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ON Semiconductor (NASDAQ:ON) Beats Q3 Sales Targets, Next Quarter Sales Guidance Is Optimistic


Full Report / November 02, 2021
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Analog chips maker ON Semiconductor (NASDAQ:ON) reported strong growth in the Q3 FY2021 earnings announcement, with revenue up 32.2% year on year to $1.74 billion. Guidance for next quarter's revenue was $1.79 billion at the midpoint, 4.04% above the average of analyst estimates. ON Semiconductor made a GAAP profit of $310.4 million, improving on its profit of $161.2 million, in the same quarter last year.

ON Semiconductor (ON) Q3 FY2021 Highlights:

  • Revenue: $1.74 billion vs analyst estimates of $1.71 billion (1.7% beat)
  • EPS (non-GAAP): $0.87 vs analyst estimates of $0.74 (18.2% beat)
  • Revenue guidance for Q4 2021 is $1.79 billion at the midpoint, above analyst estimates of $1.72 billion
  • Free cash flow of $355.7 million, roughly flat from previous quarter
  • Inventory Days Outstanding: 118, up from 116 previous quarter
  • Gross Margin (GAAP): 41.3%, up from 33.4% 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 slow, averaging 4.31% annually. But as you can see below, last year has been stronger for the company, growing from quarterly revenue of $1.31 billion to $1.74 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 good quarter for ON Semiconductor as revenues grew 32.2%, topping analyst estimates by 1.7%. This marks 4 straight quarters of revenue growth, implying we are mid-cycle for ON Semiconductor, as a typical upcycle tends to last 8-10 quarters.

ON Semiconductor believes the growth is set to accelerate, and is guiding for revenue to grow 35.8% YoY next quarter, and Wall St analysts are estimating growth 9.15% 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 118, 3 days below the five year average, showing that despite the recent increase there is no indication of an excessive inventory buildup 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 41.3% in Q3, up 7.9 percentage points year on year.

ON Semiconductor Gross Margin (GAAP)

ON Semiconductor' gross margins have been trending up over the past year, averaging 36.7%. This is a welcome development, as ON Semiconductor's margins are slightly below the group average, potentially pointing to improved demand and pricing.

Profitability

ON Semiconductor reported an operating margin of 24.5% in Q3, up 12.6 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 17.8%. ON Semiconductor's margins are around the midpoint for the semiconductor industry, as its cost structure is appropriately managed.

Earnings, Cash & Competitive Moat

Analysts covering the company are expecting earnings per share to grow 47.2% over the next twelve months.

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 $355.7 million in Q3, up 249% year on year.

ON Semiconductor Free Cash Flow

ON Semiconductor has generated $1.16 billion in free cash flow over the last twelve months. This is a solid result, which translates to 18.1% of revenue. That's above average for semiconductor companies, and should put ON Semiconductor in a relatively strong position to invest in future growth.

Over the last 5 years ON Semiconductor has averaged a 15.6% return on invested capital (ROIC), implying it has a very healthy competitive position and a track record of investing in profitable growth.

Key Takeaways from ON Semiconductor's Q3 Results

Sporting a market capitalization of $23.6 billion, more than $1.38 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 impressed by how strongly ON Semiconductor outperformed analysts’ earnings expectations this quarter. And we were also glad to see the improvement in gross margin. On the other hand, there was an increase in inventory levels. Zooming out, we think this was a fantastic quarter that should have shareholders cheering. The company currently trades at $55.89 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 very weak, and analysts expect growth rates to deteriorate from there. And while its high return on invested capital suggests it can grow very profitably and has been well managed, unfortunately gross margins are weaker than its semiconductor peers we look at.

ON Semiconductor's price to earnings ratio based on the next twelve months is 19.6x. 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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