Nvidia is a great company and a great stock, but it currently trades on slightly more than 50 times Wall Street's 2024 earnings estimates. That's fine for many investors willing to pay a premium for a high-quality growth stock, but for investors who are willing to take some near-term risk on board, ON Semiconductor (ON 1.35%) might be a better option. Here's why.
Cyclicality matters for semiconductor stocks
Semiconductors are highly cyclical; they always have been and always will be. That's because the first thing their customers do when they see demand picking up is order chips to prepare for a production ramp. Conversely, when they see a slowdown coming the first thing they do is stop or cancel chip orders as they prepare to slow production.
As such, semiconductors are always early bellwethers of their end markets. However, not all end markets are made equal, and this year, the hot area of spending has been around artificial intelligence (AI) and the high-performance computing (HPC) chips necessary to power it. That's why Nvidia has done so well and why Taiwan Semiconductor Manufacturing continues to outperform, led by a strong recovery in its HPC sales.
NASDAQ: ON
Key Data Points
ON Semiconductor's positioning
However, ON Semiconductor's key end markets, industrial and automotive, remain challenging, which is why the company's stock price is down 21% over the last year. I'll come back to that point in a moment, but first, a few words on the company itself for those unfamiliar with it.
The investment case is based on management repositioning the company for growth in exciting long-term growth markets, and that's best seen in its silicon carbide operations. Management has invested heavily in positioning itself in the silicon carbide business, not least by recently announcing a multiyear $2 billion investment in a silicon carbide (SiC) manufacturing facility in central Europe. Silicon carbide chips offer several benefits over traditional silicon chips, and notably at the higher voltages needed for electric vehicles (EVs).
In addition, the chip company has positioned itself in other exciting growth markets in new technologies where it has relatively high content, including factory automation, EV charging, renewable energy infrastructure, 5G, and advanced driver assistance systems (ADAS).
Image source: Getty Images.
ON Semiconductor's challenges
Unfortunately, while these end markets have great long-term growth potential, they are slowing in 2024. The impact of the slowdown is best seen in the company's declining sales and in the slowdown in its silicon carbide business. EV sales growth has tailed off as persistently high interest rates have made car loans more expensive. As such, automakers have pared back investment in EVs, and the company's sales have been negatively impacted.
For example, back in October, management said that a reduction in demand from one original equipment manufacturer (OEM) automotive customer would result in the company only hitting $800 million in 2023 rather than the target of $1 billion. Fast forward to February, and CEO Hassane El-Khoury told investors, "OEM's latest EV plans indicate a more tapered growth signaling a SiC market growth in the range of 20% to 30%" compared to market reports calling for "30% or 40% growth for silicon carbide in 2024."
In a sign of a declining market, El-Khoury updated investors in April and said he still expected the silicon carbide total addressable market to increase in 2024, "although at a lower rate than previously anticipated."
While he noted that there were signs of demand stabilization, he was quite clear that "I'm not going to call the bottom. I was very clear last time. I'll call it when I'm sitting on the top on the other side."
As such, anyone thinking of buying in needs to appreciate that there's potential for some negative near-term news flow.
Two reasons to buy ON Semiconductor
If you can tolerate the near-term risk, the stock is highly attractive. After all, no one disputes that EVs are the future of the industry. All it will take is a lower interest-rate environment for EV sales to pick up, and so will EV investment. In addition, the other targeted end markets referenced all have excellent long-term growth prospects.
Meanwhile, ON Semiconductor's valuation multiples are undemanding. Trading on 18.3 times estimated earnings, the company looks like an excellent value. While there's no guarantee it will make those numbers, and as El-Khoury notes, it's hard to forecast the bottom in the market, it's a pretty safe bet that ON Semiconductor's end markets and sales will recover in line with traditional cyclicality.
Given that all the company has to do is meet Wall Street estimates to look like an outstanding value, I would argue the risk/reward calculation favors buying the stock for enterprising investors.
