What's the idea?
1. ON Semiconductor Corporation (ON) is a technology company that provides energy management and sensor solutions, with a primary focus on the automotive and industrial markets. In the first quarter of 2024, the automotive sector accounted for 55% of the company's revenue, the industrial sector for 25%, and the remaining sectors for 20%. From a geographical perspective, the company's key market is the Asia-Pacific region.
2. Currently, the company is facing difficulties. In the 1st quarter of 2024, its revenue decreased by 5% y/y and amounted to $1.86 billion, while diluted earnings per share (EPS) fell by 10% to $1.08. This was due to a significant reduction in revenues in the industrial and other segments: their incomes fell by 14% and 12% y/y respectively. Moreover, inventory levels increased by $35 million q/q, and the inventory turnover ratio increased by 15 days to 194 days.
3. The ON Semiconductor management remains cautious regarding the forecasts for the second half of the year. Considering the current macroeconomic situation and demand dynamics, the company projects the revenue for the 2nd quarter of 2024 to range from $1.68 billion to $1.78 billion, while expecting weakness in all markets.
4. The macroeconomic situation may become more complicated in the short term due to slowing demand and falling prices for electric vehicles in China, as well as the trade war between the EU and China, connected to the EU's import duties on Chinese-made electric vehicles.
5. We recommend to buy PUT options on ON shares with a strike price of $70.00 and an expiry date of 18/10/2024. The cost of the option is about $5.78, with the purchase of a single contract costing $578, as option deals are for 100 shares.
6. Clients who are more optimistic about the possible dynamics of ON's quotation and are prepared to take on a bullish position can buy CALL options with a strike price of $70.00 and an expiry date of 18/10/2024. The cost of the option is about $7.78, with the purchase of a single contract costing $778.
Why do we like PUT OPTION ON.US @70?
ON Semiconductor Corporation (ON) is a technology company that provides energy management solutions and sensor solutions with a main focus on automotive and industrial markets. The company distinguishes the following operating segments based on the products and technologies used:
PSG - offers a wide range of analog, discrete, modular and integrated semiconductor products that perform a variety of functions, including power switching, energy conversion, signal conditioning, circuit protection, signal amplification and voltage regulation. This segment accounted for 47% of revenues in Q1 2024.
ASG - offers analog, mixed signals, power management chips, and sensor interface devices for a wide range of end users in the automotive, industrial, computing, and mobile markets. This segment accounted for 37% of revenues in Q1 2024.
ISG - offers CMOS image sensors, image signal processors, single photon detectors including SiPM and SPAD arrays, as well as autofocus and image stabilization drivers for a wide range of end users in various markets. This segment accounted for 16% of revenues in Q1 2024.
ON Semiconductor gets most of its revenue from sales in the Asia-Pacific region (47%). Europe accounts for 24% of revenue, North and South America — 23%, and the remaining 6% — to Japan. As for the end markets, the automotive sector is the largest market, securing 55% of the company's revenue in the 1st quarter of 2024. The industrial sector, covering factory automation and energy management, brought in 25% of the revenue in the 1st quarter of 2024. The remaining 20% of revenue goes to other sectors.
Revenue structure in the 1st quarter of 2024
ON Semiconductor and the entire industry are currently facing certain difficulties. In the first quarter of 2024, the company performed better than expected, although the overall trend remains downward. Its revenue decreased by 5% y/y, amounting to $1.86 billion, while diluted earnings per share (EPS) decreased by 10% to $1.08. Profit margin also declined during the quarter.
This was caused by significant reductions in the industrial and other segments - revenue in these segments decreased by 14% and 12% y/y respectively. The automotive segment brought more positive results: revenue moderately grew by 3% y/y but decreased by 9% compared to the previous quarter. This growth was provided by the silicon carbide manufacturing business, which shows better financial results at full load: more than 50% of substrates were produced in-house in the first quarter of 2024.
Financial results for the 1st quarter of 2024
In the first quarter of 2024, ON Semiconductor faced a gradual weakening of the market beyond its silicon carbide manufacturing business. The automotive and industrial markets continue to be saturated with inventory, although some stabilization was noted in the traditional part of the industrial business. Inventory levels increased by $35 million quarter-over-quarter, while inventory turnover increased by 15 days to 194 days.
ON Semiconductor management maintains caution in relation to the forecast for the second half of the year. Considering the current macroeconomic environment and demand dynamics, the company forecasts revenue for the second quarter of 2024 in the range of $1.68 billion to $1.78 billion, expecting weakening across all end markets.
The situation for ON Semiconductor may turn out to be more complex than anticipated due to several external factors. First off, Chinese car manufacturers are facing a slowdown in demand and falling prices in their domestic market. Although electric vehicle sales in China in March increased by 10.5% y/y thanks to discounts, the total sales volume for January-March amounted to 1.03 million electric vehicles (+14.7% y/y) - this is the slowest quarterly growth since Q2 2023.
Secondly, the EU imposed temporary tariffs on imports of Chinese-made electric vehicles, ranging from 17% for BYD to 38% for SAIC. Analysts believe that these tariffs will not entirely stop Chinese car manufacturers from entering the EU market, but some slowdown is anticipated. Electric car exports from China to EU countries have already decreased by 19.6% during the first two months of 2024, accounting for just over 75,600 electric vehicles shipped to 27 EU member states in January and February.
Export of Chinese electric vehicles to the EU
In addition, if China takes retaliatory measures that could cover other types of vehicles or even other industrial sectors, German car manufacturers will suffer the most, creating additional problems for chip manufacturers.
Thus, geopolitical and market dynamics create additional challenges for ON Semiconductor, especially in the automotive segment, as the company navigates a complex global market environment.
How to properly use the idea
We recommend buying PUT options on ON shares with a strike price of $70.00 and an expiration date of 18/10/2024. The cost of the option will be about $5.78, while the purchase of one contract will cost $578, since option deals are made for 100 shares.
The investor will make a profit if, on the expiration day, the price of the underlying asset is below the break-even point* of $64.22. The lower the cost of ON shares falls below this mark, the greater the profit will be. We recommend closing the position when the cost of the option reaches $12.00. In this case, the profit will amount to 108%.
If on the day of expiration the price of the underlying asset is below $70.00, but above $64.22, the investor will incur a loss, the size of which is limited. If the price of the underlying asset is above $70.00, then the investor will suffer a maximum loss of $578.
The diagram below shows the distribution of profits and losses from the option position depending on the cost of ON shares on the expiration date.
Bullish view on stocks and purchase of CALL options
It cannot be ruled out that positive corporate events may lead to a rise in shares. If you adhere to a bullish view of the company, you can buy CALL options with a strike of $70.00 and an expiration date of 18/10/2024. The cost of the option will be about $7.78, and the purchase of one contract will cost $778.
If on the day of expiration the price of the underlying asset is higher than the breakeven point of $77.78, then the potential profit is unlimited.
If on the day of expiration the price of the underlying asset is above $70.00, but below $77.78, then the investor will suffer a loss, the size of which is limited. If the price of the underlying asset is below $70.00, then the investor will suffer a maximum loss of $778.
Important!
Options should be purchased using a limit order. Buying a contract by market order may result in extremely unfavorable prices.
This idea is speculative in nature and carries increased risks. Investing in options can lead to an increase in the value of the asset by 50%, 100%, 200%, and in some cases even higher, as well as to a complete loss of its value and, consequently, to losses at the level of 100%! In cases where volatility turns out to be low, profits or losses fluctuate within 20%-30%.
A sensible approach to implementing option ideas is to invest a small portion of the portfolio in many similar cases. In this way, losses from unsuccessful ideas will be offset by the high returns of successful investments.
Key risks
There is a chance that positive corporate events will lead to a rise in ON shares. In this case, PUT options will depreciate, but CALL options will appreciate. A relatively low level of volatility of ON shares may lead to a depreciation of options by the expiration date.