Finance
Can this popular semiconductor stock continue to outperform Nvidia?
The market heated up ON Semiconductors (NASDAQ: ON) second-quarter earnings report, and the stock has now significantly outperformed Nvidia over the past month, up 14.2% compared to a 5.4% decline for the stock market darling (at the time of writing). The question is why and whether this can continue.
A cyclical stock to buy
ON Semiconductor serves two highly cyclical end markets, automotive (electric vehicles, energy management, advanced driver assistance systems, etc.) and industrial (automation, EV infrastructure, machine vision, etc.), which are shrinking this year for various reasons.
The chart below shows the sequential trend of revenue declines since the third quarter of 2023. Additionally, management expects year-over-year declines to continue in the third quarter, with expectations for revenue of $1.7 billion to $1.8 billion, compared unfavorably to Q3 2023 figures. $2.18 billion reported in Q3 2023.
However, as a sign of stabilization, the midpoint of expectations for the third quarter implies a consecutive increase in revenue from the $1.74 billion just reported in the second quarter. This is just one of the reasons why investors bought the stock after the recent results. In other words, they look at the forecast for successive improvements and consider this a potential bottoming process in action.
It’s an intriguing view, especially since semiconductor stocks are considered highly cyclical. The optimal time to buy is often during the darkest hour, before the light of recovery appears. That kind of argument is why ON Semiconductor can outperform Nvidia. Given the increasing interest and investments in AI applications driving demand for high-performance computing (HPC) chips, the latter is already firing on all cylinders.
Is ON Semiconductor on the road to recovery?
The crucial question here is not only whether a recovery is coming, but also what kind of recovery it will be. While investors typically look for a V-shaped recovery, ON Semiconductor CEO Hassane El-Khoury does not share this view. He continues to predict an “L-shaped curve” for the recovery. In plain English, this means that there will not be a dramatic increase in sales, but sales will decline and then decline further.
That may not be what investors want to hear, especially if they’re buying ON Semiconductor as a typical example of a semiconductor recovery. Still, El-Khoury’s cautious approach is entirely understandable under the circumstances.
Relatively high interest rates make monthly car loan payments more expensive, which negatively impacts car sales, including electric car sales. In turn, car manufacturers are withdrawing their investments in electric vehicles – bad news for ON Semiconductor, which is positioning itself in the market for intelligent power solutions for electric vehicles.
In addition, industrial end markets, as typified by industrial automation, are struggling to increase orders as customers continue to deplete inventory built up when product lead times were much longer and need to build inventories to meet demand. I have discussed this dynamic regarding Rockwell Automation earlier.
It’s fair to say that both of ON Semiconductor’s end markets have deteriorated through 2024.
Why ON Semiconductor is still a buy
While the near-term prospects remain uncertain, there is little doubt that the company is poised for long-term growth. Moreover, it is only a matter of time before end markets recover. History suggests that the interest rate cycle will reverse, and there is no return of a future where electric car sales exceed internal combustion engine (ICE) sales – ON Semiconductor has far more intelligent power and chip content sensing on electric cars than on ICEs.
Indeed, in a sign of the company’s potential, the company announced that “Volkswagen Group has selected Onsemi as the primary supplier of a complete power box solution as part of its next generation traction inverter for its scalable system platform.”
Moreover, industrial automation is the future in countries with relatively high labor costs and the solution for cost-effective reshoring of production. Investments in automation are likely to increase as end demand picks up, and distributors destocking now will only make the recovery stronger when it does.
Finally, whether it’s an L-shaped recovery or a V-shape, or even an L-shape that turns into a hockey stick recovery, ON Semiconductor’s valuation, which is 18.6 times the Wall Street’s 2024 earnings forecast is very attractive and quite capable. to continue to outpace Nvidia.
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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 Volkswagen Ag. The Motley Fool recommends ON Semiconductor. The Motley Fool has one disclosure policy.
Can this popular semiconductor stock continue to outperform Nvidia? was originally published by The Motley Fool
