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Onto Innovation (NYSE:ONTO) is riding the wave of AI semiconductor proliferation, as led by Nvidia (NVDA). The company is seeing a huge influx of demand for high bandwidth memory and advanced packaging products for semiconductor companies. This space of semiconductor equipment has proven to be lucrative, with companies directly involved seeing significant revenue acceleration with good visibility. Onto has recently called out strong growth in 2024 and into 2025, allowing for continued share gains. Looking at the financials, Onto is well positioned, with minimal China revenue compared to some of its closest competition in the space. While I would have the company as a strong buy, one must consider high revenue upside already baked into shares at current levels. The potential for further upside is significant as the industry pushes towards new technologies for the 2025 and 2026 semiconductor growth cycle.
Q2 - Results Assuaged Fears On 2H
The market was a bit anxious in the past month on the trajectory of growth, in part due to potential 'pauses' by the major AI players in spending. However, the big takeaway from the Q2 results and forward guidance were full steam ahead with continued improvement in sales. Total revenue of $242.3m was up 27% over 2023 and showed continued strength in many facets. The advanced packaging portion of the business continues to shine with $164 million in sales. The AI advanced packaging in particular was called out as $90m in sales and significantly ramping the past few quarters. This portion of the business is expected to grow over 70% in 2024, as additional customers add to their AI capabilities. The company also signed $300 million of new business into 2025 to increase visibility in this area even more. That said, this portion of the business is going to be down around 10% in the second half, explaining why the growth rate is slowing to ~21% in Q3. However, the major companies deploying their tools won't be done with planned fab expansions until 2026 at least. The Dragonfly system has been the biggest driver of revenue growth, but other systems are beginning to see outsized gains as well. ONTO also called out their new Jetstep X500 Lithography system as seeing initial sales interest and trialing at many of these large customers. It combines the ability of both glass and substrate capability in one tool, which will be important with the increasing complexity of interconnects. Often it takes some period before a full ramp begins in full for a product, but when it does, it can be a very significant boost in revenue. Advanced nodes are helping with a return to form, with 21% q/q growth, improving the product mix in Q2. Atlas and Iris systems have seen growth for gate-all-around applications, which are the next generation of technologies expected to ramp significantly in coming years at fabs. In terms of product-market fit, ONTO has the right technologies for the coming 2 years, allowing significant market share gains to come.
As you can see above, margins are beginning to improve, as inventory reductions and improvements in manufacturing are allowing for 53-55% for Q3, up 1% potentially over Q2. This will allow continued improvement in operating margin and earnings in the coming year as the company continues to scale in high-growth areas such as advanced nodes. Leaving the year at 55% is possible with continued growth and scaling in production. This has allowed for operating margin increased from 21% to 27% in 2024 Q2, allowing for significant increases in earnings. The company continues to invest in development of new products at a measured pace, with earnings continuing to scale higher with revenue in coming quarters. Earnings and cash flow are both increasing significantly with the increased sales and gross margin, with earnings nearly doubling y/y to $65.3m. Look for this to continue, albeit at a slower pace than over the past year, with some slowdown in Q3 of AI deployments while companies build out capacity.
Onto's Advanced Packaging Portfolio (ONTO IR)
The recent Intel guidance cut and reduction of capital expenditures had some worried, but ONTO things, it will have a minimal impact on sales in the coming year. This is due to the advanced nodes and leading tools provided being required to ramp programs for 2 nanometers or lower. These programs continue to advance, with 2025 being more pivotal on the logic and memory side than 2024, giving a strong outlook to come. The company has significant sales to the major players of Taiwan Semiconductor, Samsung and SK Hynix at 56% of revenues between the three. This concentration is very common for the equipment companies, with the cyclical nature making revenue volatile and lumpy at times. That is a risk that must be considered, with more potential upside - and downside, to revenues in these upcycle.
ONTO - Strong buy
While the stock is trading at a 37x forward PE multiple, Onto has big potential in the long term with the increasing complexity of semiconductor processes. This is year one in a longer-term trend of smaller and more dense semiconductors requiring additional steps. These buildout cycles can take years before peaking, and ONTO is set to benefit heavily in the coming few years. Management is doing well to improve margins and increase efficiency to help earnings momentum over time. For those looking for a name with high torque to the AI theme that isn't NVDA, ONTO is a great choice for growth investors.
