TSLA - ON Semiconductor: More Near-Term Pain As Auto Corrects

2023-11-02 08:30:00 ET

Summary

• We remain hold-rated on ON Semiconductor.
• We think ON is at a higher risk of underperforming in the near term due to the high exposure to the auto and industrial end-markets that are currently undergoing correction.
• We believe management reduction of the FY23 SiC (Silicon Carbide) target by 20% (from $1B to $800M) shocked investors.
• We are now concerned about the possible price pressure that may lead to gross margin headwinds.
• While we are optimistic about ON's unique product positioning over the next 2-3 years, we see a less favorable risk-reward profile in the near-term for the stock.

We maintain our bearish sentiment on ON Semiconductor (ON); the stock took a massive hit post-earnings this quarter, down 25% over the past 5D versus the S&P 500, down 1% during the same period. We think our investment thesis regarding the auto and industrial markets being the last leg of the correction is playing out. And, we think ON is at higher risk of underperforming in the near-term due to the company's exposure to auto and industrial end markets undergoing a correction in 2H23; auto sales grew 9% QoQ this quarter to $1,1158M, representing 53% of total sales while industrial-related sales increased 1% QoQ to $616M. We like ON's position in the auto industry as we think the company is better positioned for content gain and strength in the EV markets in the mid-to-long run. We think ON's product positioning in the auto is unique to the peer group but don't believe the company's immune to auto demand weakness into 2024. We're seeing signs of order declines and cancelations from the industry's main EV player, Tesla ( TSLA ), among others.

Management is guiding for revenue of $1,950-2,050M, trailing consensus at $2.18B. While we think the macro headwinds have been priced into the outlook and stock, we see more near-term downside risk as demand moderates in the back end of the year. The stock is down roughly 13% over the past six months, underperforming the S&P 500 by 12%. We recommend investors stay on the sidelines for the near-term.

The following graph outlines ON stock performance against the S&P 500 and Monolithic Power Systems (MPWR).

Additionally, we believe management reduction of the FY23 SiC (Silicon Carbide) target by 20% (from $1B to $800M) shocked investors. We're now concerned about the possible price pressure that may lead to gross margin headwinds. Non-GAAP gross margin percentage declined ten basis points to 47.3% as a result of the start-up cost for its SiC ramp. Management guides for Non-GAAP gross margin to decline to the range of 45.5%-47.5% on lower sales next quarter. We don't see a favorable risk-reward profile for the stock in the near-term.

Valuation

The stock is trading well below the peer group average on all metrics, but we don't recommend investors buy the stock on weakness just yet. On a P/E basis, the stock is trading at 12.7x C2023 EPS $5.13 compared to the peer group average of 32.9x. The stock is trading at 3.5x EV/C2023 Sales versus the peer group average of 5.0x. We're bullish on the stock in the mid-to-long run but see more near-term downside ahead and recommend investors stay on the sidelines.

The following chart outlines ON's valuation against the peer group average.

Word on Wall Street

Wall Street is somewhat divided in its sentiment on the stock, leaning more toward a buy-rating. Of the 30 analysts covering the stock, 16 are buy-rated, and the remaining are hold-rated. We attribute the dispersed sentiment to ON's longer-term outlook versus its near-term headwinds due to exposure to auto and industrial markets in 2H23. We think investors would be better positioned to explore entry points down the line as we don't see the stock working in the near-term.

The stock is currently priced at $65 per share. The median sell-side price target is $91, while the mean is $90, with a potential upside of 37-29%.

The following charts outline the sell-side ratings and price-targets for the stock.

What to do With the Stock

We continue to be hold-rated on ON. The stock is at higher risk of underperforming due to the exposure to auto and industrial end demand weakness. We believe management reduction of the FY23 SiC (Silicon Carbide) target by 20% (from $1B to $800M) shocked investors, dragging the stock down post-earnings. While we are optimistic about ON's unique product positioning over the next 2-3 years, we see a less favorable risk-reward profile in the near-term for the stock.

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