The green energy revolution is here. Virtually all automakers are coming out with new all-electric designs, and electric utilities are deploying more and more clean energy power sources every year. Meanwhile, the whole transition has been turbocharged by the subsidies in last year's Inflation Reduction Act.
Many think the ways to play these trends are the electric vehicle or utility stocks themselves. However, both those industries can be capital-intensive and price-sensitive.
Instead, the power semiconductors used inside all of these applications may be the best way to play the green revolution. After all, the more electric and autonomous the machine, the more power chips, sensors, and microcontrollers need to be deployed per vehicle or utility to make it all work. And best of all, a lot of these chip companies are profitable, trade at reasonable valuations, and have a high-growth outlook.
One of the best names in the space just reported last week. Because of its ongoing business transition, there may be an opportunity in the stock.
NASDAQ: ON
Key Data Points
On Semi beats estimates with strength in auto and industrial
On Semiconductor (ON +0.23%) is one semiconductor company delivering these crucial types of chips, and just reported solid earnings. While revenue only rose 1% last quarter and adjusted (non-GAAP) EPS actually declined 2.5%, both figures came in ahead of expectations.
However, those headline figures obscure much better underlying numbers. You see, On Semi is in the midst of a business transition, purposefully exiting low-margin businesses in commodity-like chips for things like consumer electronics, while doubling down on silicon and silicon carbide chips for auto and industrial applications.
While overall revenue grew just 1%, On's automotive and industrial chip revenue grew 22.6%, making up 79% of revenue -- clearly, much better than 1%. But On is still exposed to end markets it's consciously exiting, such as lower-margin consumer revenue. That 21% proportion of overall revenue fell over 39%.
So while On is trading at 18 times earnings or so, investors should probably view the company as a high-growth company, not a no-growth cyclical. So, that valuation makes sense.
But margins may be rocky in the near-term
On's operating metrics have vastly improved since new CEO Hassane El-Khoury was installed by activist investors back in 2020. However, the company is still proceeding through a big operational shift, even two years after he took the reins.
Just a few months ago, On bought a 300mm fab in East Fishkill, New York, from Globalfoundries, with the goal of transitioning its silicon power chips from 200mm production to 300mm production. And late last summer, On opened its new silicon carbide production facility in Hudson, New Hampshire.
El-Houry is calling 2023 a "transition year" for On's margins, which may decline for the first time in years as these two endeavors begin to ramp up.
In the first quarter, results were mixed. On the positive side, On's silicon carbide manufacturing came in ahead of plan, with SiC revenues nearly doubling quarter-over-quarter. Yet on the other hand, the new East Fishkill plant had much higher costs than management had anticipated.
El-Khoury pledged that On will be able to find efficiencies and reduce costs at the new 300mm plant, but that won't likely happen until 2024. Meanwhile, since the silicon carbide plant is doing better, the below-average margins for those products should subside by the third quarter of this year as volumes increase.
Silicon carbide progress is a huge plus
While no margin headwinds are ever pleasant, it was a positive surprise that On is doing so well in its silicon carbide ramp. Two of its silicon carbide competitors, Wolfspeed (WOLF +0.00%) and STMicroelectronics (STM +0.87%), both reported trouble ramping their silicon carbide products on 200mm wafers last week, sending each stock down sharply.
SiC is set to be a key type of semiconductor material in both electric vehicles and electric utilities, as it has properties that allow chips to operate at both high voltages and high temperatures when compared with traditional silicon. With the technology reaching a mature stage and adoption growing, the SiC market is projected to compound at a 11.7% annualized growth rate through 2030, according to Grand View Research. Therefore, if On's competitive positioning in SiC production is improving, that would be a big plus in this important growth market.
Overall, On's stock could remain under pressure due to the temporary margin headwinds and the ongoing shedding of low-margin revenue. But that could be an opportunity; with EVs and clean energy gaining steam, On's long-term picture looks bright -- as long as it keeps executing like it has.
