Stock Analysis: On Semiconductor (ON)

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.

Last week On Semi reported their third quarter results, posting $904.2M in revenues and $0.23 EPS.  Earnings were in line with expectations, while revenues were slightly below what was expected of the company.  Additionally, the company repurchased just over $100M worth of stock at a weighted repurchase price of $10.64.

The quarter was relatively mixed, as there were unexpected pressures seen in the macroeconomic conditions.  China is a major geographical revenue source and slowdowns were seen there across all of the four business segments.  The fourth quarter isn't looking to be a any stronger as management sees the supply chain working off excess inventories.  To compensate, the company is making a number of cost cuts to align with what they're seeing that will take effect in the fourth quarter, including job cuts and factory shut downs during the holidays.  They are expecting this to be the end of this trend, though, as the company is at some of it's leanest levels already and they see the rest of the market nearing similar conditions.  The one area that really concerned me was seeing a slowdown in the automotive industry.  Cars in the US have been flying off the lots, image sensors are becoming a mandated feature and it seems that On has a vast share of that market.  It is fair to think that it's possible the whole Volkswagon fiasco has had an impact to the sales, but this is a little bit of a concern point for me, as the automotive industry is very cyclical, has been strong for some time now, and sales have reached levels most didn't think we'd hit.  If this trend is changing, there's some significant risk in front of us.

Fourth quarter guidance is down from what was expected, but in line or better with what's happening with peers in the industry.  I feel I see some chinks in the armor right now, however, the company does seem to be managing costs well to navigate through the tough times.  That said, they have a long way to go to reach their 40% gross margin rates in 2017 as is their goal.  This quarter, margins were down to 34.1% due to the necessary factory slowdowns to meet the market.  Management tends to have very good visibility into the market trends and believes we're going to see things improve in the first quarter.  The confidence and reputation seem to build a lot of favor for the company at this time as the stock price has launched over 12% since reporting these results.  The seasonal trend for this stock has gone into its positive cycle.  We've seen the first in what tends to be 3 or 4 shots straight up with minor pullbacks in between.  The company's dedication to the buyback, which is ahead of schedule, will potentially help the stock climb even more.

So this company has a mix of good and bad.  It'll be important to keep an eye on car sales as the canary to the coal mine, with general information about China being a secondary factor.  Based on results and guidance, I have to lower my earnings target for 2015 from $0.86 to $0.84.  I think a fair multiple, right now, is 14 due to the 12% earnings growth this number projects.  With that, the 2015 target price is set at $11.75, but with the year already in its final 2 months, that doesn't mean a lot.  My 2016 EPS target is $0.94 and that same multiple my price target is raised to $13.25 with potential for the multiple to expand to 16 if trends do actually turn more positive, giving a rosy outlook of $15 as a possibility (though likely for a short time).  Given current price levels, I give the stock a rating of a 2.