Onto Innovation: Pros And Cons Of Going Long (NYSE:ONTO)

Onto Innovation (NYSE:ONTO) continues to do very well from an operational standpoint. That has not changed this year. What has changed is the stock. The stock outperformed with a gain of over 100% in 2021, but the same can’t be said of 2022. The stock has fallen in 2022. In fact, the trend was decidedly bearish, giving people plenty of justification to keep their distance from ONTO. However, there are encouraging signs change is underway. Still, it may not be enough to convince everyone to get back in just yet. Why will be covered next.

Why the time may have come to go long ONTO

ONTO had an outstanding year in 2021 with the stock appreciating by 113%. However, the stock will need to do much better in the second half than the first half if it is to come close to equaling that kind of performance in 2022. The stock is down 19% YTD. The chart below shows how the stock has trended lower in what can be described as a descending channel.

However, the decline stopped when the stock reached what can only be support at the $70 region, which would not be so unusual since it happens to be a price level where the stock has managed to find support before. There were multiple attempts to break through support over the last two months, but they were all unsuccessful. No news lows have been set and it looks like the bottom is in, at least for the short term.

More importantly, the stock has broken through the resistance at the upper trendline of the descending channel. Note that there were several chances for the stock to fall back below the trendline after the initial breakthrough, but the stock managed to recover to close back above resistance on each occasion. This is a very good sign.

The stock also managed to briefly overtake the 200-day moving average, although the stock fell below it again on Friday. Still, the recent price action is encouraging. The trend seems to have shifted. The charts have leaned bearish for much of 2022, but after a period of consolidation with the stock going sideways, the stock appears to be on the verge of another move higher. The stock has gained 15% in the last two weeks.

Earnings growth still support the bull case

The charts suggest the time has come to place bets on ONTO after a long decline earlier in the year, but that is not the only reason. Earnings growth is another. While some suppliers of wafer fab equipment have encountered headwinds, especially due to supply chain disruptions in combination with COVID-19, ONTO has remained pretty much unscathed.

ONTO is still seeing sales and profits go up at a rapid clip. In fact, ONTO surpassed estimates and its own guidance with its most recent earnings report. Q1 revenue increased by 42.58% YoY to $241.4M, a record high. GAAP EPS increased by 118.37% YoY to $1.07 and non-GAAP EPS increased by 79.45% YoY to $1.31. Note that tax changes that went into effect at the start of 2022 reduced the tax rate from the usual 16-17% to 13-14%, which added about $0.05 to EPS. The table below shows the numbers for Q1 FY2022.

(GAAP)	Q1 FY2022	Q4 FY2021	Q1 FY2021	QoQ	YoY
Revenue	$241.350M	$225.644M	$169.279M	6.96%	42.58%
Gross margin	54%	55%	53%	(100bps)	100bps
Operating margin	24%	22%	16%	200bps	800bps
Operating income	$58.744M	$49.855M	$27.485M	17.83%	113.73%
Net income	$53.330M	$46.737M	$24.113M	14.11%	121.17%
EPS	$1.07	$0.94	$0.49	13.83%	118.37%
(Non-GAAP)
Revenue	$241.350M	$225.644M	$169.279M	6.96%	42.58%
Gross margin	54%	55%	54%	(100bps)	–
Operating margin	31%	31%	25%	–	600bps
Operating income	$74.264M	$69.036M	$41.874M	7.57%	77.35%
Net income	$65.628M	$61.218M	$36.339M	7.20%	80.60%
EPS	$1.31	$1.23	$0.73	6.50%	79.45%

Source: ONTO Form 8-K

Guidance calls for Q2 FY2022 revenue of $234-248M, an increase of 24.61% YoY at the midpoint. The forecast expects GAAP EPS of $0.90-1.09, an increase of 40.14% YoY at the midpoint, and non-GAAP EPS of $1.16-1.35, an increase of 36.41% YoY at the midpoint. Note that guidance does not include any contributions from lithography systems, which could potentially add another $20M to the top line.

	Q2 FY2022 (guidance)	Q2 FY2021	YoY
Revenue	$234-248M	$193.4M	20.99-28.23%
GAAP EPS	$0.90-1.09	$0.71	26.76-53.52%
Non-GAAP EPS	$1.16-1.35	$0.92	26.09-46.74%

ONTO is projected to grow revenue by 33% and non-GAAP EPS by 55% YoY in the first half of 2022. In addition, while guidance did not extend beyond Q2, ONTO did have some comments as to the outlook for the rest of FY2022. ONTO expects the second half of the year to be even stronger than the first half. From the Q1 earnings call:

“Based on the backlog, we have, we expect both products to increase in revenue in the second half of the year and continue to grow into 2023. So with end market demand expected to remain healthy through the year and the additional tailwinds from new applications such as panel lithography, 3D NAND and expansions in silicon wafer manufacturing, we maintain our view that the second half of 2022 will be stronger for Onto Innovation than the first half. Of course, this assumes no unforeseen supply chain or geopolitical impacts, which is certainly a factor, but remains very difficult to predict.”

A transcript of the Q1 FY2022 earnings call can be found here.

Keep in mind though that not everything is going perfect. For instance, ONTO is facing cost pressures, which has impacted gross margins somewhat.

“Gross margins were 54.3%, up from 53.8% in the same period a year ago and down from 54.9% in the fourth quarter. That has been widely publicized by others in the industry. We are experiencing multiple cost pressures from our supply chain that have impacted our gross margins. We have accelerated inventory deliveries to help mitigate unexpected supply chain disruptions. It impacted production and customer shipments or commitments.

We have also seen increases in commodity and chip pricing difficulty in supply availability and a significant increase in logistic costs due to high demand and China lockdowns, where possible we are working with suppliers to influence second sources and increase adoption of our newer higher value systems.”

Nevertheless, ONTO has been able to overcome these challenges to post strong earnings growth.

Valuations are fair

Valuations have also come down. The decline in the price of the stock combined with strong earnings growth have made sure of this. ONTO is now assigned an enterprise value of $3.6B after adjusting for the cash balance of $512M, which is equal to 14 times EBITDA on a trailing basis and 12 times EBITDA on a forward basis. The table below shows the multiples ONTO trades at.

	ONTO
Market cap	$4.12B
Enterprise value	$3.60B
Revenue (“ttm”)	$861.0M
EBITDA	$253.8M
Trailing P/E	23.94
Forward P/E	18.71
PEG ratio	0.13
P/S	4.72
P/B	2.76
EV/sales	4.18
Trailing EV/EBITDA	14.17
Forward EV/EBITDA	11.98

Source: Seeking Alpha

Why some might have second thoughts about ONTO

However, potential supply chain problems are not the only concern hanging over ONTO. One of the reasons why semis have drawn increased interest in recent years is because of the perception that the semiconductor industry is in the midst of a boom. Semiconductor demand is going up. So much so that there is talk of a semiconductor shortage.

However, the concern is that the semiconductor shortage could turn into a semiconductor glut, especially since companies are racing towards increasing their output. The semiconductor industry is still in good shape, but some investors are on the lookout for any evidence that the market is turning south.

There are signs a slowdown in demand is in the works. For instance, more and more companies are reporting a slowing in demand for several consumer goods that have driven up demand for semiconductors. This includes PCs and smartphones, two heavy users of semiconductor chips. Some companies have even been downgraded due to this.

The slowdown has yet to trickle down to equipment suppliers like ONTO and the backlog pretty much ensures the quarterly numbers will remain strong throughout FY2022. But the concern is what will happen in the following years. If there’s a perception of a looming downturn, investors may simply decide to bail out on ONTO, even if the quarterly numbers themselves don’t show any signs of any weakness.

Investor takeaways

Up until fairly recently, there was a pretty good reason why someone would want to stay away from ONTO. Stock prices were going lower with the stock moving down in a channel. However, the stock appears to have broken through the channel boundaries after weeks of consolidating. It looks like the downtrend that was in place for much of 2022 no longer applies.

The charts suggest long ONTO is the way to go. In addition, earnings are still growing at a strong clip. The outlook suggests the second half of 2022 will be even better than the first half, which was nothing to sneeze at. Valuations are also very fair. There are a number of reasons why people may decide the time has come for long ONTO.

I got out of ONTO earlier in the year as mentioned in a previous article. And while it’s tempting to get back in with recent developments and not going long could very well turn out to be a mistake, I would still not be a buyer at this point. There are certainly encouraging signs the stock has turned the corner, but the possibility of a downturn in the semiconductor market should not be ignored. Sales of consumer goods like TVs, PCs and smartphones have all gone down for a number of reasons.

Consumers seem to have less spending power due to several factors. For instance, rising inflation and less government stimulus have all taken a bite out of people’s wallets. It’s true there is not much evidence of a slowdown based on the quarterly numbers from ONTO, but it’s important to note that equipment suppliers are not the first to be hit by a fall in semiconductor demand. If consumer demand for things like PCs and smartphones continues to go down, then it’s only a matter of time before companies start cutting back on capital equipment spending from suppliers like ONTO.

Bottom line, while ONTO looks to be in good shape at the moment, there is reason to question for how long this can continue, especially as the industry takes its time to digest all the new capacity being added. Sales have been booming for the last two years or so and a temporary moderation in demand is likely, if not inevitable.

ONTO may not be there yet, but it could be heading towards a moderation in demand for wafer fab equipment. It all depends on whether demand for semiconductors remains strong or whether the initial signs of weakness that have been reported continue to spread. At the moment, there’s no way of telling which of the two is the more likely outcome. Staying put with regard to ONTO is probably best.