It’s usually difficult to find a stock at a bargain price when growth is involved but not always. ON Semiconductor (ON, Financial), a manufacturer of semiconductor components for power management and imaging, surprisingly offers growth and value.
The company posted explosive revenue growth during the first half of the year, yet it’s priced at 10 times forward earnings, and the growth is not expected to vanish during the next few years. Double-digit top-line growth is in the cards. Regarding the bottom line, analysts expect earnings to grow 27% during the next five years. Let’s analyze ON Semiconductor in detail.
ON Semiconductor reported its second-quarter earnings at the start of August, beating revenue estimates while missing on EPS consensus. Revenue grew 51.5% to reach $1.34 billion on a year-over-year basis. Analysts were short by $20 million in their estimates. The company posted a non-GAAP EPS of 29 cents, translating into 30% sequential growth. Analysts were modeling for a non-GAAP EPS of 32 cents.
For the third quarter, ON Semiconductor is guiding for midpoint revenue of $1.365 billion, which is in line with the consensus of $1.37 billion. Despite the earnings miss, some analysts took the earnings news quite positively. Needham upgraded the stock citing gross margin expansion and ON Semiconductor’s presence in the automotive market. Investor reaction was largely neutral as the stock is trading around $16 since the earnings release. Let’s explore earnings in detail.
Revenue insights
Strong demand for power, analog and sensor semiconductors led the revenue growth of ON Semiconductor during the first half. The company posted impressive 63% revenue growth during the first half. The highest growth came from the consumer segment, which grew 96%. Communication was the second-fastest segment in terms of growth; the segment registered 67% revenue growth.
Nonetheless, automotive is the highest revenue generation segment with 31% of the company’s total revenue coming from the segment during the first half. In absolute terms, industrial revenue grew the most. The segment’s revenue grew by $261.3 million during the first half.
From a business unit perspective, power solution group is the highest revenue-generating segment. The company’s analog semiconductors are the second prominent products of the company.
It is worth mentioning that a boost to power solution revenue is because of the acquisition of Fairchild Semiconductor (FCS, Financial) during the last year. Power solution group revenue increased 92% year over year during the first half.
The company has a diverse revenue base in terms of end markets.
It’s not heavily relying on one market for its revenue. The market favors the power solutions more than its analog and image sensor solutions. All in all, several revenue channels add stability to ON Semiconductor’s top line, but it should be noted that the current explosive growth isn’t sustainable as most of it is acquired rather than organic.
Industry watchers forecast health growth
Regarding further growth, it might not be as explosive, but the company is going to witness healthy growth.
The global automotive semiconductor market is set to grow at CAGR of 6.4% from 2017 to 2022, according to Lucintel. The automotive application of the imaging sensor market is expected to grow at a CAGR of 15.91%Ă‚ from 2015 to 2020. Advanced driving assistance systems and security awareness are driving the growth of the imaging sensors market. Regarding power management, TechNavio predicts the market will grow 7% p.a. until 2020.
Overall, ON Semiconductor is set to benefit from the growth of power management and image sensors. End markets like automotive will fuel this growth. Low double-digit growth is in the cards for the company amid its strong presence in the imaging semiconductor market.
Earnings insights
Expanding gross margin
Revenue growth and gross margin expansion fueled the bottom line during the first half. Gross margin increased from 34.4% in first-half 2016 to 35.9% in first-half 2017.
Integration synergies
Further, integration synergies of the Fairchild acquisition are kicking in as operating expenses grew at a slower rate than revenue growth. OPEX increased 46% year over year during the first half.
Overall, gross margin expansion and operating discipline led to earnings growth. Some analysts expect the gross margin to reach 40% by 2020.
Bargain price
ON Semiconductor’s EPS is expected to reach $1.58 by year-end 2018. This is achievable as double-digit top-line growth will follow during the next couple of years. Based on 2018 earnings, the stock is trading at a price-earnings (P/E) of 10.12. This is cheap given double-digit earnings growth going forward. GuruFocus’ Piotroski F-score indicates a healthy situation for the stock. The score for ON Semiconductor stands at 7. The Piotroski score ranges from 0 to 9 with 9 being the best. Overall, ON Semiconductor seems to be priced cheaply.
What are the risks?
The company has a high level of debt, which increases financial risk. The company issued $2.1 billion of debt during the last three years, according to GuruFocus’ database. Moreover, the company is increasing its assets faster than its revenue growth, which is indicative of declining asset efficiency. Risks/reward balance favors the bull side. The company will be able to de-lever amid high free cash flow. Asset accumulation can be explained by recent acquisition of Fairchild Semiconductor.
Final thoughts
ON Semiconductor has witnessed strong top-line growth during the first half, thanks to the acquisition of Fairchild Semiconductor. The company’s exposure to power management, imaging and automotives will drive further growth. The growth won’t be as high as it is now, though. Double-digit growth can be inferred from industry forecasts. Margin expansion and acquisition synergies also paint a favorable picture for the company.
ON Semiconductor seems to have more upside amid prospective revenue growth, margin expansion, synergy benefits and low valuation.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
