Analog chips maker ON Semiconductor (NASDAQ: ON) reported Q4 FY2022 results that beat analyst expectations, with revenue up 13.9% year on year to $2.1 billion. However, guidance for the next quarter was less impressive, coming in at $1.92 billion at the midpoint, being 3.87% below analyst estimates. ON Semiconductor made a GAAP profit of $604.3 million, improving on its profit of $426.4 million, in the same quarter last year.
ON Semiconductor (ON) Q4 FY2022 Highlights:
- Revenue: $2.1 billion vs analyst estimates of $2.07 billion (1.2% beat)
- EPS (non-GAAP): $1.32 vs analyst estimates of $1.26 (4.4% beat)
- Revenue guidance for Q1 2023 is $1.92 billion at the midpoint, below analyst estimates of $1.99 billion
- Free cash flow of $389.3 million, down 46.7% from previous quarter
- Inventory Days Outstanding: 136, up from 126 previous quarter
- Gross Margin (GAAP): 48.5%, up from 45% 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.
Sales Growth
ON Semiconductor's revenue growth over the last three years has been mediocre, averaging 15.8% annually. But as you can see below, last year has been stronger for the company, growing from quarterly revenue of $1.84 billion to $2.1 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).
While ON Semiconductor beat analysts' revenue estimates, this was a very slow quarter with just 13.9% revenue growth. This marks 9 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.
ON Semiconductor's revenue growth was positive this quarter, but the company is guiding to decline of 1.28% YoY next quarter, while analysts expect to see declines of 3.41% 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, 9 days above the five year average, suggesting that that inventory has grown to higher levels 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 48.5% in Q4, up 3.4 percentage points year on year.
Over the past year, ON Semiconductor has seen its already reasonably high gross margins continue to rise, averaging 48.9%, indicative of a solid competitive offering, efficient cost controls, and relatively low pricing pressure.
Profitability
ON Semiconductor reported an operating margin of 34.1% in Q4, up 5.5 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 34.4%. 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
Wall St analysts are expecting earnings per share to decline 15.7% 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 $389.3 million in Q4, down 14.8% year on year.
ON Semiconductor has generated $1.62 billion in free cash flow over the last twelve months, translating to 19.5% 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% 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 Q4 Results
With a market capitalization of $34.9 billion, more than $2.91 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 operating margin this quarter. And we were also glad to see the improvement in gross margin. On the other hand, it was unfortunate to see that the revenue guidance for the next quarter missed analysts' expectations and inventory levels increased. Zooming out, we think this was still a decent, albeit mixed, quarter, showing the company is staying on target. But the market was likely expecting more and the company is down 3.89% on the results and currently trades at $77.68 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 mediocre, and analysts expect growth rates to deteriorate from there.
ON Semiconductor's price to earnings ratio based on the next twelve months is 18.1x. 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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