Is It Time to Invest in ON Semiconductor?

The semiconductor sector has seen a surge in interest, especially with the rising demand for artificial intelligence (AI) chips. However, one chip maker, ON Semiconductor, seems to be flying under the radar despite its potential. This $31 billion company, based in Scottsdale, Arizona, has not enjoyed the same stock performance as many of its peers, with shares plummeting 31% to $72 since hitting a record high on July 28, 2023. During the same period, the S&P 500 index has increased by 29%, highlighting the unique challenges ON Semiconductor faces.

Current Challenges Facing ON Semiconductor

ON Semiconductor predominantly serves the automotive sector, which accounts for over half of its total revenue. Recent data indicates that sales of auto chips fell to $907 million in the second quarter of this year, down 21% from the previous peak of $1.16 billion the previous year. The automotive market experienced its hurdles; after COVID-19 lockdowns, manufacturers rushed to purchase chips, fearing shortages. Now, however, they have surplus inventories, particularly as car production slows. Companies like Ford Motor and General Motors are reducing chip orders due to this excess supply, adversely affecting ON Semiconductor’s financials.

This reduction in chip demand coupled with a sluggish industrial chip market resulted in a contraction of ON’s gross profit margins, which fell to 45% from 47.3% in the third quarter of 2023. Consequently, ON’s earnings have dropped by 31%, prompting concerns regarding future profitability.

Signs of Recovery on the Horizon

Nevertheless, there are indications that the worst may be behind ON Semiconductor. A favorable economic backdrop, driven by anticipated Federal Reserve interest-rate cuts, could stimulate growth in the automotive industry. Additionally, the potential election of Donald Trump could bolster the economy and automotive sales, even though it could slow the progress of electric vehicle (EV) initiatives—an important segment for ON.

According to analysts, demand for automotive semiconductors is set to rebalance. Harsh Kumar, an analyst at Piper Sandler, predicts that car manufacturers remain committed to EV production, suggesting that they will eventually resume ordering more chips as sales pick up. The signs of improvement are already emerging; ON Semiconductor’s auto sales increased by 4.9% to $951 million in the third quarter, with profit margins ticking up to 45.5%.

Market Dynamics and Future Projections

Analysts are optimistic that an uptick in automotive sales, accompanied by growth in industrial sectors—which is expected to grow by approximately 6% annually—could help ON Semiconductor recover its footing. The company’s overall revenue is anticipated to rise by 10%, reaching around $9 billion by 2027. This forecast is optimistic considering the limited competition in silicon-carbide chips for the automotive sector, where ON Semiconductor’s main rival, STMicroelectronics, reports just over $1 billion in annual sales.

Significant cost improvements are also on the horizon after ON Semiconductor’s acquisition of GlobalFoundries’ East Fishkill plant, which is equipped to produce chips more efficiently without significantly increasing expenses. Such advancements are expected to enhance profitability, with management targeting gross margins of 53% in the near future. Analysts also highlight the company’s robust cash flow position, with over $1 billion in free cash flow, and plans to funnel half of each quarter’s cash flow into share repurchases, further supporting shareholder value.

Valuation and Investment Potential

Looking at ON Semiconductor’s stock valuation, it currently trades at 17 times its 12-month forward earnings—substantially lower than the S&P 500’s 22 and the average chip stock’s 23.8 multiple. This presents a compelling case for investors, as even maintaining this valuation level could drive the stock price to approximately $112 by the end of 2026, reflecting a 25% annualized gain from current levels.

With the potential for accelerating sales and improving profitability, ON Semiconductor stands out as an attractive investment opportunity for long-term investors who are willing to take a calculated risk. B. Riley Securities analyst Craig Ellis notes that there is an element of “chip ordering that’s like flipping a light switch.” If auto sales recover and other sectors rebound, ON Semiconductor could experience substantial growth, making it a stock worth considering.

Conclusion

In evaluating the dynamics of the semiconductor sector, ON Semiconductor may not yet be a household name in AI investments, but the company’s fundamentals point toward a rekindled growth phase. As automotive and industrial markets stabilize, and with positive macroeconomic conditions on the horizon, investors could benefit from capitalizing on ON Semiconductor’s undervalued stock. Given the company’s strategic positioning and low valuation compared to its peers, now might be the right time for investors to reassess ON Semiconductor as part of their diversified investment portfolio.