ON Semiconductor (ON 1.30%) puts the "O" in MANGO -- the high-conviction semiconductor stock acronym Bank of America analysts recently coined. For reference, the "M" is Marvell Technology Group; the "A" is Advanced Micro Devices, Broadcom (based on the stock ticker), and Analog Devices; the "N" is Nvidia; and the "G" is Global Foundries.
It's been a few years since I last caught up with ON Semiconductor, but it's time to revisit and weigh the company on its own merits. It has new leadership and is undergoing efforts to refocus on its most profitable chip design and fabrication segments -- automotive and industrial automation technology. Is this auto supplier stock a buy?
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New (and familiar) company leadership focused on profitable growth
ON Semiconductor (more commonly referred to as onsemi) is a top electronics supplier to automakers and industrial companies. CEO Hassane El-Khoury said that automotive and industrial electronics were 63% of revenue in the fourth quarter of 2021, delivering sales of $641 million and $522 million, respectively, during the period.
El-Khoury might be a familiar name to some. He was brought in as CEO in December 2020 after a few years of service as CEO of Cypress Semiconductor. El-Khoury oversaw the sale of Cypress to Germany's leading chipmaker Infineon Technologies in early 2020. Onsemi's new CFO, Thad Trent, was also the CFO of Cypress for the six years leading up to the sale to Infineon.
Since taking over, onsemi's new C-suite appears to be utilizing a similar playbook as before: Incremental growth, but not at the expense of profitability. It's a great time to be embarking on such a scheme, given the global shortage of chips. All sorts of businesses, especially automakers and industrial companies looking to automate their factories, can't get enough semiconductor content right now. That means favorable pricing and rising profitability on products sold for a company like onsemi.
It recently sold two of its fabrication (fab) facilities that cranked out low-profit margin products, and the proceeds will be used to refocus efforts on more lucrative chips and fabs. El-Khoury said that onsemi "walked away from $170 million of non-core business with an average gross margin of 20%" in 2021. For context, the business' overall gross margin on product sold was 40% in full-year 2021, compared to just under 33% in 2020. Due to onsemi's efforts to keep a tight lid on operating expenses, free cash flow surged 167% higher year over year to $1.38 billion, good for a healthy free-cash-flow margin of 20%.
Riding the wave of vehicle electrification and automation
As previously mentioned, this chipmaker focuses on auto and industrial equipment. Its portfolio of hardware helps automakers build electric vehicle (EV) models with various power management parts. Additionally, onsemi designs vision sensors and image processors used in advanced driver-assist systems (ADAS). Some of these same parts have applications in factories, where companies are looking for ways to implement robotics and energy management systems to reduce long-term operating costs.
Electronic parts like these are in high demand and could remain so for many years. El-Khoury said on the last earnings call that it looks like the global chip shortage could last well into 2023. This isn't just a problem of too little supply. Every sector of the economy is hungry for technology that enables automation. That's good news for onsemi, which historically has been exposed to commoditized semiconductors with subpar profit margins.
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In a nutshell, secular growth trends for EVs, vehicle autonomy, and general business automation empower onsemi to leave behind its historical norms. A business with steady growth and healthy profitability is emerging. But is this "MANGO" stock a buy?
Management expects sales to increase at least 25% year over year in the first quarter of 2022 and for earnings per share to increase at least 350% compared to Q1 2021. As is often the case for a manufacturing outfit, onsemi's balance sheet has more debt than cash ($1.35 billion in cash and equivalents, $2.91 billion in debt), but the company has more than enough liquidity to fund its strategic initiatives.
As of this writing, onsemi trades for 25 times trailing 12-month earnings per share and 19 times trailing 12-month free cash flow. It isn't exactly cheap for a company that has historically been prone to severe swings in revenue and profits. But perhaps onsemi will successfully transform itself into a much more stable enterprise over the next decade via exposure to the EV megatrend.
I won't make a call on it beating the semiconductor industry overall, but I do believe onsemi stock can outperform most of the other EV start-ups over the next few years. At the very least, I think this semiconductor stock is worth a close look for investors wanting exposure to automotive technology.
