2023-12-05 09:00:00 ET
Summary
- With great growth premiums, comes great market expectations, with ON's underwhelming FQ4'23 guidance directly triggering a -25% plunge at its worst.
- However, the deceleration in EV sales is to be expected, attributed to the elevated borrowing costs and the uncertain macroeconomic outlook.
- Things may lift soon, with the Fed unlikely to further hike rates and a pivot potentially occurring by Q1'24, consequently triggering the recovery of new auto sales by H2'24.
- Combined with ON's growing exposure to the EV, solar/ energy storage and industrial markets across different OEMs, we believe that its prospects remain excellent through the next decade of electrification.
- Its valuations may also be corrected nearer to its historical averages of 17x once the market sentiments surrounding EVs normalize, implying an improved upside potential.
We previously covered ON Semiconductor Corporation ( ON ) in September 2023, discussing why it deserved the premium growth valuations, as the ongoing electrification trend contributed to its growing backlog and lead time.
However, we had also cautioned investors that with great expectations, great volatility might accompany the stock, in the event of earning misses or deceleration in growth.
ON 3M Stock Price
It appears that our cautionary tale has materialized in the recent FQ3'23 earnings call, with the ON stock drastically losing -25% of its value, or the equivalent of -$9.11B of its Enterprise Value at its worst, thanks to the underwhelming FQ4'23 guidance.
Then again, we maintain our Buy rating, with the recent dip offering opportunistic investors with the rare chance to ride the next decade electrification trend.
The EV Investment Thesis Has Only Stalled Temporarily
For now, ON has recorded a double beat FQ3'23 earnings call , with revenues of $2.18B ( +4.3% QoQ / -0.5% YoY ) and adj EPS of $1.39 (+4.5% QoQ/ -4.1% YoY).
In addition, the company has been able to sustainably consolidate its manufacturing fabs while improving its overall gross margins to 47.3% (inline QoQ/ -1 points YoY), compared to FY2019 levels of 35.8% (-2.3 points YoY).
However, the ON management also offered an underwhelming forward guidance, with FQ4'23 revenues of $2B (-8.2% QoQ/ -4.7% YoY) and adj EPS of $1.20 (-13.6% QoQ/ -9% YoY) at the midpoint, compared to the consensus estimates of $2.18B and $1.37, respectively.
This has directly contributed to the stock's steep price plunge by -25% in the days after the latest earnings call, demonstrating how the growth premium embedded in its valuations may be a double-edged sword.
While the near-term headwinds are to be expected as automotive comprises 52.7% of ON's top-line (+12.9 points YoY), with the lowered 2023 silicon carbide shipment from $1B to $800M attributed the decelerating demand for EVs, we are not overly concerned since the Fed is unlikely to further hike interest rates, thanks to the cooling inflation .
Therefore, while the average Car Loan APR Rates are still elevated at 11.6% for used vehicles and 7.6% for new vehicles by October 2023, compared to 8.2% and 5.4% in December 2019 , respectively, we believe that the peak is almost here.
Most importantly, ON completed its capacity expansion and fab consolidation while maintaining a healthy balance sheet, with expanding cash/ equivalents of $2.67B (+1.9% QoQ/ +7.6% YoY) and moderating long-term debts of $2.54B (inline QoQ/ -16.4% YoY) by the latest quarter.
This is on top of the sustained share repurchases, with 1.7M already retired over the past twelve months, demonstrating its friendly shareholder policy despite not paying out a dividend.
In the long-term, ON's prospects remain extremely secure with an impressive Long-Term Service Agreement of $18.4B ( -8% QoQ / +30.4% YoY ), implying that it is sold out over the next two and a half years. The LTSA also offers the management with demand visibility, pricing stability, and sustainable capacity planning over the next few years.
We believe that the management has already shown great caution thus far, attributed to the notable step down in its capex plans in 2024, down to the low tens over the next few years, from the $1.64B guided in 2023 (+59.2% YoY).
As a result of the richer FCF generation ahead, we may see ON's balance sheet further improve from current levels, with the additional liquidity likely used to pay off $912.9M of debts maturing over the next twelve months.
So, Is ON Stock A Buy , Sell, or Hold?
ON Valuations
Thanks to the recent correction, we believe that ON currently trades at a highly attractive FWD P/E valuation of 14.50x, down from its 1Y mean of 16.95x and hyper-pandemic peak of 34.62x.
Even then, it is apparent that the ON stock is inherently undervalued compared to its semiconductor peers with a median FWD P/E of 22.54x, with the same discount also observed in its SiC peers, such as Infineon Technologies ( IFNNY ) at 15.34x and STMicroelectronics ( STM ) at 11.21x.
The Consensus Forward Estimates
ON's top and bottom line growth prospects have also been notably moderated to a CAGR of +2.08% and +1.48% through FY2025, compared to the previous +3.93% and +6.23%, respectively.
Even then, we believe that the stock is trading near its fair value of $74, based on the management's adj EPS guidance of $5.11 (-4.1% YoY) and its impacted FWD P/E of 14.5x.
ON 2Y Stock Price
In the long-term, we believe that ON's valuations may be corrected nearer to its historical averages of 17x once the market sentiments surrounding EVs normalizes, resulting in a greater upside potential to our long-term price target of $94.60 based on the consensus FY2025 adj EPS estimates of $5.57.
Some are already speculating a Fed pivot as soon as Q1'24, likely to trigger the moderation of borrowing costs and consequently, the recovery of new auto sales by H2'24, if not earlier.
Combined with its growing exposure to the EV, solar/ energy storage and industrial markets across different OEMs, we believe that ON's prospects remain excellent through the next decade of electrification, further aided by the well diversified geographical revenues with no one region comprising over 30% of its sales.
As a result of the attractive risk reward ratio, we continue to rate the ON stock as a Buy.
We maintain our belief that the ongoing electrification transition is here to stay, with the global 2050 decarbonization target likely to accelerate EV and solar adoption once the macroeconomic outlook normalizes and the EV/ grid parity is achieved.
Do not miss this dip.
For further details see:
ON Semiconductor: Buy This Deep Correction