NXPI - onsemi Continues To Execute Very Well In Auto SiC And Restructuring

2023-05-02 11:57:15 ET

Summary

• A beat-and-raise quarter saw onsemi outperform on revenue and margins and provide better guidance for Q2'2023 than many peers.
• Electrification and new ADAS offerings continue to power auto opportunities, while a pivot toward energy infrastructure offers above-average growth in the industrial category.
• Weaker utilization, normalizing demand, and start-up/capacity ramp costs will pressure margins relative to the exceptional levels of 2022.
• High single-digit revenue growth and double-digit adjusted FCF growth can support a higher share price, but onsemi's upside is better understood by the Street and better reflected in the shares.

The changes pursued by management at onsemi ( ON ), including a greater focus on silicon carbide (or SiC) and advanced auto and industrial products, as well as exiting lower-margin business, continue to drive good results from this power, analog, and imaging semiconductor company. With that, the shares have continued to do pretty well relative to the wider semiconductor sector, rising about 28% since my last update and modestly outperforming the broader semiconductor sector, though underperforming peers like Infineon ( OTCQX:IFNNY ) and STMicroelectronics ( STM ) since then.

I like onsemi's leverage to advanced power opportunities (including electric vehicles, automation, and energy infrastructure/renewables), as well as the overall mix shift toward markets like auto and industrial where I expect a multiyear growth trend on increasing chip content. I also continue to like onsemi's efforts to shift away from lower-margin products. What I like relatively less is the valuation - although I do think there is still beat-and-raise upside here, as well as upside from sector-wide rerating, the valuation isn't quite as exciting as before.

Upside From Growing Industrial Markets And Good Execution Drive Another Beat

First quarter results were good at onsemi, though decisions to manage channel inventories do seem to have tempered some of the growth, and guidance was pretty strong in a quarter where guidance once again seems to be a challenge for many chip companies.

Revenue rose just under 1% year over year and declined about 7% sequentially, with that sequential performance coming in pretty much in line with NXP Semiconductors ( NXPI ) and Texas Instruments ( TXN ) and modestly weaker than the 4% decline at STMicro.

Reported revenue was about 2% better than expected, with auto revenue up 38% yoy and flat sequentially, inline with expectations, while industrial revenue rose 2% yoy and 1% qoq, beating by more than 6%. Other revenue, which includes exposure to weaker markets like computing and consumer, declined about 26% qoq. Auto revenue was a bit soft relative to TI and basically inline with NXP, with the company deciding to work down some channel inventory.

Gross margin declined 260bp yoy and 160bp qoq to 46.8%, slightly ahead of expectations. Although onsemi is seeing some margin leverage from increased sales of higher-margin image products (8MP imaging chips have ASPs about 2.5x 1MP products) and exiting lower-margin products, but those benefits are being offset in the near term by costs tied to ramping capacity (especially SiC) and lower capacity utilization (down 300bp qoq to 71%), as well as a slower-than-expected exit from some lower-margin products due to high customer demand (in other words, choosing to delay some product exits to maintain customer relationships).

Operating income fell 4% yoy and 12% qoq, with margin down 170bp yoy and 190bp qoq to 32.2%; operating income beat by more than 6%, while operating margin beat by about 140bp.

Mix Helping To Drive A Better Outlook

While there are still significant pressures in multiple computing, consumer, and communications markets, and there are areas of weakness in industrial, onsemi is benefiting from what is overall a beneficial end-market mix. With that, management guided to over 3% sequential revenue growth and a revenue midpoint for Q2'2023 that was 5% above sell-side expectations.

The auto story at onsemi is, I believe, pretty well-understood by the Street. The company continues to benefit from growing build-rates for EVs, and onsemi has done a good job of securing platform wins for auto power products, including wins with Jaguar Land Rover, VW Group, Mercedes, and Tesla ( TSLA ). Maybe less well-appreciated relative to the SiC-based auto powertrain opportunity is the ongoing opportunity in ADAS, where the company is seeing healthy demand for advanced image sensor products.

Industrial markets have been more mixed, with some slowdowns evident in certain sectors but healthy growth in areas like automation, building controls, and energy infrastructure. The company has made a stronger pivot toward opportunities in energy infrastructure (including renewables) and saw over 50% year-over-year revenue growth here this quarter. Given the long-term opportunity in energy infrastructure - building and factory automation requires electrical infrastructure upgrades, not to mention future demand for additional generation and transmission capacity (including renewables and microgrids) - I believe this will be a long-term growth opportunity for onsemi.

The margin outlook isn't quite as favorable. While onsemi's guidance for the next quarter was better than expected (about 40bp above sell-side estimates), it's likely going to take a few years for onsemi to regain or improve upon last year's record margin given the costs of new capacity additions and normalization of the demand environment (less opportunity to raise prices).

The Outlook

I'm still pretty bullish on onsemi, and I'm looking for long-term revenue growth of over 7% driven by opportunities like vehicle electrification, ADAS, industrial/building automation, and growth in advanced energy infrastructure, as well as imaging-related opportunities in auto, industrial, and consumer markets. As far as challenges or risks go, I do see a risk of eventual over-capacity in SiC power and other power products, not to mention the regular cyclicality of the semiconductor industry.

I haven't changed my model that much, though my long-term revenue growth rate is now closer to 7% simply due to moving the model ahead a year. I expect long-term free cash flow growth of over 10% as adjusted FCF margins move into the 20%'s.

Between discounted cash flow and margin-driven multiples (EV/revenue, EV/EBITDA, et al) I believe the shares still offer some upside - my cash flow model suggests a high single-digit long-term annualized prospective return, while near-term margin expectations get me close to $90 for near-term fair value; if and when semiconductor valuations re-rate higher, there is some upside there.

The Bottom Line

The only real issue I have with onsemi now is valuation - the stock simply isn't as cheap as before and the company's performance has already convinced many analysts and investors who were skeptical that the company could secure a strong seat at the table in next-gen power and/or execute on margin-improvement efforts. Valuation alone doesn't cap upside and I think onsemi can still be a worthwhile stock from here, but a pullback would certainly be a more interesting opportunity for those who don't already own shares.

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