On Semiconductor’s Earnings Spark Mixed Reactions but Signals Promising Future
Power, analog, and image sensor semiconductor leader On Semiconductor (NASDAQ: ON) released its earnings report on Monday, October 28. Investors responded with volatility: the stock initially dropped before rebounding to a peak of 5.5% gains, ultimately settling at a 1% increase by the end of the day.
This rollercoaster suggests a level of uncertainty among investors. However, examining the details from the earnings call provides compelling reasons to believe that On’s profitability could rise significantly in the coming years. Here are three key factors that suggest investors should consider buying this stock at its current price.
1. Promising Growth in Silicon Carbide Technology
On Semiconductor is establishing itself as a leader in silicon carbide (SiC) chips, a cutting-edge material that enhances the efficiency of power semiconductors. These semiconductors are crucial for electric vehicles (EVs) and industrial power systems.
In its recent third-quarter results, On reported a weak performance in its automotive segment, with revenues declining by 18% year-over-year, but showing a 5% increase sequentially. Sales of automotive chips have been down since early 2023 as manufacturers worked to reduce excess inventory. Additionally, the pace of electric vehicle adoption has slowed, raising concerns about future sales.
Despite these challenges, CEO Hassane El-Khoury expressed optimism about the long-term outlook, indicating that while EV production volumes fell short of earlier expectations, manufacturers are still committed to launching new EV models:
[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 indicates short-term demand fluctuations rather than a shift in strategy or long-term trends.
On has achieved about 50% market share in the SiC chip sector within China’s battery EV market, as seen in the latest vehicle models introduced at the Beijing auto show. This is noteworthy since China’s demand for electric vehicles and hybrids utilizing SiC chips continues to grow. Meanwhile, Texas Instruments reported a 20% sequential increase in auto revenue from China, demonstrating positive momentum in that region.
Importantly, aside from Tesla, the largest North American manufacturer, only 6% of electric vehicles use silicon carbide, suggesting significant growth opportunities as traditional silicon chips dominate the market. Considering all these factors, On’s position in the growing electric vehicle market looks favorable for future growth.
2. AI Data Centers Present New Opportunities
On Semiconductor is not limited to the automotive sector; it also has a strong presence in industrial clean energy applications. Last quarter, On increased its industrial SiC client count by 17%, despite an overall decline in industrial chip sales of 29% year-over-year and 6% sequentially.
A new and promising market is emerging in AI data centers. These centers require substantial power, and On is prepared to meet this demand with its products. El-Khoury stated, “We have invested in this space through the downturn, delivering a silicon and silicon carbide product range that meets the growing needs of AI data centers.”
Currently, On generates minimal revenue from data centers but stands to benefit from the burgeoning $2.2 billion market for power chips, which is expected to double by 2028. Capturing even a small share could provide a significant boost to its revenue of $7.4 billion over the past year.
3. Reduced Capital Expenditures Signal Efficiency
Looking ahead, On Semiconductor appears well-equipped to enhance its profitability as the automotive and industrial chip markets recover. The company has completed significant investments in its production capacity and technology in recent years.
In 2022, On’s capital expenditures accounted for 19.1% of its revenue, but this figure dropped to 10% in the latest quarter. Management anticipates this will fall to around 5% in the long run, which is below previous targets.
A significant factor in this change was On’s acquisition of a large manufacturing facility in East Fishkill, NY from Globalfoundries earlier this year, along with efforts to improve efficiency at that facility.
Furthermore, On is converting its 150mm (6-inch) silicon carbide production lines to 200mm (8-inch) wafers. Notably, On reported that its manufacturing yields for 200mm wafers are now comparable to those of the older 150mm technology. This advancement is crucial since 200mm wafers can produce more chips while lowering costs. In contrast, competitor Wolfspeed (NYSE: WOLF) has faced challenges in achieving good yields with its own 200mm production.
With the ability to repurpose existing equipment during the conversion process, On is set to increase capacity efficiently, positioning the company for significant earnings growth that may outpace revenue growth in the future.
Summarizing On Semiconductor’s Growth Potential
Combining all these factors—On’s growing share in the silicon carbide market for electric vehicles, anticipated increases in SiC application in EVs, new opportunities in AI data centers, and decreasing capital expenditure demands—indicates that On Semiconductor’s profits are likely to rise sharply in the near future.
While predicting the precise timing of a recovery in the automotive and industrial sectors is difficult, On’s current valuation of 18.5 times earnings, reflecting potential bottom-of-cycle profitability, presents an attractive opportunity 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.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.