This has been a pretty mixed quarter for chip companies. Stalwarts with leverage to mobile devices, like Qualcomm (Nasdaq:QCOM), have held up pretty well, but it's been more challenging for the companies with broader market focuses. While ON Semiconductor's (Nasdaq:ONNN) reported earnings didn't look all that great at first blush, it does appear that the business has bottomed. More importantly, management has made good progress on improving both the growth and margin profile of the business for the next move up in the industry.
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A Tough End to the Year, but as Expected
ON Semiconductor's fourth-quarter numbers doesn't look all that good, but the company was basically in line with (or slightly better than) expectations.
Revenue fell 16% from the year-ago level and approximately 6% from the prior quarter, as weakness in autos, computers and industrial markets all weighed on results. Management has worked to get the company more exposure to mobile, however, and sales of wireless products tied to Qualcomm reference designs helped communications results for the quarter.
Likewise, operating results provided bad news and good news. I wouldn't call the one-and-a-half point decline in non-GAAP gross margin a good thing, but if this is the bottom then it looks like the company could have meaningful leverage to come. Likewise, the 39% decline in adjusted operating income is not a good thing, but this would represent a higher bottom than in past cycles.
SEE: Spotting A Market Bottom
More Progress at Sanyo
Sanyo remains the elephant in the room for ON Semiconductor, as margin pressure here has weighed on results ever since the deal was closed. I was pleased to hear that management lowered the breakeven target once again - to $190 million from $200 million - particularly as Sanyo's fourth-quarter revenue of $170 million suggests that breakeven is quite close.
Can Headwinds Become Tailwinds?
Management at ON Semiconductor has done a good job of driving costs out of the business and looking to position the company for better growth. That said, there are still sizable elements of this story that are out of their hands.
SEE: Evaluating A Company's Management
Computing is still a meaningful part of the business, and that market has been gasping. Like Marvell (Nasdaq:MRVL) and LSI (Nasdaq:LSI), ON Semiconductor's computing business has softened considerably on weaker PC and hard disk drive sales.
Likewise, the auto business has slowed down significantly - particularly in Europe, where ON Semiconductor counts companies like Continental and Hella as major customers. Unlike parts/components suppliers like Johnson Controls (NYSE:JCI) and Honeywell (NYSE:HON), ON Semiconductor has less tho gain from higher auto production levels in China, but the rollout of new models with higher chip content (the new BMW 7 Series reportedly has about 70 microcontrollers in it) should help offset some of the pressure in Europe.
The Bottom Line
I do think the company's long-term revenue prospects are solid (4 to 5% growth), particularly if the company's efforts to address higher-growth markets like mobile pay off. I have more optimism about the company's potential margin leverage and the timing of that leverage, as the Sanyo breakeven point gets closer. All in all, I've boosted my long-term target here above $10.
These shares have been pretty strong since November on the overall market melt-up and increased optimism about chip stocks in 2013. That makes me a little hesitant to chase the stock. It's also worth noting that a lot of the value here is tied to operating leverage which, in turn, is tied to volume - so if the revenue growth disappoints, the whole buy thesis erodes fairly quickly. Even so, this is a name worth thinking more about at today's levels.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.
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