This Chip Maker Isn’t A Big AI Player. It’s Time to Buy Its Stock

ON Semiconductor’s Current Landscape

ON Semiconductor (ON), based in Scottsdale, Arizona, has recently found itself overshadowed in the booming chip market, particularly as artificial intelligence (AI) chips dominate the spotlight. Despite being a key player in the semiconductor industry, the $31 billion company has faced challenges, with a significant 31% drop in its stock price, falling from its record high of $72 on July 28, 2023. This downturn stands in stark contrast to the S&P 500 index, which has seen a gain of 29% during the same period.

Changing Dynamics in the Automotive Sector

Historically, ON Semiconductor’s customer base has primarily consisted of automakers and manufacturers, industries that have struggled amid changing market demands. The chipmaker’s auto segment, responsible for over half of its total revenue, saw a sharp decline in sales. In the second quarter of the year, auto chip sales plummeted to $907 million, a decrease of 21% from its peak of $1.16 billion in the third quarter of the previous year. This decline was attributed to oversupply after automakers hastily stocked up on semiconductors post-COVID-19 lockdowns, exacerbating the problem as car production stagnated.

Looking Ahead: Signs of Recovery

However, there are promising signs indicating that ON Semiconductor’s fortunes may be turning. Analysts, including Jack Egan from Charter Equity Research, believe the company is poised for outperformance as the demand for vehicles rebounds. A combination of economic factors, including anticipated Federal Reserve interest rate cuts and potential economic shifts following the next presidential election, could catalyze further growth.

Moreover, consumer trends in the automotive industry suggest that demand for chips might be on the rise as car manufacturers gear up for an increased production capacity, which could lead to higher chip orders. In fact, in the most recent quarter, ON’s auto sales experienced a modest increase of 4.9%, reaching $951 million, showing signs that the worst may be over.

Unlocking Growth Potential

The road to recovery appears promising for ON Semiconductor, especially in its industrial revenue, which is projected to grow by 6% annually over the next three years. As manufacturers increasingly adopt automation to enhance productivity, ON could see a significant upturn in demand for its products. Total revenue is forecasted to grow by 10%, hitting roughly $9 billion by 2027—an attainable goal given the limited competition in the silicon-carbide auto chip market.

With only STMicroelectronics as a larger competitor, which generates just over $1 billion in silicon-carbide chip sales annually, ON Semiconductor is well-positioned to capitalize on this niche.

Operational Improvements and Financial Health

Adding to its strategic advantage, ON Semiconductor has recently expanded its production capability by acquiring GlobalFoundries’ East Fishkill, N.Y., plant. This acquisition enables the company to produce more chips without significantly increasing costs, thereby enhancing its efficiency. Analysts anticipate that the company’s gross margins will improve, with management targeting a gross margin of 53% in the near future.

Additionally, ON Semiconductor boasts over $1 billion in free cash flow, with plans to allocate half of its quarterly cash flow towards share repurchases. This disciplined capital allocation, coupled with sales growth and improving profitability, positions ON for substantial growth, with projected earnings per share (EPS) expected to rise by approximately 21% annually, reaching $7.11 by 2027.

Investment Opportunities and Valuation

From an investment perspective, ON Semiconductor’s current stock valuation appears attractive. Trading at 17 times forward earnings, it is significantly undervalued compared to the S&P 500 and average chip stock multiples. If ON’s price-to-earnings ratio holds steady, the stock could potentially reach around $112 by the end of 2026, translating to an annualized return of 25% for long-term investors.

Conclusion: A Stock to Consider

In conclusion, while ON Semiconductor may not be at the forefront of the AI revolution, its potential for a rebound in the automotive chip sector and its strategic operational improvements highlight a compelling investment opportunity. As analysts suggest, with the current favorable market conditions, there may be more risks to the upside than downside for ON Semiconductor, making it a stock worth considering for investors looking for long-term growth in the semiconductor space.