ON Semiconductor Corporation

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

ON Semiconductor Corporation (ON), is a semiconductor company that provides intelligent power and sensing technologies for a wide range of industries, including automotive, industrial, and cloud computing.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

An assessment of ON’s moat requires a deep dive into the intricacies of its industry, its operations, and its competitive landscape. While the company exhibits certain characteristics of a durable moat, the rapidly changing technological landscape of the semiconductor industry, paired with intense competition, limits its moat width.

Moat Rating: 3/5

Justification:

  • Economic Moats: The company primarily operates in the fragmented market for power and analog semiconductors where it enjoys a moderate level of market share. The primary value proposition is not having a monopoly over a very specific market, or intellectual property that’s very difficult to reproduce. This is primarily a commodity industry, where price sensitivity is important.
    • The company has carved out a presence in specific niches (e.g. Silicon Carbide, Auto). While these niches are profitable and allow ON to charge a premium, there isn’t enough pricing power in its product offerings to make a lasting moat.
    • Some switching costs may exist in some areas like Automotive but these are less strong and long-lasting. Also, these switching costs are shared among all players in the industry and don’t provide an outsized advantage to ON alone.
  • Intangible assets: The company does have intellectual property and patents that it can use, and brands that are recognizable. However, there are a lot of semiconductor companies that have similar patents and brands. These are not very unique compared to competitors. So, these do not provide a lasting competitive edge. In the long run, the success of a chip company is heavily reliant on new innovation, and not the continuation of past patents, which further limits any durable competitive advantage.
  • Cost advantage: The company has certain advantages in its manufacturing and supply chain, but in an increasingly globalized world, those advantages can be quickly replicated by other competitors.
  • Overall: Given the dynamics above, its moat is limited to a narrow moat. It does have strong ties with clients, but that can be quickly broken. A narrow moat can help sustain profitability and growth for the medium term, but is not really durable for longer periods.

Risks to the Moat:

  • Technological Disruption: The semiconductor industry is subject to very rapid change, and the emergence of new technologies or materials can quickly make ON’s products obsolete. New competitors in a specific space (SiC etc.) could severely harm ON if they become dominant.
  • Intensified Competition: The semiconductor landscape is getting more and more competitive, with many players having better technology, making it difficult for ON to have a lasting edge. New entrants can also easily enter specific segments.
  • Supply Chain Vulnerabilities: The company is heavily reliant on supply chains, which may be disrupted in case of major geopolitical or global events. Also, the cost of production could drastically change if there are unforeseen events.
  • Pricing Pressure: A semiconductor company has difficulty in passing increased costs to its customers, so they might see margins decrease when prices of raw materials or other things surge.

Business Explanation:

  • Revenue Distribution: ON’s revenue is primarily derived from three main segments:
    • Power Solutions Group (PSG): This segment provides power-management and energy-efficient solutions for various applications.
      • Provides discrete power and signal devices, power management and battery protection, and automotive power.
      • Focuses on high performance power for industrial and automotive end users
  • Advanced Solutions Group (ASG): This segment focuses on advanced analog, mixed-signal, and sensor products.
    • Offers advanced solutions for computing, sensing and imaging applications, primarily for automotive and industrial end users.
  • Intelligent Sensing Group (ISG): This segment concentrates on imaging and sensing technologies.
    • Includes imaging, sensing and LiDAR solutions primarily for automotive end users
  • Industry Trends: The semiconductor industry is experiencing several key trends:
    • Increased adoption of electric vehicles: This has fueled an increase in the demand for power management and sensing solutions used in EVs.
    • Growth in automation and robotics: Automation and robotics in industries have fueled the demand for the solutions provided by ASG.
    • The growth of 5G and communications networks: The expansion of these networks is driving demand for higher-power semiconductors.
    • Increasing importance of the cloud: The increasing reliance on cloud-based systems leads to a rising demand in power management and connectivity infrastructure.
  • Margins: ON has high gross margins typically around 45%, and their operating margins are in low-mid 20% range.
    • The company has been steadily increasing operating margins as its new products and acquisitions are becoming more integrated.
  • Competitive Landscape: The market is highly competitive, with many players, including Texas Instruments (TXN), STMicroelectronics (STM), Infineon Technologies (IFNNY), and Analog Devices (ADI) offering a wide variety of products and solutions.
    • Most of ON’s competitors are not only its rivals, but also its clients who depend on ON for certain parts. The landscape is complex.
  • What Makes ON Different?:
    • Focus on long-term growth markets: ON has a very diversified set of end customers, but many of its products are designed for high-growth markets like automotive, data centers, and industrial automation.
    • Focus on R&D: ON heavily invests in research and development (R&D) to maintain a competitive edge and introduce new products. In 2022 alone, ON spent $1.3 billion in R&D, which was 16% of revenue.
    • Strong industry position in certain niche products like silicon carbide. However, this alone is not enough for a long and lasting moat.
    • Has multiple manufacturing locations globally. This helps in mitigating regional shocks and is good for efficiency in operations.
  • Recent Controversies and Problems:
    • The company recently acquired GTAT, but that led to some write-offs and impairments to their financial statements. It remains to be seen if this acquisition proves valuable in the long run.
      • It seems that the main rationale for acquiring GTAT was to improve their silicon-carbide business, which ON believes, is a very large opportunity.
    • The company has been investing heavily in R&D, and they should continue to keep up innovation at a fast pace. This means costs will rise and there is no guarantee that it will lead to profit.

Financial Analysis:

  • Revenue: ON’s revenue in 2022 was $8.327 billion, up by about 23% from the previous year. However, there was a decline in revenue in the most recent quarters (3Q 2023).
  • Profitability: The company has very good gross profit margins, around 45% in 2022, and it reported positive operating income.
    • ON has had impressive revenue growth and operating income, but there is no indication on whether it can be maintained long-term.
    • This industry has high volatility, and it is important to see what their long term profitability might be.
  • Cash Flow: ON generated a very high free cash flow in 2022 ($2.3 billion), but that has declined to $1.36 Billion TTM in 3Q 2023. However, most of that reduction has come from large increases in capital expenditures to fund their expansions.
  • The company has a great ability to generate cash and has shown its capability in the past. However, it remains to be seen if this trend of high profitability will be retained in the future, given increasing competition and technological change.
  • Balance Sheet: ON has a good balance sheet with $1.4 billion in cash and cash equivalents. They have about $5 billion in debt, which is a manageable amount.
  • They also have $2.1 billion in goodwill from acquisitions and that is also worth watching out for.
  • Share Repurchase: ON has an aggressive share repurchase policy and they have been buying their shares at reasonably high valuations, which is not good for long term investors.
    • Stock repurchases are good when the company is valued at a bargain price, but not at high prices as that is not creating value for shareholders.
  • Overall: The company seems to have a very strong financial position, with high growth in revenue and good margins. However, some trends suggest that these metrics have hit a top. It remains to be seen if this company can show these results consistently.

Understandability Rating: 3/5

Justification:

  • While ON’s operations can be understood, the intricacies of their value-creation mechanism, in the quickly changing semiconductor industry, make it complex to predict their future performance. It is a complex and difficult to understand industry.
  • One has to constantly keep up to date with the recent trends in technology to fully understand if the company has a competitive advantage in the future.
  • It is also important to be fully knowledgeable about their financial statements to understand where the company’s profits are coming from.
  • Overall, this is not too complex for someone who is moderately proficient with finance, but requires keeping an eye out for the newest industry trends to properly analyze the company.

Balance Sheet Health Rating: 4/5

Justification:

  • ON has a good cash position, and is able to comfortably service their existing debt load and has a history of generating high cash flow. However, an increasing amount of debt and goodwill in their balance sheets means that they should maintain good and consistent profitability for the foreseeable future.
  • The company is very liquid and is expected to remain so.
  • Overall, the company’s balance sheet is good, but they are carrying more leverage than ideal, making it less safe in the event of some unforeseen negative surprises.

I hope that this has been helpful, please let me know if I can help with anything else.