A Few Years From Now, You'll Wish You Had Bought This Undervalued Stock
A key tenet of value investing is to invest in stocks that are high quality yet currently unloved in the market.
That's often a tough combination to find.
So what market is out of favor today, but may turn around in the future? Electric vehicles. And one key chip supplier to the EV market can be had at a tantalizingly low valuation today.
Investors should get on board with On
On Semiconductor (NASDAQ: ON) is a key chip supplier to the automotive market and is a leader in silicon carbide solutions for EVs and electric infrastructure. Of note, silicon carbide (SiC) is a new type of alloy that is somewhat difficult to produce, but yields great benefits. SiC power modules take up less space than traditional silicon, and their conductive advantages make SiC chips more efficient when used in an electric vehicle's powertrain. Therefore, SiC chips greatly boost the range for EVs or enable EV makers to produce cars with a smaller battery, drastically lowering costs.
On Semiconductor CEO Hassane El-Khoury was installed by an activist investor in December 2020 and has transformed the company. After divesting some of On's internal fabs as well as lower-margin consumer businesses, El-Khoury has positioned On as a higher-margin producer of power, analog, and sensor chips. Last quarter, 52% of On's revenue came from autos, with another 27% coming from the industrial segment.
These two segments should have long-term tailwinds behind them, given the transition to electric vehicles as well as the electrification of energy infrastructure. Still, both segments are in a downturn right now, following the past couple years of high interest rates and a slowing Chinese economy.
On's advantage in SiC
One of the main reasons to like On is its early leadership in silicon carbide manufacturing. While other competitors are still trying to get their silicon carbide plants up and running, On has jumped out to a leading 35% to 40% market share in the SiC industry. Moreover, management aims to grow its SiC chip revenue at two times the rate of the industry. At a recent industry conference, El-Khoury also noted that 50% to 60% of new Chinese EVs in the recent Beijing Auto Show had On Semi's SiC chips inside --and China is where EV adoption has been the highest.
On also differentiates itself from peers by producing the full packages containing its chips. There are tradeoffs between the size and type of SiC chips and the type of packaging they need. So On's ability to make the full solution for automaker OEMs and Tier 1 suppliers, determining the ideal chip and packaging combination, is another differentiator.
EVs are down, but not out, and hybrids offer growth
El-Khoury's strategy to target SiC chips may be questioned, given that electric vehicle sales and industrial equipment have slowed markedly, especially in the U.S. and Europe. In the uncertain economic environment, car buyers have retreated, especially from higher-priced EVs. Moreover, after early adopters, the mass market is increasingly turning to traditional or hybrid vehicles. This is why On's stock has retreated 37% from its all-time highs.
Hybrids, however, still offer content growth for On. Whereas On typically has about $50 worth of content in an internal combustion engine (ICE) car, that amount grows to $350 for hybrids and $750 for pure battery EVs. Moreover, "extended range" hybrids are another type of hybrid increasingly popular in China, and even that type of hybrid has the same $750 of On content as a battery EV.
But over the long term, El-Khoury and most industry executives still believe EVs will become the dominant vehicle sold. This is partially because battery prices continue to come down, and the battery is the most expensive part of electric vehicles. On a recent appearance on CNBC, former Tesla board member Steve Westly highlighted that 2025 will be the first year the "EV premium," by which electric vehicles largely cost more than their ICE counterparts, will disappear, thanks to falling battery prices.
So while all EV stocks and EV chipmakers have declined as EVs have slowed, the disappearance of the EV premium and lower interest rates next year could lead to a resurgence of EV demand in 2025.
On is super-cheap right now
On currently trades at just 15.8 times trailing earnings, but remember, the current earnings base reflects what is likely the bottom of the auto and EV bear market.
But with leading SiC solutions and an EV industry very likely to reaccelerate growth a few years from now, you will probably look back and wish you'd have bought On at these beaten-down levels.
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Billy Duberstein and/or his clients have positions in ON Semiconductor. The Motley Fool has positions in and recommends Tesla. The Motley Fool recommends ON Semiconductor. The Motley Fool has a disclosure policy.
A Few Years From Now, You'll Wish You Had Bought This Undervalued Stock was originally published by The Motley Fool