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ON Semiconductor (NASDAQ:ON) Reports Strong Q3, Quarterly Guidance In Line


Full Report / October 31, 2022
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Analog chips maker ON Semiconductor (NASDAQ: ON) reported Q3 FY2022 results beating Wall St's expectations, with revenue up 25.8% year on year to $2.19 billion. The company expects that next quarter's revenue would be around $2.07 billion, which is the midpoint of the guidance range. That was in roughly line with analyst expectations. ON Semiconductor made a GAAP profit of $312.4 million, improving on its profit of $310.4 million, in the same quarter last year.

ON Semiconductor (ON) Q3 FY2022 Highlights:

  • Revenue: $2.19 billion vs analyst estimates of $2.11 billion (3.58% beat)
  • EPS (non-GAAP): $1.45 vs analyst estimates of $1.31 (10.4% beat)
  • Revenue guidance for Q4 2022 is $2.07 billion at the midpoint, below analyst estimates of $2.08 billion
  • Free cash flow of $731.3 million, up from $202.7 million in previous quarter
  • Inventory Days Outstanding: 126, down from 136 previous quarter
  • Gross Margin (GAAP): 48.2%, up from 41.3% 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.

ON Semiconductor’s peers and competitors include Analog Devices (NASDAQ:ADI), Texas Instruments (NASDAQ:TXN), Skyworks (NASDAQ:SWKS), Infineon (XTRA:IFX), NXP Semiconductors NV (NASDAQ:NXPI), Monolithic Power Systems (NASDAQ:MPWR), Marvell Technology (NASDAQ:MRVL), and Microchip (NASDAQ:MCHP).

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. Read More The semiconductor industry is broadly divided into analog and digital semiconductors. Digital chips are what most people think of as the brains of almost every electronic device. Their primary purpose is to either store (memory chips) or process (CPUs/GPUs) data. By comparison, analog chips regulate real world signals, such as temperature, speed, sound, or electrical current, converting them into a stream of digital data that can be processed by digital semiconductors. Analog semiconductors are also used to manage power in any electronic device; they convert, store and distribute the electrical energy that comes from a battery or wall plug. Analog chips are found everywhere from household appliances like refrigerators or washing machines, to smartphones, cars and factory production lines.

Sales Growth

ON Semiconductor's revenue growth over the last three years has been mediocre, averaging 14.1% annually. But as you can see below, last year has been stronger for the company, growing from quarterly revenue of $1.74 billion to $2.19 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).

ON Semiconductor Total Revenue

This was a decent quarter for ON Semiconductor as revenues grew 25.8%, topping analyst estimates by 3.58%. This marks 8 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 12.3% YoY next quarter, and Wall St analysts are estimating growth 3.37% 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.

ON Semiconductor Inventory Days Outstanding

This quarter, ON Semiconductor’s inventory days came in at 126, which is exactly around the five year average, suggesting there isn't any unusual buildup of inventory at the moment.

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 48.2% in Q3, up 6.9 percentage points year on year.

ON Semiconductor Gross Margin (GAAP)

Over the past year, ON Semiconductor has seen its already reasonably high gross margins continue to rise, averaging 48.1%, indicative of a solid competitive offering, efficient cost controls, and relatively low pricing pressure.

Profitability

ON Semiconductor reported an operating margin of 35.4% in Q3, up 10.9 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.

ON Semiconductor Adjusted Operating Margin

Operating margins have been trending up over the last year, averaging 33.1%. 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 be fairly flat 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 $731.3 million in Q3, up 105% year on year.

ON Semiconductor Free Cash Flow

ON Semiconductor has generated $1.69 billion in free cash flow over the last twelve months, translating to 21% of revenues. This is a strong result; ON Semiconductor's free cash flow conversion was higher than most semiconductor companies, in the last year. If it maintains this level of cash generation, it will be able to invest plenty in new products, and ride out any cyclical downturn more easily.

ON Semiconductor’s average return on invested capital (ROIC) over the last 5 years of 20.5% 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 Q3 Results

With a market capitalization of $29.2 billion, more than $2.45 billion in cash and with free cash flow over the last twelve months being positive, the company is in a very strong position to invest in growth.

We were very impressed by the strong improvements in ON Semiconductor’s gross margin this quarter. And we were also excited to see that earnings outperformed Wall St’s expectations. On the other hand, it was unfortunate to see that the revenue guidance for the next quarter slightly missed analysts' expectations. Zooming out, we think this was a fantastic quarter that should have shareholders cheering. The company is down 2.09% in the pre-market and currently trades at $66 per share.

Is Now The Time?

When considering ON Semiconductor, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. 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 13.7x. 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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