2023-10-27 12:24:06 ET
Summary
- ON Semiconductor Corporation will benefit from the shift and adoption of EVs and ADAS technology through decade end.
- The company forecasts margin expansion and targets significant growth in cash flow margins, with expectations for annual revenue growth of 10% through 2027.
- ON Semiconductor stock is cheap at 15x '24 EPS targets.
Global electric vehicle ("EV") demand has probably disappointed during 2023, but ON Semiconductor Corporation ( ON ) will still benefit from the ultimate shift and adoption of EVs through 2030. The semiconductor company continues to report record automotive sales, yet the stock is now falling off a cliff. My investment thesis is ultra Bullish on the stock after this major move down.
Source: Finviz
Secular Shift
The auto tech sector is playing two major shifts benefitting substantial growth in content per vehicle. Both the EV transition from internal combustion engine ("ICE") vehicles and the ADAS focus leads to substantially higher content for technology.
On Semi. has already outlined the higher spending the company immediately gets from these shifts in vehicles. An ICE drivetrain only drives $50 worth of content for ON Semi. while a similar EV produces $750 in content. The company immediately obtains $700 in additional revenues.
The company gets an additional $1,000 on the safety components with new products like LED lights driving higher revenues over time. The business remains a secular driver of higher content per vehicle and not a focus on annual units sold, though the recent U.S. auto market strikes and pushback on EV plans can't help sales in the short term.
ON Semi. isn't currently reporting any revenue growth due to the industrial market weakness. The company reported Q2'23 sales growth of only 0.8% and guided to Q3 sales weakness leading to consensus estimates for a 2% dip to $2.15 billion.
In the meantime, the stock has now fallen $30 from the highs in late July when the company reported Q2 results. ON Semi. reported record automotive revenue topping $1 billion for 35% growth YoY.
Margin Expansion
While ON Semi. has already seen substantial financial gains in the last few years, the company still isn't topping 50% gross margins. In fact, margins have slipped in the last few quarters due to industrial market weakness and lower silicon carbide margins pushing the gross margin targets down to only 47%.
ON Semi. forecasts a 2027 gross margin target of 53% leading to free cash flow targets of 25% to 30%. The company only produced 14% cash flow margins in Q2'23 with a 2023 target of 20%.
In essence, ON Semi. ultimately sees some 50% upside in the key cash flow margins while the operating margin continues to expand. The profit picture will only improve based on expectations for annual revenue growth of 10% through 2027.
The secular trends in EVs and ADAS aren't actually leading to substantial forecasted sales growth in the short term, but the business will ramp up in the years ahead. The opportunity is for ON Semi. to top some of these minimal growth targets through the end of the decade when auto tech demand is set to surge.
The stock has slipped down to only $83 leaving ON Semi. at only 15x 2024 EPS targets of $5.68. The market isn't factoring in any significant growth rates into these numbers.
In essence, the company is targeting up to $4 billion in free cash flows by 2027 for a stock with a current market cap of only $35 billion. ON Semi. is spending up to 50% of free cash flows on share repurchases, so shareholders shouldn't necessarily complain about the lower stock prices.
Takeaway
The key investor takeaway is that ON Semi. remains well positioned for the secular growth of auto tech. The growth rates will be volatile in the company quarters due to the timing of the shift to EVs and auto strikes around the U.S. impacting auto production and the push out of EV plants.
Investors should use the weakness to own ON Semiconductor Corporation shares and ride the secular trends in autos through the end of the decade.
For further details see:
On Semiconductor: Riding The EV Wave