ON Semiconductor (NASDAQ:ON) handily beat third-quarter 2018 expectations when it released earnings on Oct. 28 and issued a rosy outlook that sent shares higher. The rebound provided much-needed relief for chip shareholders since the sector has been gouged the last few months by overly pessimistic Wall Street analysts. While the semiconductor business is admittedly a cyclical one, secular tailwinds make stocks like ON long-term buys.

2018, so far...

ON Semiconductor had a great 2017. A big acquisition of a rival chip maker, 4Fairchild Semiconductor, led to big gains in sales -- to the tune of 42% -- which ON used to create a 340% boost in annual earnings. Strategic moves into new products, especially in the auto industry, also helped. With the immediate effects of those tailwinds now in the past, year-over-year 2018 results have been a bit more modest thus far:

Metric

Nine Months Ended September 28, 2018

Nine Months Ended September 29, 2017

YOY % Change

Revenue

$4.38 billion

$4.17 billion

5%

Gross profit

$1.67 billion

$1.52 billion

10%

Operating profit

$625 million

$514 million

22%

Earnings per share

$1.05

$0.66

59%

Data source: ON Semiconductor. YOY = year over year. 

In light of these more modest results, investor worry over an impending slowdown -- stoked by analyst calls for a pullback in the semiconductor industry -- has mounted: ON's stock has fallen 40% from its highs reached over the summer months.

However, during the third quarter, revenue came in at a 6% year-over-year clip, and earnings expanded by 9%. The fourth quarter outlook was even better as management sees growth re-accelerating. Sales are expected to increase at least 7% versus the same period in 2017, and gross margins should be the same or slightly better than a year ago. That should equate to another big bump in earnings and helps debunk any near-term fretting that business is sputtering to a halt.

An artist's illustration of devices getting chips embedded in them.

Image source: Getty Images.

Chips are a long-term buy

ON management did note a few areas of weakness that cropped up in the third quarter, notably China revenue due to trade disputes with the U.S., but chip manufacturers like ON are finding plenty of uses for their products these days to compensate. CEO Keith Jackson said this about his company's success:

Our business today is driven by sustainable secular growth drivers in the fastest growing semiconductor end-markets, as opposed to being driven by macroeconomic conditions and semiconductor industry cyclicality a few years ago. 

Historically, sales for many semiconductor manufacturers ebbed and flowed with supply and demand and could suffer steep increases followed by declines in just a short period of time. Today, though, chips are finding plenty of new uses in areas like industrial equipment, automobiles, data centers, and the new 5G mobile network buildout. That means lots of new sales in specialized markets, helping smooth out those peaks and valleys. ON says its outlook remains solid.

Even though ON continues to sign long-term sales agreements with customers, too much inventory could derail progress for the chip maker. Sales have slowed this year, but ON says its inventory is currently at the lower end of its targets, and an excess of supply in the overall market isn't a risk at the moment. That also bodes well for the chip maker's progress in the months ahead.

With business still growing at a healthy pace and ON's stock trading at a one-year forward price-to-earnings ratio of just 8.3, a rebound should be in order for this chip maker. Semiconductor bears don't have much left to stand on at this point.

Nicholas Rossolillo and his clients own shares of ON Semiconductor. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.