EUR 850.00 For Business Accounts Only

Morningstar | ON Boasts Narrow Moat and Looks Cheap; Initiating With $28 FVE, High Uncertainty Rating

We believe ON Semiconductor and its portfolio of products will benefit from the secular growth trends around advanced driver-assist systems and autonomous driving, electrification, and increasing connectivity. The firm’s portfolio of analog, image-sensing, and power discrete products is on the narrower side, but we think it has sufficient tools to benefit from this rising tide. We are initiating our coverage of ON Semiconductor with a $28 fair value estimate and note that shares are currently in 4-star territory. With the firm’s improved manufacturing scale and solid exposure to sticky growth markets, ON Semiconductor warrants a narrow moat rating. That said, because of its dependence on quickly commoditized products and the strength of competitors in the more differentiated areas the firm is pursuing, it has a high uncertainty rating.

ON Semiconductor is well-placed to benefit from the content growth in the automotive market as well as the increasingly complex power and connectivity needs of industrial, data center, and communications markets. The most attractive of these is the area of transportation. We expect the firm’s suite of power solutions should help facilitate hybrids, electric vehicles, and the requisite charging infrastructure. Its power management, image-sensing, and lidar products should also give it a strong foothold to realize emerging opportunities in assisted safety and fully autonomous vehicles. The lack of microcontroller products may prevent it from deriving the same margins as large competitors for many of these attractive markets, but we believe the firm’s combination of moat sources (intangible assets, customer switching costs, and cost advantage in its power business) will keep it earning excess returns over the next decade.

Mergers and acquisitions are a key part of ON’s growth strategy, and the firm announced on March 29, 2019, plans to purchase high-performance Wi-Fi chip company Quantenna. The acquisition, set to complete in the first half of 2019, will be immediately accretive to earnings, but we expect it will take a couple of years to recognize material revenue synergies, as there is little overlap between the two firms’ markets or technologies.

In 2016, ON Semiconductor purchased Fairchild Semiconductors, which significantly increased its discrete portfolio and made it the number-two player in the market behind Infineon. With the increased scale, ON Semiconductor can spread its costs across a larger, more diverse customer base. We think this move is replicable by consolidation of other discrete players in the next decade, but believe it would take more than five years to materially erode the firm’s cost advantage.