The tech and news world is pumping game-changing generative AI technology, fueled by powerful new chips that greatly accelerate computing times.
Meanwhile, over in the automotive industry, vehicle electrification has industrialists turning to "old" technology, but with a twist. Many more semiconductor devices that have been around for decades are needed to manage electricity in EVs and the power grid, but some of these devices are being made with a novel material: silicon carbide (SiC). Investors have been trying to whittle down the field of chip companies that can deliver the best returns from this electric future. I've homed in on Onsemi (ON -3.53%), an American semiconductor giant with a large market footprint in exciting growth sectors like automotive computing.
Building a resilient supply chain for EVs and beyond
I've been an Onsemi shareholder before, from early 2017 until the summer of 2020. The company was known as ON Semiconductor back then. After the pandemic started, I logged some profit on the stock as I was cleaning up my portfolio for what I thought would be a rough go for chip stocks going forward.
Suffice to say selling was a mistake, given all that ensued. Onsemi stock is up nearly 300% in the three years since the summer of 2020.
Booming EV sales are only part of the story. Onsemi has been working on differentiating itself from its peers, and those efforts are beginning to become apparent under new management: CEO Hassane El-Khoury and CFO Thad Trent. El-Khoury and Trent were previously heading Cypress Semiconductor (I was a happy shareholder of Cypress, too), which was acquired by Infineon (OTC: IFNNY) in early 2020.
I mention this because El-Khoury and Trent had a goal to make Cypress a more efficient semiconductor business, and something similar is now going on at Onsemi. This is particularly the case with SiC chips, used increasingly in EVs, as well as EV charging stations, energy grid battery packs, solar inverters, and other power delivery systems.
However, one limiting factor for SiC at the moment is that these devices are expensive. This is largely a result of the manufacturing of SiC being in the early aughts. Trent told me in a recent conversation that this is why Onsemi acquired a company called GT Advanced Technologies (GTAT) in late 2021. With GTAT's capabilities, Onsemi has been building its own equipment to grow SiC boules (like a big log of salami), which then get cut up into SiC wafers (slices of salami), which in turn get diced into SiC chips that help power EVs and the like. The majority of the company's SiC boules and wafers will be produced internally by the end of the year, making for a more efficient (profitable) chipmaking enterprise.
Basically, Onsemi is building its own end-to-end supply chain for SiC devices by migrating over existing manufacturing lines to support these new devices (unlike Wolfspeed (WOLF -6.49%), which is building new fabs from scratch), to great customer reception. Trent said SiC sales should be about $1 billion in 2023, up from about $200 million in 2022. (Peer STMicroelectronics (STM -2.55%) is expecting $1.2 billion in SiC sales this year, but STM is also twice as big as Onsemi. STM also said it will be internally sourcing only about 40% of its SiC by the start of 2024.) Onsemi's financial results have been stellar.
Data by YCharts.
Bridging an ugly 2023 with more EV sales
But what about a weakening global economy in 2023? After all, new auto sales tend to take a big hit in tough times. With nearly 80% of Onsemi's sales coming from automotive and industrial markets, 2023 could be a rough year.
When I asked about this, Trent said to consider this tidbit: Onsemi sells an average of about $50 worth of chips in an internal combustion engine vehicle. In an electric vehicle, Onsemi's content balloons to about $1,700 on average. In other words, the overall auto market could get clobbered this year, but as long as EV sales keep rising as a percentage of the total, this chipmaker can remain in growth mode.
The main concern now is ramping up production to meet long-term customer demand (Onsemi strikes long-term sales agreements with its partners, a divergence from pre-pandemic business practice that often left chipmakers holding the bag during downturns). This could lead to temporary chip oversupply, a situation that has hit the smartphone and PC market as of late. Trent said they are monitoring the situation, but even should oversupply hit this year or next, the overall trend is still seeing sharp increases in demand from EV automakers, power grid electrification, and other power-hungry applications like manufacturing equipment and 5G mobile base stations.
A new, shareholder friendly, Onsemi
Onsemi also initiated a $3 billion share repurchase plan at its final 2022 financial update. The new shareholder return policy is good through 2025. Trent said Onsemi is targeting about 50% of free cash flow generated to be returned to stockholders each year. Though the company is expecting some elevated expenditures in 2023 on equipment as it continues to ramp up its SiC production, it will still generate positive free cash flow -- which means share buybacks will continue this year, but likely below that $1 billion-a-year average.
However, in subsequent years (2024 and forward) when Onsemi's purchases of equipment decrease, free cash flow should rise. That will equate to a higher rate of share repurchases, making up for the lower cadence of cash return in 2023.
All said, if Onsemi uses up all $3 billion in authorized buybacks through 2025, that would equate to nearly 10% of the current market cap. If you're looking for a dividend yield equivalent, that's roughly 3% a year in cash returns to shareholders over the next three-year stretch. Not bad, Onsemi.
The stock has run up quite a bit since 2020, but I think there's plenty of runway left for this bet on an electric future. I recently started buying and plan to buy more in batches over the next year.
