Near Its 52-Week Lows, 1 Top Chip Stock Could Be an Incredible Value


ON Semiconductor is in a slump, but it’s navigating difficult times in admirable fashion.

One of the leading producers of silicon carbide (SiC) power chips, ON Semiconductor (ON 1.67%), is in the midst of a slump. The company — one of the biggest manufacturers of SiC chips along with STMicroelectronics and Wolfspeed — is forecasting a tumble in revenue through at least the first half of 2024 because of a slowdown in electric vehicle (EV) sales. Shares are just above their low point of the past year.

That said, ON Semiconductor has been on an epic rise for five years (up well over 200%, including the recent drop), and demand for its advanced power and sensor chips is fully expected to pick up pace again before too long. Here’s why the stock could be an incredible value right now.

A cheap valuation, but just how cheap?

Since taking over in late 2020, CEO Hassane El-Khoury and the rest of the top management team have been off-loading old legacy lines of the company’s manufacturing business and focusing on higher-end and more profitable chips.

That includes SiC chips, key ingredients in the electric motors and battery charging systems for EVs, as well as image sensors used in self-driving and advanced safety systems in cars.

The reshuffling of the product portfolio the last few years hasn’t made for the fastest-growing chip company. However, profit margins have soared far higher than ON’s traditional mix of commoditized power parts and sensors. This has been the primary reason for the stock’s rise.

ON Revenue (TTM) Chart

Data by YCharts; TTM = trailimg 12 months.

ON Semiconductor is in the midst of a cyclical downturn, though, not unusual for any manufacturing company. At the midpoint of guidance, management expects revenue to be down 22% year over year in the second quarter, and for earnings per share (EPS) to be down 32%.

The sequential decline in the second quarter is largely in line with other auto and industrial chip suppliers, as a slowdown in EV sales and excess chip inventory for industrial equipment have meant customers are delaying orders from ON and its peers.

As a result, the current trailing-12-month price-to-earnings ratio under 15 is going to get worse as 2024 progresses. The stock trades for 18 times forward earnings, based on Wall Street analysts’ full-year 2024 expectation for EPS.

Power chips are a secular growth trend

The near-term outlook is rocky, but 18 times current-year earnings (if that ends up being in the ballpark for 2024) might be cheap. Management says its customers will have plenty of need for more power chips in the years to come — for the SiC variety and for other applications like factory automation and data center power.

In fact, though revenue could be trending lower for much of 2024, ON’s communication with customers must be constructive enough that it has left its financial targets through 2027 unchanged after the most recent update. It still expects revenue to compound at an annual growth rate of 10% to 12% through the next few years, and its free-cash-flow margin to ratchet up 25% to 30%. Not that free cash flow was close to zero at times in 2023 as ON built its SiC manufacturing facilities.

Based on this outlook, El-Khoury anticipates revenue being over $13 billion in 2027, with free cash flow of roughly $3.5 billion to $3.7 billion. Along the way, management plans on returning about half of that free cash flow to shareholders via stock buybacks (and maybe, eventually, a dividend).

For investors looking for a solid bet on power chips and sensors in support of secular growth trends like EVs and energy efficiency, ON Semiconductor stock looks like a great value right now.

Nicholas Rossolillo and his clients have positions in ON Semiconductor. The Motley Fool has positions in and recommends Wolfspeed. The Motley Fool recommends ON Semiconductor. The Motley Fool has a disclosure policy.



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