2023-11-01 08:30:15 ET
Summary
- ON Semiconductor stock collapsed, losing most of its gains over the past year.
- The company faces broad-based challenges in the automotive industry, including inventory issues and high interest rates. It has also lowered its silicon carbide revenue for 2023.
- As a result of the collapse, ON's valuation has normalized, as the market quickly priced in these challenges. As such, ON is looking attractive again.
- I assessed why the capitulation move is constructive for dip buyers, as ON's structural growth drivers are expected to remain robust. It's finally time for me to upgrade ON.
I last updated my thesis on leading automotive and industrial semiconductor company ON Semiconductor Corporation or onsemi ( ON ) in early December 2022. It's a moment that I have been waiting for: the capitulation move. My Sell thesis on ON over the past year has worked out, as ON significantly underperformed the S&P 500 ( SPX ) ( SPY ) since then.
As a result of the collapse, ON lost most of its gains over the past year, registering a 1Y total return of 2%, underperforming most of its peers listed above. On a price-performance basis, ON was down nearly 45% from its July 2023 highs through this week's lows, as dip buyers likely rushed out, stunning late buyers who chased ON toward its summer highs.
With that in mind, I believe it's opportune for me to update whether it's timely for investors who have been waiting on the sidelines patiently to consider adding exposure.
The company reported a solid third-quarter or FQ3 earnings release. However, it's important for investors not to focus on what has passed (third quarter) but on what lies ahead. Always remember that the market is forward-looking.
As onsemi is a leading player in the automotive and industrial market, worsening headwinds in the auto industry wouldn't help. Accordingly, management telegraphed broad-based challenges in the automotive industry, driven by ongoing inventory challenges and high-interest rates. Management also indicated a reduction in silicon carbide or SiC revenue from $1B to $800M for FY23, attributing it to "a reduction in demand from a single automotive original equipment manufacturer."
Despite that, the company remains confident about the legally binding structure of its long-term supply agreement or LTSA, contributing to revenue visibility. However, the need to strike "win-win" arrangements in the near term might require necessary adjustments, although onsemi doesn't anticipate structural challenges. In other words, onsemi is confident that these headwinds are transitory, although management isn't ready to guide for 2024.
As a result, I wasn't surprised that the market needs to reflect these challenges and uncertainties in ON's seemingly attractive valuation. With the plunge, ON last traded at a forward EBITDA multiple of 9.1x, slightly above its 10Y average of 8.9x. Given onsemi's exposure to the secular tailwinds in EV and the world's energy transition, investors likely didn't expect the light guidance on its near-term growth cadence.
However, with ON's valuation back into more attractive levels in line with its long-term average, I assessed that the opportunity to buy more into ON is back into attractive zones, with some caveats.
ON's disastrous collapse from its July 2023 highs nearly took out buyers all the way back toward its early 2023 lows. As such, I assessed that much froth has been digested, constructive for ON dip buyers looking to return with a more attractive risk/reward upside.
However, there's a possible re-test zone underpinned by ON's January 2023 lows ($60 level), which must be sustained. In other words, if you are more conservative, wait for ON to possibly re-test that level and force a false downside breakdown or bear trap reversal before committing more funds.
A failure of that level could see ON falling further toward its July 2022 zone ($45 level), which isn't my base case for now. As such, I assessed that ON's risk/reward profile had improved significantly as it capitulated, allowing me to be more constructive on ON, suggesting I believe the near-term headwinds have been priced in.
Rating: Upgraded to Buy.
Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.
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For further details see:
ON Semiconductor: This Is The Plunge That I've Been Waiting For (Rating Upgrade)