Power, analog, and image sensor semiconductor specialist On Semiconductor(NASDAQ: ON) reported earnings Monday, October 28.
The stock reacted very strangely in its aftermath: Initially, the stock fell, then surged to a gain up as much as 5.5%, before pulling back to a mere 1% gain that day.
This reaction basically says, investors don't know what to think!
However, peering under the hood and listening to the conference call with analysts, there's good reason to think On's profits are set to surge in the years ahead. Here are three reasons investors shouldn't pass up the current opportunity in the stock at this price.
1. Silicon carbide to grow by leaps and bounds
On has jumped out to a lead in silicon carbide chips, a new kind of alloy that is difficult to produce but can greatly increase the efficiency of power semiconductors, which are heavily used in electric vehicles and industrial power infrastructure.
On's third quarter results reflected a soft auto business, with auto-related revenue down 18% year over year, though up 5% on a sequential basis. Auto chip sales have been on the decline since early 2023, when sales slowed and OEMs looked to take down their inventory. Moreover, electric vehicle adoption has slowed down, raising questions about the future of EVs.
But management maintained its positive long-term outlook. On the call, CEO Hassane El-Khoury noted that while the volume of EVs has been down relative to expectations, companies are still launching EV models and making electric vehicles key parts of their roadmaps:
[T]he designs or the models that we expected to ramp did go into production, they just didn't ramp to the level that we expected, which says that it's a short-term demand, back to the lumpiness of EV adoption and not a change in strategy or a megatrend type. Otherwise, those models will have been canceled or not even launched.
Speaking of design-ins, management also noted On has won about 50% market share of silicon carbide chips in the Chinese battery EV market, based on this year's models unveiled at the recent Beijing auto show. That's important, because in contrast to the rest of the world, electric vehicles and extended range hybrids, which use a lot of silicon carbide chips, are taking off in China. Last week, fellow auto chip customer Texas Instruments noted its China auto revenue grew 20% sequentially in both Q2 and Q3 to an all-time high, even as other geographies were down.
Finally, On noted that outside of the largest North American OEM -- likely, Tesla --silicon carbide penetration of electric vehicles was only 6%, with the rest of the market being served by traditional silicon power chips.
When you add it up, you have an EV market that is set to rebound, increasing SiC content within EVs, and On's SiC chips in particular gaining market share over rivals. That bodes well for On's growth in the future.
2. AI data centers just beginning to take off
On also has other businesses besides electric vehicles, with the biggest non-auto segment in industrial clean energy applications. Management noted on the recent call it had increased its industrial SiC customer count by 17% last quarter, even though industrial chip sales declined 29% year over year and 6% sequentially.
However, there's a new key end market that is just emerging in AI data centers. AI data centers require huge amounts of power to run, and On now has products ready to capture the opportunity. El-Khoury noted, "We have invested in this space through the downturn, delivering a silicon and silicon carbide portfolio capable of meeting the ever-increasing demands of AI data centers across the entire power trees."
On is now set to capture some of the $2.2 billion market for power chips in data centers that is forecast to grow to $4.4 billion by 2028. Of note, On makes minimal revenue today from data centers, but capturing some of that pie could make an incremental difference to its $7.4 billion in revenue over the past 12 months.
Image source: Getty Images.
3. On's big capex spending is now behind it
Finally, On's bottom line seems primed to exceed its top-line growth whenever auto and industrial chips pivot back to growth. This is because the company has already completed the bulk of its capacity and technology investments over the past few years.
Last year, On's capital spending as a percentage of revenue was 19.1%, but it has fallen this year to just 10% as of last quarter. Even better, management now sees capital spending as a percentage of revenue falling to around 5% long-term, which is about half of management's prior target.
How is On achieving this? On bought a massive fab in East Fishkill, NY from Globalfoundries in early 2023, and has spent the past year investing to make that foundry more efficient. So, a lot of that investment is now behind the company.
Additionally, On management noted it is converting its 150mm (6-inch) silicon carbide lines to 200mm (8-inch) wafers. Encouragingly, On noted its manufacturing yields on 200mm are now in-line with that of its 150mm wafers. That's a big deal, as 200mm wafers are seemingly more difficult to produce, but can ultimately yield more chips at lower cost. Notably, potential competitor Wolfspeed(NYSE: WOLF) has invested massively in its own 200mm fab but has struggled to get those wafers up to good yields. So, On's conversion to 200mm should head off that competitive threat to some extent.
Meanwhile, On will be able to reuse capital equipment in converting 150mm wafer lines to 200mm wafer lines, which will efficiently increase capacity without having to invest in an entire new line of capital equipment. Thus, the company is set to very efficiently grow in the years ahead, likely boosting earnings per share well above revenue growth.
Add it all up...
When you add all these elements up -- On taking share in electric vehicle silicon carbide, SiC content gains ahead, a potential EV turnaround in the future, a new data center end market, and declining capital intensity, it sure looks like On's bottom line is in for a surge sometime in the near future.
While it's hard to time the exact turnaround in the auto and industrial markets, On's current valuation at just 18.5 earnings on what should be bottom-of-cycle profitability sure seems like a great deal for long-term investors.
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Billy Duberstein and/or his clients have positions in ON Semiconductor and Texas Instruments. The Motley Fool has positions in and recommends Tesla, Texas Instruments, and Wolfspeed. The Motley Fool recommends ON Semiconductor. The Motley Fool has a disclosure policy.
