growth Drivers

The discussion centers on a "buy" rating for ASML with a price target exceeding €1,000. The bullish sentiment is primarily driven by the company's recent results and, more importantly, the order intake, which is seen as a positive step towards potential stock appreciation. The narrative suggests that ASML has been on a "journey over the last year in terms of resetting a base for 2026." Management has confirmed that expectations for 2026 are at a "reasonable level," and while growth isn't explicitly called out yet, a decline is not anticipated. This removal of uncertainty regarding next year's performance has contributed to the stock's current valuation, just shy of €900.

The key driver for further appreciation beyond 2026 is expected to be the demand stemming from artificial intelligence (AI) players into the data center sector. While there is significant positive news flow and momentum in the AI chip industry, ASML management acknowledges that this is "not yet fully reflected in their order flow." However, the expectation is that this demand will materialize in future quarters, propelling the stock higher.

Disconnect Between Announced Deals and Committed Spend

A critical point raised is the growing disconnect in the semiconductor industry between the numerous deals being announced by AI companies (like Nvidia, OpenAI, AMD) and the actual committed spend to equipment manufacturers like ASML. While ASML reported a healthy order intake of €5 billion in the recent quarter, this figure is described as "nothing too out of the ordinary" and "certainly they've had stronger quarters in terms of order intake."

This raises the question of when this anticipated demand will translate into firm orders. The argument is that given the long lead times for ASML's advanced equipment, particularly the EUV tools, orders need to pick up in the coming quarters to support the future demand projected by the AI sector.

Lead Times and Supply Chain Preparedness

The significant lead times for ASML's EUV tools are a crucial factor. These lead times are approximately 12 months. This means that an order placed today in the fourth quarter will not result in tool delivery until the fourth quarter of the following year, with production ramping up into 2027. This extended timeline necessitates that the supply chain be prepared well in advance for the anticipated ramp-up.

Regarding the broader supply chain's ability to sustain the 2026 targets set by companies like Nvidia, the analysis suggests that ASML, as the sole supplier of EUV tools, is "close to but not quite fully booked for 2026 deliveries." It is projected that ASML will be fully booked for 2026 by the end of 2025. While there might be some upside from capacity planned for installation next year, the company is already nearing its limits. The primary play for investors is the growth expected into 2027.

ASML management has acknowledged the lack of perfect visibility due to orders not yet being in place but is actively trying to prepare themselves and their suppliers to avoid becoming a bottleneck in future years.

China Revenue Exposure and Future Outlook

A notable aspect of ASML's recent performance was its 42% revenue exposure to China in the just-concluded quarter. Management has indicated an expectation for this exposure to "decline significantly" into next year. Year-to-date through September, ASML's system sales to China stood at approximately 32%, with the third quarter showing a higher 42%.

Despite current restrictions, Chinese companies are still ordering what they can, leading to strong business generation. However, ASML anticipates this will normalize in the future. The lead times for the types of tools Chinese customers are purchasing are shorter than for EUV tools, typically around six months or less. This shorter lead time means that the situation regarding China's revenue exposure could change more rapidly as 2026 approaches.

Synthesis and Conclusion

The outlook for ASML remains bullish, underpinned by its critical role in supplying EUV lithography machines essential for advanced chip manufacturing, particularly for the burgeoning AI sector. While current order books are not yet fully reflecting the projected AI-driven demand, the long lead times for ASML's equipment necessitate proactive planning. The company is nearing full capacity for 2026 deliveries, with significant growth anticipated in 2027. A key factor to monitor is the evolving revenue exposure to China, which is expected to decline but currently remains strong due to Chinese companies ordering within existing restrictions. The market is looking for concrete order flow to materialize to fully validate the growth narrative beyond 2026.