Chip Wars Boost Europe’s Top Tech Company—for Now

When ASML, the Dutch company that makes the world’s most advanced lithography machines for manufacturing microchips, reports fourth-quarter results next week, one of the most eye-catching numbers will be the share of sales it made in China. This reached an extraordinary 46% in the third quarter, up from just 8% in the first three months of the year.

One reason for the increase was a slowdown in Western demand, which gave ASML the chance to catch up on Chinese orders. But another was export controls. While the company has never been allowed to ship its most sophisticated “extreme ultraviolet” machines to China, the Netherlands and Japan last year agreed to join the U.S. in banning sales of even some less cutting-edge gear to the country. Chinese chip makers likely rushed to source equipment before the restrictions took effect this month.

Even with the bans in place, ASML’s sales to China might be strong this year. The company has said only 10% to 15% of its shipments to the country would be affected. Most of its business with Chinese chip makers is for mature technologies that are still within bounds. For more advanced applications, China may be able to use several older-generation machines to achieve similar results to the newer ones it can’t buy, potentially giving orders a further boost.

China is investing aggressively in new industries such as electric cars and wind turbines that require lots of semiconductors. The country still sources most of these from Western chip makers: It imports more microchips than oil these days. But Beijing is intent on self-sufficiency, and U.S. anxieties about China catching up with Western chip technology have only accelerated this effort.

Companies that sell chips to China are increasingly being replaced by local peers. When UBS had a popular electric vehicle made by BYD taken apart, it showed that 36% of the semiconductor content in the powertrain came from domestic suppliers. The current global leaders in powertrain chips, Germany’s Infineon, STMicroelectronics of Switzerland and U.S.-based onsemi, will likely suffer from the rise of Chinese EVs.

But China can’t easily replace the machines to make chips, leaving it dependent on ASML and competitors such as Applied Materials. This is why export controls are so sensitive. In a call with U.S. Secretary of Commerce Gina Raimondo last week, Chinese Minister of Commerce Wang Wentao voiced “serious concerns” about U.S. restrictions on third-party exports of lithography equipment to China, according to the Chinese Ministry.

Although the measures are showing few signs of hurting ASML, investors cannot relax. For one thing, China’s underlying level of demand has become hard to gauge. Even if the country’s industrial strategy will require a lot of lithography machines, everyone assumes it has been over-ordering, perhaps in case restrictions tighten further. That raises the risk of a sudden slump.

Longer-term, export controls will force China to develop its own semiconductor ecosystem. This is very challenging, particularly without access to the established supply chains in Europe, Japan and the U.S. But even if China only succeeds in reverse-engineering older lithography machines, it would close off an important revenue source for Western suppliers.

Not even ASML’s most advanced competitors have managed to copy its extreme-ultraviolet equipment, giving the Dutch company a monopoly on one of the underpinnings of artificial intelligence. This is one reason its stock, at 33 times forward earnings, trades at a premium to peers, helping make it Europe’s most valuable technology company.

But the market dominance that makes it so attractive to investors has also placed ASML squarely in the middle of the U.S.-China chip war. This is an unwelcome development, even if it has given the company’s financials a boost so far. ASML isn’t priced to become a geopolitical football.

Write to Stephen Wilmot at stephen.wilmot@wsj.com