ON Semiconductor Rebound Delayed Over Trade War Concerns

Latest earnings report indicates that Sino-American scuffles took a bigger bite out of business this go-round.

Nicholas Rossolillo
Nicholas Rossolillo
Aug 6, 2019 at 10:19AM
Technology and Telecom

The semiconductor industry has been anticipating a rebound in business, but ON Semiconductor's (NASDAQ:ON) second-quarter 2019 report may have tossed a bit of tepid water on those hopes.

Paired with a further escalation in the trade dispute between the U.S. and China, the results reported this week left investors less than pleased. It looks like, for now, a rebound may be getting pushed into next year instead.

Less "optimistic, more "challenging"

After a less-than-stellar end to 2018, shares of ON Semiconductor were rebounding nicely at the halfway point of 2019 with a more-than-30% advance. With August underway, though, the stock is down some 20% from its recent highs, as a result of the potent combination of trade tension and an underwhelming business outlook.

In its earnings report, the company said revenue in the second quarter fell 7%, and adjusted earnings were down 9% as demand cooled off and ON's end customers backed off new orders to try and work through existing inventory. It was a different story from past quarters -- the chipmaker brushed aside trade worries and still put up solid sales and earnings results.

Metric

Six Months Ended June 28, 2019

Six Months Ended June 29, 2018

Change

Revenue

$2.73 billion

$2.83 billion

(7%)

Gross profit margin

37%

37.8%

(0.8 pp)

Operating profit

$338 million

$383 million

(12%)

Adjusted earnings per share

$0.85

$0.86

(1%)

Pp = percentage point. Data source: ON Semiconductor.

When breaking down sales, we find the automotive segment fell 5% in Q2. Automotive, which provides power management, connectivity, LED lighting, and sensor solutions to the increasingly tech-forward vehicle industry, is ON's most important segment at 32% of total revenue. China accounted for most of the drop, but sluggish global auto sales did their fair share to drag down ON's results as well. China was also blamed for weakness in the industrial segment, which makes up 27% of total sales, fell 12% year over year.

The small computing and consumer electronics end markets also logged steep losses in the quarter, each falling 7% and 21%, respectively. However, both divisions are undergoing change. Computing customers are refreshing their product cycle and should pick up steam again, and ON has decided in recent years to take a more selective approach to selling within the consumer electronics end market.

The lone bright spot was communications, which managed to grow 7% year over year on the back of a new 5G mobile network buildout. While 5G has been a hyped technology providing a boost for many companies, it's impressive that the segment managed a gain in the quarter after ON had to suspend shipments to Chinese telecom equipment maker Huawei -- as did many other American semiconductor manufacturers during the spring and early summer. Despite the hiccup, 5G should be a promising business outlet for ON in the years ahead.

Graphic of a digital network superimposed on two globes

Image source: Getty Images.

Trying to look beyond 2019

It's beginning to look like the chip sector's much-anticipated rally is being delayed. ON said that business remains challenging, although the slide shows signs of easing up by the fourth quarter of this year. Still, 2019 is unlikely to amount to an up year. Third-quarter 2019 revenue is expected to be $1.355 billion to $1.405 billion, good for a 10.5% decline at the midpoint of guidance.

Nevertheless, ON has been taking advantage of the soft results out there to make some moves for the future good of the business. The company closed its acquisition of WiFi chip maker Quantenna during the quarter -- a move that puts it in the spotlight in the industrial connectivity market, now that rival Cypress Semiconductor is soon to be merged into German technologist Infineon. Quantenna should start contributing to overall results in the third quarter.

ON also said it will be acquiring a new manufacturing operation from Global Foundries in a staged takeover, which management said will help ON increase its capacity, and save about $1 billion in total capital expenses through 2022. Expect to see more details on both that and Quantenna later on, when the two separate operations are integrated into the overall company's results.

In short, it looks like the escalating trade war is starting to put a serious cap on the back half of 2019, and ON will be suffering some short-term collateral damage as a result. As far as cyclical downturns for the chip industry are concerned, though, this one appears to be mild at the moment. ON is still positioned to benefit over the long term from tech advances in the automotive, industrial, and mobile communications industries.