Context matters when considering buying stock in a company that's going through some cyclical weakness that could easily be confused for a structural issue.
That's the case with ON Semiconductor (ON 1.57%) stock right now. Shares of the specialty chipmaker have been under pressure of late -- down by nearly a third in the past year.
Yet upon closer inspection, it becomes clear that the current challenges are likely temporary, and if investors are willing to be long-term minded, then the stock is one of the most compelling investments to consider today.
ON Semiconductor's growth strategy
During the company's investor day presentation in May 2023, management outlined an aggressive growth strategy targeting higher-growth end markets in the automotive and industrial sectors, as well as artificial intelligence (AI) and data centers, with its intelligent power and sensing solutions.
Much of the growth would be driven by Silicon Carbide (SiC) chips in growth areas like electric vehicles (EVs), advanced driver assistance systems (or ADAS, an automotive end market), and EV charging, industrial automation, and renewable energy infrastructure (industrial end markets). SiC chips confer power-to-size advantages over silicon chips, making them ideal for EVs and fast charging networks, for example.
It's a strategy that captured the zeitgeist, and the presentation helped drive the stock to an all-time high in the weeks that followed. But here's the thing. Or rather, here's the chart. As shown below, the company's sales have been under sustained pressure since the second half of 2023.
Data source: ON Semiconductor presentations. Chart by author.
Why ON Semiconductor has faced challenges
As ever, when such things happen, investors start asking whether the problem is a structural one (implying management and investors will need to pencil in a lower long-term growth rate into their assumptions) or a temporary one that will resolve over time.
There's a compelling case for the issue being driven by temporary factors. It comes down to a combination of the lingering impact of the lockdowns on the economy and a relatively high interest rate environment.
The pandemic-era lockdowns ended en masse in early 2022 and then later in China at the end of the year. At that point, the global economy was playing catch-up while it continued to try to patch up decimated supply chains. The result was inflation and a supply chain crisis, with companies rushing to build up inventory to meet demand as they struggled to ensure a steady supply.
Unfortunately, the inventory build overshot and then coincided with a period of relatively high interest rates that curtailed demand in the industrial sector. Don't take my word for it -- here's how the Institute for Supply Management (whose purchasing managers' index is the most widely respected gauge of U.S. manufacturing) sees it: "Economic activity in the manufacturing sector contracted in September for the seventh consecutive month, following a two-month expansion preceded by 26 straight months of contraction."
Image source: Getty Images.
It's even worse in the automotive sector
A combination of the above factors, along with some exceptional circumstances in the automotive sector, made it doubly challenging for ON Semiconductor in its key end market. It's no secret that many automakers accelerated their EV investment plans during the lockdown periods in response to the difficulty in selling cars at that time.
Unfortunately, that rate of growth has slowed, and EV makers have pared back investment plans in response to slowing sales growth and intensive competition.
Why the slowdown should prove temporary
History suggests that the interest rate cycle will eventually turn and that companies will adjust to the tariff landscape. In addition, while the rate of EV sales growth has slowed, it remains notably greater than that of traditional internal combustion engine vehicle sales.
As Ford Motor Company's recent $5 billion commitment to investing in EVs demonstrates, there is no other viable option available to automakers, and they will have to ramp up spending to stay relevant.
Image source: Getty Images.
A stock to buy?
Despite the near-term challenges, ON Semiconductor remains a highly profitable and cash-generative company. Wall Street analysts expect $1.4 billion in free cash flow (FCF) and $2.29 in earnings per share for 2025, which would put the stock at a multiple of 14 times FCF and 21 times earnings in 2025.
Those estimates may prove optimistic as the near-term environment remains challenging, and this stock is not for investors who can't tolerate near-term risk. Still, there's enough of a margin of safety to make the stock attractive from here, and even more so on any near-term weakness if the company's third-quarter earnings disappoint.
