Earnings 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.

Monday morning, On Semi posted earnings of $0.19 on revenues of $840M.  Earnings met expectations, but the revenues missed slightly.  The result was the stock getting pounded hard.  It was a little above $8 prior to the release and has subsequently hit a 52 week low of $6.97.  I certainly don't feel like this quarter's results justified the move down like this, but let's see what else may have had an impact.

The quarter really seemed to have a mixed bag of results.  On the positive side, expenses were down and free cash flow was up.  On the down side, all products sales were down quarter over quarter - with Systems Solutions down quite bad due to white good in China and Japan going through an inventory clear out.  Margins were also down, though it was expressed to be mostly due to lower utilization.  Finally, guidance came in a bit lower than expected, with revenue guidance set at $800 - $840M for the first quarter.  Management noted that demand was soft in the fourth quarter, but that they've seen a much improved order demand so far in the first quarter.  Management didn't shy away from saying that we've seen these false positives recently before, though, so they are staying cautious.  

Some of the key themes that were worrisome was the fact that all semiconductors are feeling the pain.  There's claims that we're just burning through excess inventory, but I heard that claim last quarter too.  They were expecting improvement, but we didn't see it yet.  You also have to question stock buybacks of $20M when their average price was $10.46 and now the stock is hovering just above $7.  To top it off, management stated (albeit wisely) that they aren't prepared to buy more shares while the Fairchild deal is still in flux.  This both opens a door for short sellers to slam the stock because they know the company won't come in and buy, but also prevents the company from taking advantage of such low prices, if they truly believe they're under valued.  Speaking of Fairchild, I'm really not sure what to think here.  The management team talks as though the merger is continuing and expected to close in the middle of the second quarter as planned despite the fact that the bid from the China company is considered "superior."  To me, it doesn't seem like the deal is in hand when a competitor has a better offering.  I'm not sure how to read this, though management did say they would stay disciplined if this became "competitive."  Perhaps they're just waiting until a competitive deal is struck before raising the offer?

Things to like out of the call were the fact that they are focused on discipline - both in the merger and when it comes to managing costs and expenses.  This discipline should help maintain margins during the softness we're seeing in the market.  Additionally, 85% of their forecasted sales are already booked.  This helps raise some confidence that they can hit their numbers - though there is always some risk for cancelled orders.  The company's free cash flow is strong and they're growing organically faster than others in the industry.  The Auto, wireless, and industrial markets continue to be strong, but we have entered seasonally slower times.  

In the end, we have to decide what future earnings are going to look like and how the company is priced.  Right now, analysts have an average expectation of $0.88 for the year, which is definitely lower than my $0.92 estimate.  For now, I think I'm going to keep my estimate.  I see either the Fairchild deal going through, which should be a boost to earnings in the second half of the year or the deal falls through and the company likely accelerates its buyback - hopefully while prices are still low.  With my estimate, I'm looking at 9.5% earnings growth this year.  A multiple of 12 probably isn't fair - especially without signs of stabilization or growth.  A multiple of 9 to 10 though?  I think that's likely fair.  I'll place my price target at $9.  I believe in long-term abilities and growth, but my price target isn't meant to look out that far.  I also see down side risk that can still take us to 2012 lows near $6 without any signs of stabilization in the stock market, itself.  As such, I'm willing to raise the stock to a 3.  It's really too cheap to sell at these levels and should only be sold in an absolute need for cash.  That said, I don't have enough conviction in the stock's behavior, or the market in general, to justify buying in just yet.

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