ON Semiconductor feels off as slowing demand in noncore end markets in Q2 spurs some uneasiness (ON)
12:40 pm Monday, July 18th, 2022
ON Semiconductor (ON -5%) feels slightly off today despite toppling earnings and revenue expectations in Q2 while guiding Q3 numbers ahead of consensus. Like its peer Texas Instruments (TXN), ON benefited drastically from robust demand in its automotive and industrial markets.
Why, then, are shares sliding today? Although nothing glaring stands out, we think ON’s comments regarding slowing demand within its noncore end markets are stirring some uneasiness today. Profit-taking may also be in the works as shares have soared roughly 40% from July 1 lows as of Friday’s close. Meanwhile, after TXN’s sizeable Q2 earnings beat last week, investors may have expected better numbers from ON in Q2. Lastly, the company expressed cautious optimism about the near future, stating that it remains sensitive to dynamic market conditions.
Despite these weak points, ON’s Q2 report contained plenty of positives. Adjusted EPS surged 113% yr/yr to $1.34 as non-GAAP gross margin expanded 1,130 bps yr/yr to 49.7%.
Within automotive and industrial, which ignited ON’s explosive earnings growth, high-growth, high-margin businesses such as vehicle electrification and industrial automation paved the way for solid Q2 numbers. Combined, these two industries grew 38% yr/yr, making up around two-thirds of ON’s total revs in the quarter, which appreciated 24.9% yr/yr to $2.08 bln.
More specifically, ON’s Intelligent Power segment, which contains sales to the electric vehicle (EV) market, jumped 31% yr/yr and 10% sequentially. Part of why ON is benefiting enormously from EVs is that they require up to $700 of incremental ON components for drivetrain and onboard charging compared to traditional internal combustion engine (ICE) vehicles. As a result, along with the transition from ICE vehicles to EVs, ON expects Intelligent Power to continue experiencing robust growth over the long term.
Supply chain constraints that continue to disrupt industries are also acting as a tailwind for ON, spurring accelerated factory automation growth. This is highlighted by 70% growth yr/yr in ON’s scanning business within its industrial end market. Combining this with automotive manufacturers incorporating more image sensors into their vehicles for advanced driver assistance systems (ADAS), ON’s Intelligent Sensing segment grew 39% yr/yr and 10% sequentially.
Looking ahead at Q3, ON guided adjusted EPS and revs above consensus, predicting 51% growth in earnings yr/yr and 22% growth in revs at the midpoint. ON stated that although demand is expected to continue slowing within its noncore businesses, parts of which it is exiting, strength within automotive and industrial end markets should persist.
Overall, ON’s Q2 results were solid. However, weak demand within its noncore businesses and a higher bar following TXN’s upbeat Q2 numbers are clouding many positive developments. Nevertheless, ON’s exceptional growth within its high-margin, high-growth businesses proves that its move around a year and a half ago to shift focus toward margins and growth is paying off. With a forward P/E ratio of ~14x, a nice discount relative to TXN at ~20x, ON still has plenty of upside over the long run.
