ON Semiconductor: ready for the worst-case scenario (NASDAQ: ON)


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ON Semiconductor (NASDAQ: ON) develops cutting-edge solutions for high-growth megatrends such as communications, automotive and industrials. It benefits from its aggressive cost reduction initiatives and strong capital expenditure outlook with growing long-term agreement with end consumers. ON’s strategy of reducing volatility in its margins and maximizing benefits from market downturns serves as a powerful catalyst for the business.

ON is currently showing a slowdown in earnings in addition to investor concerns about the expected cyclical peak in 2022, which may lead to near-term uncertainties. This implies a potential opportunity for short-term profit amid uncertainty. One analyst, on the other hand, believes the industry is in a “super cycle“, while others say that the demand for semiconductor chip sales will be higher than 3 times the global GDP rate.

Management assures investors that they have sufficient supply and a diversified product portfolio to meet demand, regardless of market developments. ON is still relatively cheap compared to its peers with a disciplined approach to today’s uncertainties. It’s a buy on one retreat.

Dealing with a Reasonable Concern

There is a lot of speculation that we are approaching the top of the cycle, with limited growth potential, and if Moore’s law is dead or else applicable. However, semiconductors are currently in a different era, where innovation is faster than it has been for the past decade. With the growth of IoT and artificial intelligence, semiconductors can power almost everything from automating cars to building vehicles that can take us into space. In reality, Applied materials (AMAT) expects the semiconductor market to reach $1 trillion in the next decade. AMAT CEO Gary Dickerson provided a positive full-year 2022 outlook in their latest earnings call, where they ended their first quarter of 2022 with strong revenue and earnings per share, respectively. surprising $110.91 million and $0.04.

We expect to outperform the market again in 2022 with particularly strong growth in optical wafer inspection, combined with a further extension of our leadership in electron beams.

CFO Bob Halliday closed their call, mentioning an interesting catalyst, as quoted below:

First, demand continues to be very strong. We see our business growing as the year progresses, and we believe 2023 will be even stronger. Second, Applied’s position is very strong. I am convinced that we are really making progress with our supply chain; we will be able to demonstrate that we are well on the way to achieving our market share and gross margin objectives. And third, even in this constrained environment, we’re generating record revenues and operating cash flow, fueling strong shareholder returns.

Additionally, other companies in the industry like Analog devices (ADI), Intel (INTC), and Advanced micro-systems (AMD) forecasts that the demand environment will continue to be strong and expects shortages to persist through 2023. Returning to concern, the PHLX Semiconductor Sector Index (SOX), according to its past performance, tends to recede after 2 to 3 years. of rally. Today we are about to slow down and they are expecting a 4% drop, better than the actual 8% drop in 2018.

5-year line chart of SOX

SOX 5-Year Line Chart (Thetechnologyletter.com)

In addition to the projected peak, the ON is currently showing a decline in revenue growth, as shown in the chart below.

ON Semi

ON Semi Quarterly Earnings Trend (data from SeekingAlpha, curated by InvestOhTrader)

Additionally, ON’s price action showed weakness at today’s price and was rejected in the $67 area. A breach in its 20-day simple moving average could support short-term bearish price action over the next trading week.

ON Semi-weekly chart

ON Semi-Weekly Chart (TradingView.com)

However, before going short or taking profits, there are other positive catalysts regarding ON, which support my bullish view in its long-term perspective.

Reassuring updates from management

1. Their disciplined approach to a competitive market.

Management reassures that it has reached a long-term agreement with its customers and provided a positive outlook for its first quarter 2022 of total revenue of between $1,850 million and $1,950 million, a growth of two figures compared to its $1,487.7 million in the same quarter last year. Management also reassures that its committed revenue will reach more than $2.6 billion through 2024. In addition to this, ON is benefiting from a successful shift towards its strategic markets such as automotive and industrial. , contributing 75% of its total revenue, positioning the company to capitalize on the growing market, as seen in the image below.

Q4 2021 Investor Presentation

Q4 2021 Investor Presentation (onsemi.com)

2. Their disciplined approach to stable margin growth.

ON wins in its mix optimization, which strategically positions them to provide a less volatile margin in both an improving and declining market. Management reassures in its earnings call that the growth in its revenue is not only due to the increase in the average selling price, but also that it has experienced growth in the volume sold.

Q4 2021 Investor Presentation

Q4 2021 Investor Presentation (onsemi.com)

ON’s aggressive cost reduction initiatives, such as divesting non-core operations and optimizing manufacturing processes, are two steps toward mitigating risks beyond management’s control. They are also looking to sell their 6 inch plant in Belgium to align with their long term strategy. It seems that they wanted to transfer part of their risk, thus stabilizing their long-term margin.

3. Management assures that there will be no supply problem as they have long term agreement with their manufacturing suppliers.

Thus, we remain focused on working with our external foundry partners. We were able to get more supply in the fourth quarter. That’s kind of driven the results, and we’re constantly working to secure more and more supply for 2022. Source: Q4 2021 Earnings Call

Management secured a minimum purchase obligation of $1,292.6 million payable in 2022, higher than the $598.9 million reported last year. In my view, ON is well positioned to capitalize on the $1 trillion market opportunity, shifting its capital spending to serve its megatrends. Management also provided a higher capital expenditure outlook with a 12% target in the near term, supporting their assertion that their supply will be sufficient in the long term.

Q4 2021 Investor Presentation

Q4 2021 Investor Presentation (onsemi.com)

Final takeaways

ON Semi

Relative valuation of ON Semi (data from SeekingAlpha, prepared by InvestOhTrader)

Qorvo (QRVO), NXP Semiconductors (NXPI), Analog devices (NASDAQ:ADI), Texas Instruments (TXN), Broadcom (AVGO)

Despite its positive price performance of 50.99% YoY, ON is still cheap compared to its peers. Its P/E ratio of 26.52x, P/S ratio of 3.80x and EV/EBITDA ratio of 14.12x are all relatively cheap compared to the average of its peers. It enjoys a very positive review of its revenue and earnings per share, as can be seen in the image below.


Ontario Annual Estimates Revision (SeekingAlpha.com)

ON is trading near Wall Street’s low target of $60, generating its best operating margin of 20.55%, increasing liquidity to an all-time high of 2.45x the current ratio and 0.71x the ratio of indebtedness. To conclude, ON is a great stock for a pullback opportunity.

Thanks for reading and good luck!


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