Stock Analysis: On Semiconductor (ONNN)

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.

As the stock has pulled back rather strongly in the last week, I felt it important to note new details that should be brought into consideration for the stock's future performance.  First Item I'll note is really nothing of real importance to the stock performance itself, but to its tracking.  On April 6, On Semiconductor will change its ticker symbol from ONNN to ON.  Please note this as I will reflect those changes at that time also, both in my writings and my blogging labels.

The next thing to acknowledge is a primary driver to the recent pullback.  An analyst downgraded another chip maker in the industry (Taiwan Semiconductor, ticker TSM) due to what is believed to be too much inventory at their top 5 customers.  The company's top customers are mostly in the cell phone space, to which is an area of noted growth in On's most recent conference call.  When I first bought this stock, I suffered a significant pullback and long time of watching the company nurse its wounds due to excess inventory levels in the market.  This is a killer for semiconductor stocks.  On has a wider distribution focus and automobiles has been the key driver to earnings in my views.  However, cell phone markets have been growing for the company and slower growth could change estimates.

The next risk is one I've called out in the past - insider selling.  Over the last couple months, there has been some dramatic levels of insider selling in the market.  It's important to note that insiders sell for many reasons - it's usually insider buying that really indicates something noteworthy.  However, the amount of selling from a variety of insiders and the amount that occurred during the stock's rapid ascent since February second will certainly raise your eyebrow and make you (and others) take notice.  If we come to find out in the first quarter conference call that inventories are "suddenly increasing," disappointment might be the nicest word I can find to express how I'll feel about the stock, management team, and these insiders who sold. 

The final new risk comes in the form of short sellers.  There has been dramatic growth in the short interest of the stock.  Back when the company last announced, there was minimal short interest in existence.  As of March 15, there is now 2.37% of the float short and I feel it's safe to say that last week's performance only increased that percentage.  My guess is that the short sellers feel the stock jumped too far, too fast.  The heavy insider selling likely reinforced that belief and gave it substance.  Add into that the new news of potential inventory issues and that theory only gets stronger.  That doesn't mean they're right and this could turn out to be a painful deal for them, but let's face it, given the current void of news, this is a reasonable story to put together.  

There is something more positive to note as well.  On Friday, there was news that Intel is in discussions with Altera Corporation regarding a potential merger or buyout.  Talks are interesting, however, that's not a done deal either.  It does give rise to the thoughts of "what if," though.  That potential for a deal is what I believe could have put a floor in the semiconductor industry for now.  If the talks end with no deal, the selling could be back on the board.  If a deal goes through, the size and impact could be huge and could prompt a wave of consolidation as prices likely increase and short sellers need to vacate due to risk of those take over deals.  For now, this is a "time will tell" piece of news.

What's my position?  Well, I do still strongly believe the stock is capable of reaching my $15 price target, providing the company executes as described in the last conference call.  However, I give a 12 - 18 month timeline before I think they get there too.  I think the stock did get too hot and I'm not convinced yet that the sell off is complete.  Unless some sort of deal does come out of the Intel news, I don't see the stock going a lot higher than it currently is before first quarter results are announced.  Things to be on the watch for include auto sales numbers, sales news regarding the launch of the Samsung Galaxy S6, insider selling, short selling, and other industry related news.  When Intel reports, it could be a powerful indicator of direction for many semiconductor stocks overall.  I should've done this as part of my last weekly summary, but I am downgrading my view on the stock to a 3.  This is not an outright sell call, but that the stock rose too much too fast and there's too much risk involved.  I'm more likely to sell some, rather than buy any amount of shares until I know more.  I maintain my earnings estimate of $0.86 and long-term price target of $15.  Right now the stock trades at 13.7 times my forward estimates.  Given the new risks, I don't feel confident that the stock can get higher than 14.5 times earnings without first quarter financial results that put some of those concerns to rest.