2023-09-15 16:00:00 ET
Summary
- ON's NTM P/E valuations continue to rise to 17.90x, compared to its SiC peers' mean of 14.54x, suggesting its high growth/ profitability cadence.
- Based on the management's forward projection, the consensus has also awarded the company with an FY2027 adj EPS estimates of $10.19, bringing forth an impressive long-term price target of $182.40.
- These numbers are not overly optimistic as well, due to the growing Long-Term Supply Agreements of over $20B and lead time of over 40 weeks.
- Combined with the ON management's great sensitivity to the elevated interest rate environment and moderation in operating expenses, we may see its profitability expand as projected indeed.
- Then again, the embedded growth premium also comes with great expectations, potentially triggering volatility in the event of earning misses or deceleration in growth. Investors beware.
The ON Investment Thesis Remains Robust, Despite The Rally Thus Far
We previously covered ON Semiconductor Corporation ( ON ) in July 2023, discussing the stock's optimistic rally since the start of the pandemic, thanks to the growing demand for Silicon Carbide in the EV and renewable energy end markets.
This had also led its growing backlog and raised consensus estimates over the next few years, naturally triggering its premium valuations compared to its SiC peers.
ON 3M EV/Revenue and P/E Valuations
For now, ON's valuations have continued to rise to NTM EV/ Revenues of 4.98x and NTM P/E of 17.90x, elevated compared to its 1Y mean 4.29x/ 16.50x and its 3Y pre-pandemic mean of 1.86x/12.18x, respectively
It is apparent that the stock still trades at a premium, compared to its SiC peers, such as Infineon Technologies ( IFNNY ) at NTM P/E of 12.80x and STMicroelectronics ( STM ) at 10.61x, with Wolfspeed ( WOLF ) still being GAAP unprofitable.
ON's Raised Top & Bottom Line Estimates
For now, the premium embedded in the ON stock's valuation is not surprising, given its growing Long-Term Supply Agreements [LTSA] of over $20B ( +13.6% QoQ from $17.6B / +127.2% YoY from $8.8B ) by the latest quarter.
Since "a significant portion of its orders are firm commitments that are non-cancellable," the company's top and bottom line growth are secured for the next three years, if not longer, based on the persistently hiked consensus estimates since December 2021.
It is also apparent that demand is gated by ON's supply for now, with its average lead time being mid-to-high-40 weeks, as recently communicated in the Citi 2023 Global Technology Conference in September 2023.
Due to the robust demand, it is unsurprising that the management has been considering another $2B fab investment to expand its global capacity, on top of converting and optimizing its existing fabs.
Consensus Forward Estimates
This is why ON's consensus forward estimates indicate a notable ramp up in its top and bottom lines from FY2025 onwards, with expanding profit margins.
FY2027 Management Guidance
These numbers also coincide with the ON management's FY2027 projection , with a top line CAGR of between +10% and +12% from FY2022 levels, resulting in an approximate revenue of between $13.40B and $14.66B then.
Based on the consensus FY2027 adj EPS projection of $10.19 and its NTM P/E valuations of 17.90x, we are looking at a long-term price target of $182.40, implying an excellent upside of +86.40% from current levels.
Those numbers are not overly aggressive as well, since the ON management continues to express its ambitions to "capture 40% of the silicon carbide automotive chip market by 2027" in the Analyst Day 2023 , held on May 16, 2023.
This is combined with the projected step up in its gross margin from 49.2% in 2022 to 53% by 2027, with its FQ2'23 margins of 47.4% (+0.7 points QoQ/ -2.3 YoY) only temporarily impacted by the capacity ramp up in its East Fishkill facility in New York, previously acquired from GLOBALFOUNDRIES ( GFS ).
And it is for this reason, that ON investors should not be concerned about its impacted Free Cash Flow generation of -$39.8M (-156.2% QoQ/ -123.5% YoY) in the latest quarter, since the increased capex is attributed to the management's sustained investments in capacity.
In addition, the management has been able to prudently deploy cash and debt, growing its cash/ short-term investments to $2.62B (-3.6% QoQ/ +43.9% YoY) while sustaining its long-term debt balance at $3.5B (+7.6% QoQ/ +3.8% YoY).
Most importantly, the ON management has also displayed great sensitivity to the elevated interest rate environment, by executing multiple rate swap agreements to effectively reduce its weighted-average interest rate to 1.9% (-1.2 points QoQ/ -0.8 YoY) by FQ2'23.
Combined with the tightened annualized operating expenses of $1.26B (+4.8% QoQ/ -7.1% YoY) in FQ2'23, despite the tremendous top-line expansion to an annualized sum of $8.36B (+7.1% QoQ/ +0.5% YoY), we remain confident that ON's long-term prospects remain excellent.
This is compared to the FY2019 revenues of $5.51B (-6.1% YoY), gross margins of 35.8% (-2.3 points YoY), and operating expenses of $1.35B (-2.1% YoY), further underscoring the highly competent management team and the company's clear profit trajectory over the next few years.
So, Is The ON Stock A Buy , Sell, or Hold, Despite The Embedded Premium?
ON 5Y Stock Price
This brings us back to the article's title: Is The Premium Embedded in The On Stock Sustainable? Our answer will be a resounding yes.
This is why.
ON still trades way below its diversified semiconductor sector median P/E of 22.06x, implying that the stock's premium only reflects Mr. Market's conviction on its high growth cadence, while being profitable at the same time.
As a result of the attractive upside potential to our long-term price target, we continue to rate the ON stock as a Buy.
Naturally, there is a note of warning for interested investors, since the embedded growth premium also comes with great expectations. Therefore, depending on its forward execution, the management cannot afford any earnings miss and/ or deceleration in growth, since these may trigger drastic volatilities in its stock valuations and prices.
Therefore, anyone who chooses to add the ON stock here may also want to keep their portfolio appropriately sized according to their risk tolerance.
While the management recently reported increasing Automotive revenues of over $1B and expanding LTSAs for SiC solar solutions at $1.95B, with both segments accounting for 80% of its overall revenues by FQ2'23, any moderation in demand may naturally impact its growing LTSAs.
For example, the average interest rate for auto loans on new cars has further climbed to 7.40% in August 2023 (+0.22 points MoM/ +2.41 YoY), compared to 2019 averages of 4.63%. This is on top of the ongoing impact of NEM 3.0 in California, already impacting the demand for Enphase's ( ENPH ) solar microinverters.
While the market analysts have already priced in a rate freeze in the upcoming FOMC meeting on September 20, 2023, with Morningstar expecting a Fed pivot from February 2024 onwards, it remains to be seen how discretionary spending may be impacted. This may be significantly destabilized by the restart of federal student loan repayments from October 2023 as well.
With these headwinds potentially impacting ON's prospects over the next few quarters, investors may also want to temper their intermediate-term expectations.
For further details see:
Does ON Semiconductor's Premium Valuations Make Sense?