Finance
Forget Nvidia: this semiconductor stock is much cheaper
Nvidia is a great company and a great stock, but it currently trades at just over 50 times Wall Street’s 2024 earnings estimates. That’s fine for many investors willing to pay a premium for high-quality growth stocks, but for investors who are willing to take a short-term risk, ON Semiconductor (NASDAQ: ON) may be a better option. This is why.
Cyclicity is important for semiconductor stocks
Semiconductors are highly cyclical; they always have been and they always will be. That’s because the first thing their customers do when they see demand increase is order chips in preparation for a production disaster. Conversely, if they see a slowdown coming, the first thing they do is halt or cancel chip orders as they prepare to slow production.
As such, semiconductors are always the first drivers of their end markets. However, not all end markets are equal, and this year’s biggest spend is around artificial intelligence (AI) and the high-performance computing (HPC) chips needed to power it. That’s why Nvidia has done so well and why Taiwanese semiconductor manufacturing continues to perform better, led by a strong recovery in HPC sales.
ON Semiconductor’s positioning
However, ON Semiconductor’s key end markets, industrial and automotive, remain challenging. That’s why the company’s share price has fallen 21% in the past year. I’ll get back to that point in a moment, but first a few words about the company itself for those unfamiliar with it.
The investment case is based on the company’s management’s repositioning for growth in exciting growth markets over the long term, and this is best reflected in its silicon carbide business. Management has invested heavily in positioning itself in the silicon carbide sector, not least by recently announcing a $2 billion multi-year investment in a silicon carbide (SiC) manufacturing facility in Central Europe. Silicon carbide chips offer several advantages over traditional silicon chips, especially at the higher voltages required electric vehicles (EVs).
Additionally, the chip company has positioned itself in other exciting growth markets in new technologies where it has relatively high content, including factory automation, EV charging, renewable energy infrastructure, 5G and advanced driver assistance systems (ADAS).
The challenges of ON Semiconductor
While these end markets have great long-term growth potential, they are unfortunately slowing down in 2024. The impact of the slowdown is most visible in the company’s declining sales and in the slowdown of its silicon carbide business. Electric vehicle sales growth has slowed as persistently high interest rates have made car loans more expensive. As such, automakers have scaled back investments in electric vehicles and company sales have been negatively affected.
For example, in October, management said that a reduction in demand from one original equipment manufacturer (OEM) automotive customer would result in the company reaching just $800 million in 2023, instead of the $1 billion target. Fast forward to February, and CEO Hassane El-Khoury told investors: “OEM’s latest EV plans indicate more tapered growth, suggesting SiC market growth in the range of 20% to 30%”, compared to market reports calling for “30% or 40%”. % growth for silicon carbide in 2024.”
In a sign of a bear market, El-Khoury briefed investors in April, saying he still expected the overall silicon carbide market to rise in 2024, “although at a slower pace than previously expected.”
While he noted that there were signs of stabilization in demand, he was very clear: “I’m not going to call the bottom. I was very clear last time. I’ll mention it when I’m on the other side of the top. side.”
Therefore, anyone thinking of buying in should be aware that there is the potential for negative news flow in the short term.
Two reasons to buy ON Semiconductor
If you can tolerate the short-term risk, the stock is very attractive. After all, no one disputes that EVs are the future of the industry. All it takes is an environment of lower interest rates for EV sales to pick up again, and that includes EV investment. Additionally, the other target end markets referenced all have excellent long-term growth prospects.
Meanwhile, ON Semiconductor’s valuation metrics are undemanding. The company trades at 18.3 times estimated earnings and appears to be excellent value. While there’s no guarantee it will hit these numbers, and as El-Khoury notes, it’s difficult to predict the bottom of the market, it’s a pretty safe bet that ON Semiconductor’s end markets and sales will recover in line with traditional cyclicity.
Considering that the company only needs to meet Wall Street estimates to look like an excellent value, I would argue that the risk/reward calculation favors buying the stock for enterprising investors.
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Lee Samaha has no position in any of the stocks mentioned. The Motley Fool holds positions in and recommends Nvidia and Taiwan Semiconductor Manufacturing. The Motley Fool recommends ON Semiconductor. The Motley Fool has one disclosure policy.
Forget Nvidia: this semiconductor stock is much cheaper was originally published by The Motley Fool
