15% Downside For ON Semiconductor Stock?

ON Semiconductor stock (NASDAQ: ON) is up just 6% since the beginning of this year, but at the current price of around $26 per share, we believe that ON stock has around 15% potential downside.

Why is that? Our belief stems from the fact that ON stock is still up more than 3x from the low seen in March. Further, after posting weak Q3 ’20 numbers, it’s clear that demand for ON’s semiconductor raw materials is still not back to pre-Covid levels. Our dashboard What Factors Drove 23% Change In ON Semiconductor Stock Between 2017 And Now? provides the key numbers behind our thinking, and we explain more below.

ON stock’s rise since late 2017 came despite just a 2% rise in the revenue per share, which came solely from a decrease in the outstanding share count, as revenue stood roughly unchanged.

ON’s P/S (price-to-sales) ratio rose from 1.6x in 2017 to 1.8x in 2019, and has since risen to 1.9x so far this year, as ON stock has been riding the rally in technology stocks. However, given ON’s weak performance in Q3 ’20, there is possible downside risk for ON’s multiple.

So what’s the likely trigger and timing to this downside?

The global spread of Coronavirus, has meant lower semiconductor demand from the industrial sector, which has hurt demand for ON’s semiconductor raw materials. This is evident from ON’s Q3 2020 results, where revenue came in lower at $1.32 billion from $1.38 billion for the same period in 2019. EPS came in at $0.39, significantly higher from -$0.15 in Q3 2019. However, a closer look reveals that a $170 million litigation settlement cost weighed on operating income in Q3 2019, and ON’s tax benefit came in at $83 million for Q3 ’20, over 3x more than the $25 million tax benefit in Q3 ’19. The impact of the pandemic on the company’s business is evident from its revenue drop and the fall in gross margins (33.4% in Q3 2020 vs 34.4% in Q3 2019).

We expect ON’s business to struggle in the near-term as demand for semiconductors is still far from pre-Covid levels. If there isn’t clear evidence of containment of the virus anytime soon, we believe the stock will see its P/S multiple decline from the current level of 1.9x to around 1.7x, which combined with a reduction in revenues and margins could result in the stock price shrinking to as low as $22, a downside of over 15% from the current price of $26.

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