The market warmed to ON Semiconductor’s (NASDAQ: ON) second-quarter earnings report, and the stock has now significantly outperformed Nvidia throughout the last month, with a 14.2% increase as compared with a 5.4% decline for the stock market darling (as of this writing). The query is why and whether it’d proceed.
A cyclical stock to buy
ON Semiconductor services two highly cyclical end markets, namely automotive (electric vehicles, power management, advanced driver assistance systems, etc.) and industrial (automation, EV infrastructure, machine vision, etc.), which are declining this 12 months for various reasons.
The chart below shows the sequential revenue decline trend established for the explanation that third quarter of 2023. Moreover, management expects the year-over-year declines to proceed inside the third quarter, with guidance for revenue of $1.7 billion to $1.8 billion, compared unfavorably with the $2.18 billion reported inside the third quarter of 2023.
Nonetheless, in a sign of stabilization, the midpoint of the third quarter guidance implies a sequential increase in revenue from the $1.74 billion just reported inside the second quarter. That’s just one amongst the the explanation why investors bought the stock after the recent results. In other words, they’re taking a have a look at the forecast for sequential improvement and taking it as a possible bottoming process in motion.
It’s an intriguing viewpoint, especially since semiconductor stocks are considered highly cyclical. The optimal time to buy is often during their darkest hour before the sunshine of recovery appears. That type of argument is why ON Semiconductor can outperform Nvidia. Given the surging interest and investment in AI applications driving demand for high-performance computing (HPC) chips, the latter is already firing on all cylinders.
Is ON Semiconductor on the trail to recovery?
The critical query here shouldn’t be only whether a recovery is coming, but as well as what form of recovery it might probably be. While investors typically seek for a V-shaped recovery, ON Semiconductor’s CEO, Hassane El-Khoury, doesn’t share this view. He continues to forecast an ” L-shaped curve” to the recovery. In plain English, this means there won’t be a dramatic uptick in sales, but as a substitute, revenue will bottom after which move along the underside.
That is probably not what investors have to hear, particularly within the event that they buy ON Semiconductor as a typical semiconductor recovery play. Still, El-Khoury’s cautious approach is perfectly comprehensible inside the circumstances.
Relatively high rates of interest make monthly repayments on automobile loans costlier, negatively impacting automobile sales, including EV sales. In turn, automakers are pulling back on EV investment — bad news for ON Semiconductor, which is positioning itself inside the intelligent power solutions marketplace for EVs.
In addition to, its industrial end markets, as typified by industrial automation, are battling to increase orders as customers proceed to run down inventory built up when product lead times were for for much longer, they typically have to construct inventory to service demand. I’ve discussed these dynamics with regard to Rockwell Automation previously.
It’s fair to say that every of ON Semiconductor’s end markets have deteriorated through 2024.
Why ON Semiconductor continues to be a buy
While the near-term outlook stays uncertain, there’s little doubt that the company is about for long-term growth. In addition to, it’s only a matter of time before its end markets recover. History suggests the speed of interest cycle will turn, and there is no such thing as a moving back from a future by which EV sales outpace internal combustion engine (ICE) sales — ON Semiconductor has far more intelligent power and sensing chip content on EVs than on ICEs.
Indeed, in a sign of the business’s potential, the company announced that “Volkswagen Group has chosen Onsemi to be the primary supplier of a complete power box solution as a component of its next-generation traction inverter for its scalable system platform.”
In addition to, industrial automation is the long term in relatively high-cost labor countries and the reply for reshoring production cost-effectively. Investment in automation is more prone to increase when end demand picks up, and distributors running down inventory now will only make the recovery stronger when it comes.
Finally, whether it’s an L-shape recovery or V-shape, and even an L-shape that turns right right into a hockey stick recovery, ON Semiconductor’s valuation, trading at 18.6 times Wall Street’s estimate for earnings in 2024, could be very attractive and quite able to constant to outperform Nvidia.
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Lee Samaha has no position in any of the stocks mentioned. The Motley Idiot has positions in and recommends Nvidia and Volkswagen Ag. The Motley Idiot recommends ON Semiconductor. The Motley Idiot has a disclosure policy.
Can This Hot Semiconductor Stock Keep Outperforming Nvidia? was originally published by The Motley Idiot