Stock Analysis: On Semiconductor (ONNN)

Notes:
Stock Ratings: 1 = buy at current stock prices, 2 = buy on a 5-10% dip in stock price, 3 = sell on a 5-10% increase in stock price, 4 = sell at current stock prices to raise cash.  Ratings are based upon 12-18 month outlook on stock direction and not necessarily related to moves I make due to financial positioning.

On Semiconductor announced their third quarter 2014 results Thursday after the close of the markets.  Earnings came in at $0.21, just under estimates while revenues came in at $833.5M which beat expectations.  Expenses were up some and margins were down compared to the second quarter, but it can be said that all of the misses and beats were mostly related to their acquisition of Aptiva closing 6 weeks prior to the end of the quarter.  Also, there was a pause in sales in the last half of October, which has subsequently picked back up and accelerated in October.  This is a fairly mixed bag of results, which all added up comes to roughly an inline to slight beat on the quarter.  Additionally, guidance for fourth quarter revenues were quite a bit higher than analysts expected.  It seems very apparent that the business prospects look strong moving forward and that recent acquisitions of Aptiva and TrueSense can be quickly accretive to future earnings.

I'd say the biggest story out of these results is in regard to their automotive customers.  This segment saw a nice increase in sales of 7% sequentially.  While this was not the largest sales growth this quarter, it was the fact that Aptiva, which closed 6 weeks prior to quarter end, was "a key driver of segment growth for the quarter."  With Aptiva just getting into the picture, it's clear it's having a major impact on what On has to deliver to automotive manufacturers and they're creating desirable products.  This is further backed up later in the call when CEO Keith Jackson states "I certainly see that this could become 1/3 of the business in the next couple years."  This quarter, it was 29% of sales, but it's not that high all year around.  This means they expect a significant amount of growth particular to this sector, even though other ones are still expected to grow as well.  This doesn't mean the company is going to suddenly double or anything, but it does mean they're on the right track and are capable of some significant growth.  

Based on the fourth quarter revenue guidance management provided of $835M to $875M, I'm estimating non-GAAP earnings to come in at around $0.20.  This puts 2014 earnings for the year at $0.78 and has the stock trading at 10.6 times 2014 earnings.  Looking at the company's growth in earnings trends, it appears growth is accelerating.  From 2012 to this year's projected earnings, the growth is around 65%.  It was 19% from 2012 to 2013 and then it would be a 39% increase.  Any way you slice this up, the stock is trading at a PEG rate below 1 and that makes it a significantly undervalued stock.  Right now, fears of the global economy along with some bad reports from other semiconductor companies has made this industry and sector a tough play.  However, I believe the global economy is not likely to get a lot worse, but instead better over the next couple years.  This typically brings the technology sector into favor and a company like ON Semi appears to be a high-performing selection at this point in time.  Even valuing this stock in line with the average multiple of 16 times for the semiconductor industry would give the stock a $12.48 stock price target.  The technology sector is also quick to change with it's ebbs and flows of growth.  So I want to play conservative here.  On 2014 earnings I'm going to give the stock a multiple of 14, waiting to see proof that this growth trend will continue.That puts the price target at $10.92.  I'm going to say an even $11 for now.  I am also upgrading this stock to a 1.  After all of the worries and fears, the stock pulled back to a 52-week low of $6.76.  That's about $1.25 down side risk that I don't see very likely to hit after the market has taken it's big swoon and almost $2.75 upside on my conservative estimates.  I'm slightly above my current cost basis but despite that, this is a stock to buy on pullbacks.