ON Semiconductor (NASDAQ:ON) Reports Q1 In Line With Expectations But Quarterly Guidance Underwhelms

Analog chips maker ON Semiconductor (NASDAQ:ON) reported results in line with analysts' expectations in Q1 CY2024, with revenue down 4.9% year on year to $1.86 billion. On the other hand, next quarter's revenue guidance of $1.73 billion was less impressive, coming in 5.2% below analysts' estimates. It made a non-GAAP profit of $1.08 per share, down from its profit of $1.19 per share in the 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 specializing 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. 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 15.4% annually. But as you can see below, its revenue declined from $1.96 billion in the same quarter last year to $1.86 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 slow quarter for the company as its revenue dropped 4.9% year on year, in line with analysts' estimates. This could mean that the current downcycle is deepening.

ON Semiconductor's revenue growth has decelerated over the last three quarters and its management team projects revenue to fall next quarter. As such, the company is guiding for a 17.4% year-on-year revenue decline while analysts are expecting a 6.7% drop over the next 12 months.

Product Demand & Outstanding Inventory

Days Inventory Outstanding (DIO) is an important metric for chipmakers, as it reflects a business' capital intensity 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 DIO came in at 194, which is 54 days above its five-year average, suggesting that the company's inventory has grown to higher levels than we've seen in the past.

Pricing Power

In the semiconductor industry, a company's gross profit margin is a critical metric to track because it sheds light on its pricing power, complexity of products, and ability to procure raw materials, equipment, and labor. ON Semiconductor's gross profit margin, which shows how much money the company gets to keep after paying key materials, input, and manufacturing costs, came in at 45.8% in Q1, down 1 percentage points year on year.

ON Semiconductor's gross margins have been trending down over the last 12 months, averaging 46.8%. This weakness isn't great as ON Semiconductor's margins are already slightly below the industry average and falling margins point to potentially deteriorating pricing power.

Profitability

ON Semiconductor reported an operating margin of 29% in Q1, down 3.2 percentage points year on year. Operating margins are one of the best measures of profitability because they tell us how much money a company takes home after manufacturing its products, marketing and selling them, and, importantly, keeping them relevant through research and development.

ON Semiconductor's operating margins have been trending down over the last year, averaging 31.6%. However, the company's profitability is still above average for semiconductor companies, driven by an efficient cost structure.

Earnings, Cash & Competitive Moat

Wall Street expects earnings per share to decline 13% over the next 12 months, although estimates will likely change after earnings.

Although earnings are important, we believe cash is king because you can't use accounting profits to pay the bills. ON Semiconductor's free cash flow came in at $276.3 million in Q1, up 216% year on year.

ON Semiconductor has generated $590.8 million in free cash flow over the last 12 months, or 7.2% of revenue. This FCF margin enables it to reinvest in its business without depending on the capital markets.

Return on Invested Capital (ROIC)

EPS and free cash flow tell us whether a company was profitable while growing revenue. But was it capital-efficient? A company’s ROIC explains this by showing how much operating profit a company makes compared to how much money the business raised (debt and equity).

ON Semiconductor's five-year average ROIC was 18.6%, somewhat low compared to the best semiconductor companies that consistently pump out 35%+. Its returns suggest it historically did a subpar job investing in profitable business initiatives.

The trend in its ROIC, however, is often what surprises the market and drives the stock price. Over the last few years, ON Semiconductor's ROIC has significantly increased. This is a good sign, and we hope the company can continue improving.

Key Takeaways from ON Semiconductor's Q1 Results

It was good to see ON Semiconductor beat analysts' revenue EPS expectations this quarter. On the other hand, its revenue and EPS guidance for next quarter missed analysts' expectations and its inventory levels increased. Overall, this was a mixed quarter for ON Semiconductor. The stock is up 2.9% after reporting and currently trades at $70 per share.

Is Now The Time?

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

We cheer for everyone who's making the lives of others easier through technology, but in the case of ON Semiconductor, we'll be cheering from the sidelines. Although its revenue growth has been solid over the last three years and its growth over the next 12 months is expected to be higher, its low free cash flow margins give it little breathing room. And while its sturdy operating margins show it has disciplined expense controls, the downside is its gross margins are weaker than its semiconductor peers we look at.

ON Semiconductor's price-to-earnings ratio based on the next 12 months is 15.7x. While we've no doubt one can find things to like about ON Semiconductor, we think there are better opportunities elsewhere in the market. We don't see many reasons to get involved at the moment.

Wall Street analysts covering the company had a one-year price target of $86.04 per share right before these results (compared to the current share price of $70).

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