ON Semiconductor (NASDAQ: ON – $21.72) is a worldwide manufacturer of power and data management semiconductors and standard semiconductor components. The Phoenix, Arizona-based company serves original equipment manufacturers, distributors and electronic manufacturing service providers. ON was spun off from Motorola Corp. in 1999 and has made some significant acquisitions since becoming an independent company. Some notable purchases include Cherry Semiconductor, SANYO Semiconductor, California Micro Devices and – more recently – Fairchild Semiconductor Corp. The company operates within three product groups: Analog Solutions, Image Sensor and Power Solutions. Combined, ON offers automotive and power regulation products and computing items that focus on delivering controllers and transistors for power management for audio, video and graphics processing subsystems. Its digital and consumer products include cell phones and small portable devices. The company’s solutions cover broad product markets to encompass automotive (30% of revenue), communications (20%), computing (11%), consumer (14%) and industrial, medical and aerospace/defense applications (25%). Geographically, ON produces 65% of its revenue from Asia-Pacific markets with an additional 7% from Japan. The Americas and Europe contribute 12% and 16%, respectively.
The company had revenues in the year ending 2016 of $3.9 billion and is expected to close out this year with sales of $5.47 billion. Demand within the automotive, industrial and communications end markets remained noteworthy, and synergies with Fairchild Semiconductor continue to have a positive impact on the business. Specifically, sequential expansion of the adjusted gross margin by approximately 150 basis points, to 36.9%, caused third quarter earnings per share to come in four cents ahead of Street estimates at $0.44 and management raised guidance for the full-year. Operating cash flows continue to improve in the wake of the Fairchild acquisition. For the full-year 2017, ON expects free cash flow to be somewhere around $600 million-$650 million. Indeed, over the entire duration of 2016, the company generated free cash flows of only $371 million.
Why ON? Manufacturing cost reductions and additional synergies from the Fairchild acquisition have helped to improve the outlook. Earnings per share for 2017 are in the $1.43-$1.45 range and next year is estimated to be some 15% higher at $1.66, providing a reasonable forward multiple of 13. These improvements should help ON Semiconductor to pursue its plan to buy-back shares and de-lever the balance sheet, thereby significantly reducing its current long-term debt of about $3 billion. Tailwinds associated with the current semiconductor cycle suggest that business will continue to improve and diversification within the company’s product portfolio has helped keep it insulated from demand volatility. Over the long-term, I believe these factors should help the company achieve its goal of a 40% adjusted gross margin. The company does not – and is not expected to – provide a dividend. However, a 7% allocation in a well-diversified aggressive portfolio should pay off over time.