Analog chips maker ON Semiconductor (NASDAQ: ON) reported Q2 FY2022 results beating Wall St's expectations, with revenue up 24.8% year on year to $2.08 billion. On top of that, guidance for next quarter's revenue was surprisingly good, being $2.12 billion at the midpoint, 5.18% above what analysts were expecting. ON Semiconductor made a GAAP profit of $456.3 million, improving on its profit of $184.1 million, in the same quarter last year.
ON Semiconductor (ON) Q2 FY2022 Highlights:
- Revenue: $2.08 billion vs analyst estimates of $2.01 billion (3.5% beat)
- EPS (non-GAAP): $1.34 vs analyst estimates of $1.26 (6.31% beat)
- Revenue guidance for Q3 2022 is $2.12 billion at the midpoint, above analyst estimates of $2.01 billion
- Free cash flow of $202.7 million, down 33.4% from previous quarter
- Inventory Days Outstanding: 136, down from 138 previous quarter
- Gross Margin (GAAP): 49.7%, up from 38.3% same quarter last year
Spun out of Motorola in 1999, and built through a series of acquisitions, ON Semiconductor (NASDAQ: ON) is a global provider of analog chips with specialization in autos, industrial applications, and power management in cloud data centers.
Analog Semiconductors
Longer manufacturing duration allows analog chip makers to generate greater efficiencies, leading to structurally higher gross margins than their fabless digital peers. The downside of vertical integration is that cyclicality can be more pronounced for analog chipmakers, as capacity utilization upsides work in reverse during down periods.
Sales Growth
ON Semiconductor's revenue growth over the last three years has been unremarkable, averaging 11% annually. But as you can see below, last year has been stronger for the company, growing from quarterly revenue of $1.66 billion to $2.08 billion. Semiconductors are a cyclical industry and long-term investors should be prepared for periods of high growth, followed by periods of revenue contractions (which can sometimes offer opportune times to buy).
This was a decent quarter for ON Semiconductor as revenues grew 24.8%, topping analyst estimates by 3.5%. This marks 7 straight quarters of revenue growth, which means the current upcycle has had a good run, as a typical upcycle tends to be 8-10 quarters.
However, ON Semiconductor believes the growth is set to continue, and is guiding for revenue to grow 21.6% YoY next quarter, and Wall St analysts are estimating growth 6.18% over the next twelve months.
Product Demand & Outstanding Inventory
Days Inventory Outstanding (DIO) are an important metric for chipmakers, as it reflects the capital intensity of the business and the cyclical nature of semiconductor supply and demand. In a tight supply environment, inventories tend to be stable, allowing chipmakers to exert pricing power. Steadily increasing DIO can be a warning sign that demand is weak, and if inventories continue to rise the company may have to downsize production.
This quarter, ON Semiconductor’s inventory days came in at 136, 11 days above the five year average, suggesting that despite the recent decrease the inventory levels are still higher than what we used to see in the past.
Pricing Power
ON Semiconductor's gross profit margin, how much the company gets to keep after paying the costs of manufacturing its products, came in at 49.7% in Q2, up 11.4 percentage points year on year.
ON Semiconductor' gross margins have been trending up over the last year, averaging 46.4%. This is around the average of what we typically see in semiconductor businesses, but the rising margin may be indicative of improving cost controls.
Profitability
ON Semiconductor reported an operating margin of 34.5% in Q2, up 14.9 percentage points year on year. Operating margins are one of the best measures of profitability, telling us how much the company gets to keep after paying the costs of manufacturing the product, selling and marketing it and most importantly, keeping products relevant through research and development spending.
Operating margins have been trending up over the last year, averaging 30.3%. ON Semiconductor's margins remain one of the highest in the semiconductor industry, driven by its highly efficient operating model's economies of scale.
Earnings, Cash & Competitive Moat
Analysts covering the company are expecting earnings per share to grow 8% over the next twelve months, although estimates are likely to change post earnings.
Earnings are important, but we believe cash is king as you cannot pay bills with accounting profits. ON Semiconductor's free cash flow came in at $202.7 million in Q2, down 47.1% year on year.
ON Semiconductor has generated $1.32 billion in free cash flow over the last twelve months. This is a solid result, which translates to 17.3% of revenue. That's above average for semiconductor companies, and should put ON Semiconductor in a relatively strong position to invest in future growth.
ON Semiconductor’s average return on invested capital (ROIC) over the last 5 years of 19.5% implies it has a strong competitive position and is able to invest in profitable growth over the long term.
Key Takeaways from ON Semiconductor's Q2 Results
Sporting a market capitalization of $29 billion, more than $1.79 billion in cash and with positive free cash flow over the last twelve months, we're confident that ON Semiconductor has the resources it needs to pursue a high growth business strategy.
We were very impressed by the strong improvements in ON Semiconductor’s gross margin this quarter. And we were also glad to see the improvement in operating margin. Zooming out, we think this was a fantastic quarter that should have shareholders cheering. But investors might have been expecting more and the company is down 6.4% on the results and currently trades at $62.5 per share.
Is Now The Time?
ON Semiconductor may have had a good quarter, but investors should also consider its valuation and business qualities, when assessing the investment opportunity. Although ON Semiconductor is not a bad business, it probably wouldn't be one of our picks. Its revenue growth has been weak, and analysts expect growth rates to deteriorate from there.
ON Semiconductor's price to earnings ratio based on the next twelve months is 14.1x. We don't really see a big opportunity in the stock at the moment, but in the end beauty is in the eye of the beholder. And if you like the company, it seems that ON Semiconductor doesn't trade at a completely unreasonable price point.
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