The trend of chip stocks is hot, but ON Semiconductor (ON.O) did not benefit. However, this situation may be about to change.

This semiconductor manufacturer, headquartered in Scottsdale, Arizona, with a market cap of $31 billion, has recently faced difficulties. Its customers are mainly auto manufacturers and manufacturing companies. Even with the increasing demand for AI chips, these customers are struggling. Since reaching a historical high of $72 on July 28, 2023, ON Semiconductor's stock price has dropped by 31%, while the S&P 500 index has risen by 29% during the same period.

But ON's moment may finally have arrived. After several years of weak sales, the demand from auto manufacturers may rebound. The Fed's rate cuts should help drive economic growth, and Trump's victory could also provide a boost. Although ON Semiconductor is not NVIDIA (NVDA.O), nor an AI company, its stock now appears to be worth buying.

"Once demand picks up, ON Semiconductor will be a strong candidate to outperform the market," wrote analyst Jack Heegan of Charter Equity Research.

For ON Semiconductor, the problem began with its semiconductors used in cars, which account for slightly more than half of its total revenue. In the second quarter of this year, sales of auto chips dropped to $0.907 billion, a 21% decrease from the peak of $1.16 billion in the third quarter of last year. After the lockdown due to the COVID-19 pandemic, auto manufacturers rushed to buy semiconductors due to concerns about shortages. Now, due to stagnant car production, especially companies like Ford Motor (F.N) and General Motors (GM.N) reducing chip purchases, there is an oversupply of chips. Morningstar analyst William McCowen pointed out that this weakness, coupled with the weakness in the industrial chip market, caused ON Semiconductor's gross margin to decrease from 47.3% in the third quarter of 2023 to 45%, resulting in a 31% decline in revenue.

The good news is that these pressures seem to be easing and may continue to do so. Rate cuts by the Fed and other central banks are expected to boost economic growth, and Trump's victory may help the overall economy and the auto industry, although it may slow down electric car sales, which is an important business for ON Semiconductor. However, this concern may be smaller than investors imagine. Analyst Harsh Kumar of Piper Sandler said, "The world will eventually shift to electric cars, and no automaker will abandon their electric car plans."

As auto manufacturers see increased demand, they will order more chips to produce more vehicles. This may lead to a year-on-year increase in the number of chips sold by ON Semiconductor and push up semiconductor prices, as semiconductor manufacturers need time to expand supply. There are early signs of improvement. In the third quarter, ON Semiconductor's auto sales grew by 4.9% from the poor second quarter, reaching $0.951 billion, and the gross margin also increased by 0.5 percentage points to 45.5%. This indicates that ON Semiconductor has passed the most difficult period. Analyst Craig Ellis of B. Riley Securities said, "Chip orders are a bit like turning on a switch."

The recovery of the auto industry will greatly help address the challenges facing on semiconductor, especially if this growth is accompanied by the recovery of other industries. Industrial revenue is expected to grow at a rate of 6% per year over the next three years as more manufacturers use automation equipment, driving demand for more chips.

Overall, analysts expect total revenue to grow by 10% by 2027, reaching a historical high of around 9 billion USD. Given the limited number of companies focusing on the sale of silicon carbide automotive chips of on semiconductor, this target is achievable. The company's largest competitor is stmicroelectronics, with slightly over 1 billion USD in annual sales of silicon carbide chips.

This sales growth should be accompanied by improved efficiency. Last year, on semiconductor acquired the GlobalFoundries plant in East Fishkill, New York. The facility can produce more chips at costs similar to on semiconductor's other factories, helping to reduce costs. Other costs such as research and development and employee salaries are expected to grow at a slower pace than sales growth, as the company does not require significant hiring. The company reiterated its goal of a 53% gross margin at its third-quarter earnings call, although no specific year was mentioned.

Management also holds over 1 billion USD in free cash flow and plans to use half of the quarterly cash flow to buy back stocks. Combining its potential sales growth and profit improvement, analysts expect its earnings per share to grow at an average annual rate of 21% to 7.11 USD by 2027, higher than this year's 4.01 USD. If the auto business recovers faster than expected, these expectations could be too low. "At this point, the upside risk is higher," said Charter's Igen.

Furthermore, the stock does not appear to be expensive. Its current PE ratio is 17 times the expected earnings for the next 12 months, much lower than the s&p 500 index's 22 times and the average chip stock's 23.8 times. Even if this multiple remains unchanged, by the end of 2026, the stock could rise to around 112 USD, yielding a 25% annual return from the current level.

This makes on semiconductor stock a target worth paying attention to for long-term investors.