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ON Semiconductor's Bet on the Auto Industry Yields Big Results

Nicholas Rossolillo, The Motley Fool

ON Semiconductor (NASDAQ: ON), historically a seller of low-profit-margin commoditized chips, decided to make a change a few years ago. As a result, business has been booming, and management thinks it has a long road of growth ahead. Here's how it pulled it off.

First, a recap of 2017

Metric

2017

2016

Year-Over-Year % Change

Revenue

$5.54 billion

$3.91 billion

42%

Operating Income

$681 million

$236 million

188%

Earnings per Share

$1.89

$0.43

340%

Chart by author. Data source: ON Semiconductor quarterly results.

ON Semiconductor's business had a great year, and shares followed suit, rising 64% in 2017. The key to its success was better profit margins as demand grew for its various products for the automotive, industrial, and communications industries.

It was a great 12-month run, but investors got somewhat disappointing guidance for the first quarter of 2018. Revenue is expected to be down as much as 6.5% year over year, although gross profit margins are expected to be at least 1.4% higher than the same period last year.

Nevertheless, management reiterated that it believes it is early on in realizing its full potential. The strategic moves the company made in recent years, it believes, will provide years of positive momentum.

The key to ON's transformation

Just a few years ago, ON was a seller of basic electronic chips and equipment, subject to wild swings in supply and demand, leaving shareholders whipsawed by swings in share prices. The company has been making key investments in next-generation technology, though, including the acquisition of 4Fairchild Semiconductor back in 2016, to set itself up for a more certain future.

An artist's depiction of the Internet of Things, various devices like cars, cameras, appliances, wearable devices, and industrial equipment getting hooked up to the internet.

Image source: Getty Images.

The result is a new line of products that have helped propel revenues higher. Management's excitement over the company's future revolves around advanced driver-assist systems in cars, electric and hybrid vehicles, machine vision, and robotics -- disruptive and transformative technologies that ON has a hand in developing for its customers. Earlier in the year, management also stated that no single client makes up more than 5% of total revenue. That makes ON well diversified, a luxury that many small tech suppliers don't enjoy.

It's true that ON has benefited from a fast-growing global auto industry. Revenue from that segment was 32% of the total in the last quarter. And 2016 and 2017 were back-to-back record years for total autos sold worldwide, at 77 million and just under 80 million units, respectively. Those numbers are expected to slowly rise, pushed by emerging economies in Asia. It just so happens that two-thirds of ON's business comes from that region.

It's more than just increasing car sales that help, though. Electronics are an increasingly important part of auto manufacturing. Since 2000, electronics as a percentage of the total production budget for a vehicle has gone from 20% to nearly 35%. In the next decade, that percentage is expected to increase to as much as 50%.

Because of the Internet of Things movement, ON has several positive trends working in its favor that are helping it find a multitude of applications for its devices. Paired with its successful plan of cost control and better scale in its operations, the bottom line is soaring and looks like it could continue to do so in the year ahead.

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Nicholas Rossolillo owns shares of ON Semiconductor. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.