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.

Last week, On Semiconductor reported second quarter results for 2016.  Non-GAAP earnings and revenues came in at $0.21 and $877.8M.  Both top and bottom lines beat their respective estimates of $0.19 and $854.55M.  In addition, they provided strong third quarter guidance of revenues in the $885M - $925M range.  This is an increased from the second quarter, though some of it is seasonal in nature.  

While the quarter wasn't perfect, it was really good.  As such, I do want to note a couple concerns I saw.  First, is the Fairchild Semiconductor acquisition, which is behind schedule.  It's been said that they expect the deal to close at the end of the month, however, it's possible it could get delayed some more.  A lot of this has to do with getting through FTC regulations at this point.  Next, it's a bother to see that the Communications, Consumer, and Industrial segments all did worse than they did a year ago.  The industrial sector is typically stronger in the first half of the year and was dealing with an industry burning off excess inventory, but I still don't like seeing decelerating businesses.  It's something to keep an eye on, now that they say inventories are lean and we're seeing normal business demand again.  
On the positive side of things, the company is indicating that orders are up and showing strength, despite the macroeconomic commentary.  Semiconductor consolidation that is taking place is helping, but it's not near enough to drive pricing power to the semis yet.  Inventories are lean, and we're entering the busy season for the consumer and computer segments.  Finally is the automotive segment.  This group is hot.  They grew 15% compared to the same quarter a year ago.  They expect the group to be able to continue to grow at a high single digit percentage this year and for some years to come simply because the components they deliver are in high demand as they are becoming standard for more and more vehicles.  This is particularly fortunate, given the fact that it seems that overall unit sales are starting to slow a little.  Something to watch for, but there appears to be runway yet.  The other thing worth consideration at this time is the closing of the Fairchild deal.  Synergies are expected to be found quickly.  50% of them should be found this year with the other 50% to be realized in 2017.  This should prove as an effective growth opportunity for the company, providing it's executed well.  If segment margins maintain the 35% area or even increase as management targets, this could create meaningful earnings results.  That said, Fairchild produced only $6.9M in revenues for their second quarter.  I'm not sure how much of an overall impact the purchase will ultimately have.

In the end, I think we're looking at a strong stock in a deceptively strong sector for the time being.  We're starting to enter the semiconductor "busy season" where the stock tends to run the most.  The overall environment is becoming more favorable with inventories down and orders up, and this will lead to more positive commentary, as the 3 upgrades since the earnings call help represent.  I maintain my 2016 earnings target of $0.92, and provide an target for 2017 of $0.96 at this time.  I don't see sudden acceleration of growth at this time.  I maintain my respectful multiple of 14 leaving a 2016 price target of $12.75 and a 2017 price target of $13.45.  Based on the call, I estimated third quarter revenues to cautiously be about $892M.  I just want to state a reminder that this is a technology stock.  You don't get the biggest gains by holding it forever (as I've done foolishly over the past years).  Be cognizant of prices and points at which to sell at least some profits if these market conditions don't show marked improvement and reasons why growth might be accelerating.  The stock is likely to pull back for a number of months after the "busy season" wears off.

Nothing on this site should be taken as advice, research, or an invitation to buy or sell any securities.  All views expressed are solely of my own and I am not a professional money manager.  Please consult with your financial adviser before taking any action in your own portfolio.