Shares of small semiconductor equipment company Onto Innovation (ONTO 4.08%) have been on a roll this year (up over 50% so far in 2023) and are near all-time highs. Perhaps this seems strange for a company that reported a 17% decline in revenue in the first quarter and anticipates another 21% decline in Q2.
The market is nevertheless rewarding Onto because sales and profitability could be about to soar again starting in 2024. A record number of chip fabs (the facilities that manufacture chips) have recently been green-lit for construction, and those facilities will need to be filled with advanced equipment like what Onto specializes in. Here's why this could be a monster stock to own for the rest of this decade.
Onto reveals its plans
Onto Innovation is a small company within the semiconductor manufacturing equipment space, which is dominated by the big five: Applied Materials, ASML Holding, Lam Research, Tokyo Electron, and KLA (KLAC 4.95%).
Onto specializes in metrology and process diagnostic and control (PDC) equipment. KLA and Applied Materials are the No. 1 and No. 2 players in this type of chipmaking machinery, which has become a hot part of the chip manufacturing world in recent years. As new chip technology has geared up for things like AI and automotive technology (like vehicle electrification), fabs need a way to verify their new chipmaking processes and manufacturing lines are yielding good results.
KLA, a pure play on metrology and PDC like Onto is, reported big surges in revenue over the last few years.
Data by YCharts.
The boom isn't over, though. Metrology and PDC are expected to remain hot commodities as dozens of new fabs get built out around the world over the next five years. In a recent investor presentation, Onto said more advanced chips, new materials in support of things like EVs, and more complex packaging of chips into computing units will raise the bar for fabs. Management sees a pathway to organically (excluding any acquisitions) doubling its 2022 revenue peak of $1 billion over the next five years.
2023 is of course going to be a down year as many of these new fabs break ground on construction. But growth should resume in grandiose fashion next year and through 2025, according to estimates from industry analyst SEMI.org.
Is the stock a buy?
Besides a potential doubling in revenue, Onto also thinks operating profit margins will be headed higher starting in 2024 too. Management already invested in the ability to crank out more machines, so as revenue rises, it's expected to hit new highs in operating profit margins since it's already done the heavy lifting to expand its own manufacturing capacity.
In fact, if Onto can steadily approach that $2 billion milestone in the coming years, adjusted operating margin could head from the low 30% range (2022) toward something approaching 40%. The result could be adjusted earnings per share (EPS) of over $8 and beyond. That compares to adjusted EPS of $5.52 in 2022, implying a possible 50% or more increase in adjusted EPS over the next few years.
And just as before, this possible outcome projected by Onto management excludes any potential acquisitions. The company was built via merger between two industry peers in 2019, and the management team thinks there are opportunities out there to make more "tuck-in" acquisitions of smaller peers to enhance its portfolio of metrology and PDC equipment. Onto is certainly well positioned to do so, with one of the cleanest balance sheets in this corner of the semiconductor industry. It had over $583 million in cash and short-term investments and zero debt at the end of March 2023.
Investors have certainly caught on to Onto in recent months, and the valuation has begun to creep into premium price tag territory as a result. Shares trade for 26 times trailing-12-month earnings, and 23 times next year's expected earnings. I have a small position and am happy where I'm at, but I think now may not be the absolute best time to make a purchase. I like the value stock and Onto competitor KLA a bit more at the moment and have begun buying it (KLA trades for less than 19 times next year's expected earnings).
Nevertheless, the next three to five years could present big opportunities for Onto Innovation, and if the company executes on its plans, big gains could be in store. Keep this semiconductor manufacturing equipment stock on your radar.
