Morningstar | 5G and Secular Trends Offset Near-Term Industrial Blues; Maintaining $28 FVE; Shares Undervalued
ON Semiconductor announced first-quarter results that were largely in line with our expectations, as revenue and margins both performed within the firm’s previous guidance. Management noted the headwinds experienced broadly within the semiconductor industry but struck an upbeat outlook, reiterating a viewpoint by other companies that conditions are expected to improve in the second half of the year. That said, they were also quick to note that the improving environment did not necessarily point to revenue growth for the full year. As a result, we are maintaining our fair value estimate of $28 per share. Shares for the narrow-moat semiconductor company remain in 4-star territory after trading down slightly after earnings.Total revenue in the first quarter was $1.39 billion, roughly flat year over year and down 8% sequentially. Sales by end market were mostly in line with our forecast, with industrial weakness having the largest negative effect after sales were down 5% year over year. China-related weakness, as previously noted by distributors and component companies, was the primary cause of the weakness and management expects this negative environment to carry over into the upcoming quarter. Automotive was up year over year by 5% but also showed signs of softness due to China and some diminished demand in developed markets. Communications sales grew by 15% year over year as 5G-related products ramped in the quarter, helping mitigate the sequential and seasonal decline of smartphone-related sales.
Adjusted gross margins held up fairly well despite the revenue declines, contracting 60 basis points year over year to 37%, while utilization rates were in the mid-70s during the quarter versus the low 80s in the preceding quarter. However, adjusted earnings per share increased by nearly 11% year over year to $0.43 as the firm managed operating expenses effectively amid softer conditions.
ON Semiconductor announced plans to purchase a 300-millimeter fabrication plant from GlobalFoundries on April 22 and provided further details on the benefits of the move on the call. Management had previously said that a greenfield 300 mm investment was out of the question but that they would consider picking up a used plant. While the quick action caught us slightly by surprise, we support the purchase and believe it will help maintain the firm’s cost advantage over competing firms. The purchase will cost a total of $430 million by 2022, after an initial investment of $100 million, and management expects the new fab to enable roughly $1 billion in capital expenditure savings.
At present, we do not think the additional power capacity from ON’s purchase and current competing expansions will tip the market into oversupply. Between electric and hybrid vehicles, charging infrastructure, cloud power, and renewables (among other factors), we believe there will be sufficient demand to justify ON’s investment.
ON Semiconductor is engaged in energy efficient electronics. The company is organized into three segments: Power Solutions Group, which provides a range of discrete, module and integrated semiconductor products; Analog Solutions Group, which designs and develops analog, mixed-signal, and advanced logic application specific integrated circuits and Application Specific Standard Product, and power solutions; and Image Sensor Group, which designs and develops complementary metal oxide semiconductor and charge-coupled device image sensors, as well as proximity sensors, image signal processors and actuator drivers for autofocus and image stabilization for automotive and industrial markets, among others.
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