ON Semiconductor sees drop in sales in Q4 as earnings top estimates

ON Semiconductor reported Q4 revenue of $1.53 billion (in line with estimates) and adjusted EPS of $0.64 (above $0.62 consensus), while generating $1.8 billion in operating cash flow and $1.4 billion in free cash flow with a record 24% FCF margin returned via buybacks. Management signaled stabilization but provided Q1 2026 guidance below Street expectations — midpoint revenue $1.49 billion (vs. $1.51B consensus) and adjusted EPS $0.47 (vs. $0.61) — even as AI data-center revenue is running north of a $400 million run-rate and Jefferies kept a Buy/$73 target; shares rose ~4.3% to ~$68.

Analysis

Market structure: ON’s results reallocate value toward semiconductor power + sensing suppliers tied to AI compute (ON, some custom power IC specialists) while penalizing legacy industrial/analog pockets that the company is exiting (roughly $300M of revenue across Mar–Sep). Stabilizing revenue with a >$400M AI data‑center run‑rate and record 24% FCF margin implies rising pricing/power content per server—winners are hyperscaler supply chains and margins, losers are low-growth industrial analog incumbents. Cross‑asset: stronger FCF reduces credit spread risk (positive for corporate bonds), buybacks lower float (support equities), implied volatility likely compresses after the beat (short‑term options sellers benefit), and metal/silicon commodity impact is minimal.

Risk assessment: Tail risks include a sharper analog downturn, loss of hyperscaler design wins, or new US export controls curbing China AI demand—each could remove >$400M revenue upside and compress gross margins below guidance. Immediate (days) risk is a guidance‑driven stock pullback; short term (weeks) the market will reprice around AI run‑rate disclosures and exit timing; long term (quarters) the play depends on hitting gross margin >40% by Q4. Hidden dependency: concentration of a few large AI customers—loss of one account would materially hit the run‑rate; catalysts include customer design wins, margin cadence, and cadence of the $300M exits.

Trade implications: Tactical long exposure to ON is justified by cash generation and buybacks but should be size‑controlled until Q1 guide drift resolves—target 2–3% portfolio position with layering on pullbacks to $62–65 and trim into strength above $75. Use a call‑spread (e.g., Jul $70/$85) as a leveraged, defined‑risk way to play margin improvement; sell OTM puts (e.g., $60 strike 45–60 DTE) to collect premium and establish basis if comfortable owning. Pair trades: long ON vs short ADI/TXN to isolate AI power upside versus traditional analog cyclicality, horizon 3–9 months.

Contrarian angles: Consensus underweights ON’s FCF conversion and buyback tailwind—markets focus on near‑term EPS guide but underprice capital return; a disciplined execution that sustains 20%+ FCF margin should justify a $73+ target if AI run‑rate grows >20% QoQ. The guidance miss risk may be overstated if exits are one‑time and AI offsets continue; conversely, aggressive buybacks risk understating R&D investment and long‑term design leadership. Historical analogue: companies that moved from linear analog to power/AI content captured re‑rating once design wins scaled (timeline ~2–4 quarters).

Key Decisions for Investors

• Establish a 2–3% long position in ON (ticker: ON) with staggered entries: initial 1% at market, add to 2–3% on pullback to $62–65. Target $75–80 within 6–9 months; place a hard stop at 10% below average entry or if next quarter AI run‑rate < $350M.
• Implement a pair trade: go long ON (2% notional) and short Analog Devices (ADI) or TXN (1.5% notional short) to express relative AI power exposure. Hold 3–9 months; unwind if ON underperforms ADI/TXN by >12% or ADI/TXN announces >$300M incremental AI wins.
• Use options to express asymmetric upside: sell cash‑secured puts on ON at $60 strike (45–60 DTE) size = 1% portfolio to collect premium and establish a lower basis, and/or buy a Jul 2026 $70/$85 call spread (size = 1–2% portfolio) to cap cost while targeting >2x return if ON re‑rates.
• Set explicit monitoring triggers (action within 5 trading days): reduce ON position by 50% if quarterly disclosures show AI data‑center run‑rate growth <10% QoQ or aggregate exits exceed $350M; increase to full weight if gross margin guidance trajectory points to >40% by Q4.