1 Small Semiconductor Stock You Need to Know About Right Now

The semiconductor industry is in the midst of a downturn in 2023, driven lower by sluggish PC, smartphone, and data center server (of the non-artificial intelligence variety) sales. This has had a deep impact on wafer fab equipment -- the big and expensive machines chip manufacturers need to make chips. 2023 revenue for the industry is expected to take a mid-teens-percentage tumble from its last high point in 2022. 

But dozens of new semiconductor fabs are currently under construction and will need to be filled with fab equipment. The next run higher for the fab equipment space is already getting underway. One small name that just indicated as much is Onto Innovation (ONTO 4.08%). Here's what you need to know.

Onto heating up again already

On the surface, Onto's second-quarter 2023 revenue didn't look so impressive. Sales were $191 million, missing management's mark of $203 million it told investors to expect three months ago. However, the miss was due to one specific customer asking for "enhancement packages" on three machines, with the delivery of those three units getting pushed into the third quarter (more on that in a moment).  

The resulting net income was $26 million in Q2 ($39 million on an adjusted basis), so Onto remains highly profitable even amid this downturn.  

But Onto is starting to heat up again, as indicated by the outlook for the third quarter -- which implies a return to sequential quarter-over-quarter growth. 

Data source: Onto Innovation. YOY = year over year.

An exceptionally well-positioned small business?

Leading up to this current downturn, Onto -- a product of a merger between two even smaller fab equipment players in 2019 -- was electric. Process diagnostic control and metrology (basically, measuring the nanoscopic features of wafers, which eventually get cut into chips and packaged into a computing system) equipment was in high demand as lots of new chips were undergoing development. That pace of new semiconductor innovation is only continuing. Early in the development of a new manufacturing process, Onto's equipment is especially important. 

This is leading to an upcoming growth cycle for fab equipment companies, Onto included. Onto CEO Michael Plisinski said on the earnings call that a specialty and advanced packaging customer's (probably Taiwan Semiconductor Manufacturing) revenue "grew by over 20% from the prior quarter." Also, as confirmation of Onto's ability to quickly adapt to new growth markets, Plisinski said that sales to power chip fabs (which address things like electric vehicles, among other things) grew over 35% from the prior quarter. This was Onto's largest market in Q2 and quarterly "revenue exceeded total power device revenue in all of 2021."

Of course, all of this is being dragged down by weakness in "advanced node" chipmakers, including memory chips and logic chips tied to those pesky PC and smartphone sales. A more robust demand environment from those areas is expected in 2024. Additionally, in the artificial intelligence department, equipment used in the assembly of new advanced data center servers is expected to contribute $90 million in new revenue over the next three quarters alone.

It all adds up to what could be the next jump to all-time revenue highs in 2024, perhaps extending into 2025 and beyond as governments around the globe funnel cash into new semiconductor fabs to onshore manufacturing. Onto had said earlier this summer it sees a path to annual revenue of $2 billion over the next five years (double the last peak in 2022), with increases in profit margin along the way.

Onto Innovation stock carries a premium price tag of 27 times trailing-12-month earnings, or 23 times Wall Street analysts' earnings expectations for 2024. Some of this is due to the recent slump in revenue and profit, though. Onto stock could get hot again in the coming years if it delivers on its goals of fast growth and even faster profitability expansion.  

I have a small position in Onto, and I will consider adding more after this quarterly update. As a small business (market cap of $5.4 billion) that competes against large fab equipment players that do many billions of dollars in annual sales, Onto's stock can be highly volatile. However, this business looks like it has all the makings of a rare small-cap winner in the semiconductor industry.