Onsemi (ON 2.53%) continues its epic run. Despite what's almost sure to be a flattish year of revenue growth for the integrated chip designer and manufacturer (due to chip manufacturing capacity constraints), shares keep climbing higher on optimism for the electric vehicle (EV) market.
The latest bit of good news for Onsemi isn't about the business at all, but that its stock will soon be included in the vaunted Nasdaq 100 Index. Yeah, it's been that kind of run for the chipmaker the last few years. Revenue, and more importantly profitability, have skyrocketed.
Data by YCharts.
Is it too late to buy this top EV chip stock?
How far will "fully charged" take this stock?
Onsemi stock is up nearly 40% since the start of 2022, having almost completely bucked the bear market that plagued most semiconductor stocks. The reason? Onsemi's key position as a supplier of power and sensing chips for EVs, renewable energy projects, and industrial robotics. While the chip shortage is long gone in other corners of the chip world, that's not so for many automakers -- at least not yet.
That's what may be so confounding about this stock's recent surge. Many Wall Street analysts, and myself included, believe that auto chips could flip from shortage to a bit of oversupply in the next year. A similar situation has been devastating for the smartphone and PC market since the second half of 2022.
But this isn't the smartphone market. The upshot for Onsemi is that it's picking up massive content gains from the transition from internal combustion engines (ICE) to EVs. CFO Thad Trent recently told me that Onsemi's average bill-of-sale to an ICE vehicle is about $50, compared to about $1,700 for an EV! Chip oversupply or not, Onsemi can continue to gradually grow for years to come, and it might even be able to bridge any auto industry weakness in the next year given this dynamic.
Additionally, Onsemi is helping propel a monumental shift in the semiconductor industry. In the past, chipmakers were often left holding the bag when the economy weakened and customers cut orders for silicon. But in the wake of the chip shortage, many of these customers are now more than willing to commit to long-term supply contracts. Some are even bringing cash to the table to fund chip manufacturing expansion.
Such is the case with Onsemi's recently announced silicon carbide (SiC) chip deal with German auto parts supplier Vitesco. As part of a 10-year, $1.9 billion SiC supply agreement, Vitesco is kicking in $250 million to fund Onsemi manufacturing expansion. Talk about a win-win for the chipmaker.
A high stock premium by one measure, a more reasonable one by another
As of this writing, Onsemi stock now trades for a premium 30 times trailing 12-month free cash flow. Assuming the share price remains unchanged, the premium could head higher the rest of 2023 because Onsemi is shelling out funds to purchase equipment and expand its manufacturing lines, including for SiC chips. Indeed, based on Wall Street analyst expectations, Onsemi's free cash flow margins will fall from the nearly 20% generated in 2022 to closer to 10% this year, before making a comeback in 2024 (25% to 30% free cash flow margins are Onsemi's long-term target).
Image source: Onsemi.
In the interim, though, Onsemi could remain attractively priced based on earnings per share (EPS), since EPS doesn't account for cash outflows for equipment but rather depreciates those costs over time. Shares trade for just 19 times full-year 2023 EPS estimates.
For a chip manufacturer, this valuation is still a bit elevated, but perhaps not by much considering the massive secular growth trends that could propel Onsemi higher in the coming five to 10 years. This is why I like dollar-cost average plans when building a position in a new investment. During periods when a stock surges (and I still like the company's long-term prospects), my fixed incremental investment will yield a purchase of fewer shares. When there are inevitable pullbacks in price, my fixed purchase plan will yield more shares. No market timing required.
Given the information available today, I don't think the ship has sailed for Onsemi stock. Some of this year's rally may have reduced upside for this top play on the EV market for the immediate term, but this top semiconductor stock still has a lot going for it for the rest of the 2020s.
