ON Stock Prediction: Limited Performance Improvement is Overweighted by Low Margin Issue

motek 1The stock prediction article was written by Tianyue Yu, Analyst at I Know First, Master’s candidate at Brandeis University.

Summary

  • End markets’ recovery drives the revenue expansion in the next year
  • Unfavorable margin level is the major drawback of ON stock forecast
  • A target price at $27.5 indicates a cautious buy recommendation

Revenue Tailwinds from The Ongoing Recovery in End Markets Would Help Drive the Revenue Expansion

On Semiconductor (ON) released the Q3 financial results on November 1st. In the recent quarter, ON achieved $1.32 billion in revenue, in line with the guidance and Non-GAAP EPS of $0.27. However, this earnings call failed to boost the ON stock forecast. Q3 revenue gained a 9% increase compared with the last quarter, driving the gross margin to 33.5%. This revenue increase mainly came from the recovery of the automotive market, representing 32% of the total revenue. After experiencing supply disorder and order number plunge in Q2, the automotive market segment revenue increased by 28% in this quarter. In the conference call with Deutsche Bank analyst, ON’s CEO Keith saw this end market as the biggest driver and expected the revenue will go up on a quarter-over-quarter basis in the fourth quarter.

on stock forecast
(Source: Capital IQ)
(Source: Detroit Regional Chamber)

ON’s main advantage in the automotive market is the ADAS product and silicon carbide material, widely used in electric vehicles. In March 2020, ON signed an agreement with GT Advanced Technologies for Production and Supply of Silicon Carbide Material, representing a big revenue growth potential. The silicon carbide breakthrough also benefits the industrial sector, which includes military, aerospace, and medical, contributing revenue of $327.6 million in the third quarter. Before the pandemic, ON saw strong adoption of the company’s silicon carbide modules for solar and cloud power related applications. While the industrial market gradually bounced back from the 2019 depression cycle, we can expect to see some inventory condition improvement and customer base expansion in this end market.

Rationing Manufacturing Cost Footprint and Reaching Management’s Financial Indicators Plans are the Prerequisite of Gaining ON Stock Forecast Upside

Despite well-positioned in end markets, ON falls behind its peer group in terms of both cost efficiency and profitability, explaining why ON trades at a discount to the competitors. These disadvantages of ON partly result from the fab-heavy business mode. Currently, ON’s frontend manufacturing is about 35% outsourced to foundries, and 65% in-house. The high costs and expenses encroached most of the revenue and limited investors’ payoff. Even though ON achieved the management’s gross margin guidance of 43%, the peer companies are still ahead of ON’s cost control ability.

on stock forecast
(Source: Starboard Value)

CEO Keith highlighted the importance of rationalizing the company’s fixed cost footprint and winning designs to drive mix shift towards products with a high margin in the long run. Although no specific step was mentioned in the latest earnings report, we can take a glimpse of the company’s plan in the past several transactions. ON is going to launch a 300mm wafer manufacturing process at East Fishkill fab in 2020, which had been acquired by the company in 2019. This high value-added product is expected to bring incremental revenue and boost gross margin. In August 2020, ON also announced it is exploring a sale of its manufacturing facility in Niigata, Japan, together with the closure of two other facilities in Rochester and Belgium, claiming that these changes are part of the company’s plan to optimize its manufacturing footprint. The sum of all three should get us about $75 million of annual savings that at the time of which depends on the final agreement we reached with the buyers of these entities. These transactions unveiled ON management’s correct emphasis on margin growth structural changes.

Limited Upside Space in The Next 12 Months supports a Cautious Buy Recommendation

ON’s stock forecast highly correlated with semiconductor sector performance due to the lack of company level idiosyncrasies. In light of the recovery in most semiconductor products’ end markets, I predict that ON’s stock price performance will keep at a stable level in the next year. The upside opportunities include large COGS saving from divesting Niigata facility, unexpected strong demand for electric vehicle and clean energy markets, and agreement with significant new clients. However, the stock price also remains considerable risk exposure to the transition of the CEO position, deteriorated COVID-19 situation, and US-China trade tension.

on stock forecast
(Source: Yahoo Finance)

Final Thoughts on ON Stock Forecast

on stock forecast

I issued a 12-month price target of $27.5, which is in line with analysts’ average price prediction. I also remain a positive prospect to the ON stock forecast on a longer horizon. ON’s first-move position in high growth potential markets including 5G infrastructure, clean energy, and electric vehicle is still valuable for shareholders. If the company could improve its cost structure and move towards management’s financial indicators guidance, the company will be able to generate strong cash flow in the future. My prediction is supported by I Know First algorithmic forecast – the signal for the 1-year horizon is strong at 95.87 level with 0.65 predictability.

Past Success With ON Stock Prediction

I Know First has been bullish with its ON this year. On July 21, 2020, the I Know First algorithm issued a bullish forecast for ON stock price and recommended ON as one of the top ten stocks to buy. The AI-driven ON stock prediction was successful on a three-month horizon resulting in more than 18% gain since the forecast date. See the chart below.

on stock forecast

Additionally, on October 7, 2020, the I Know First algorithm recommended ON as one of the top ten tech giants’ stocks to buy. The ON stock prediction based on the machine learning algorithm model was successful on a 14-day horizon resulting in more than 10% gain since the forecast date. See the chart below.

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Please note-for trading decisions use the most recent forecast.