Rising Operating Costs And Fierce Competition Will Impair Semiconductor Margins

Key Takeaways

• Rising geopolitical pressures, regulatory demands, and supply chain localization are increasing Onto Innovation's costs and constraining long-term profitability potential.
  
• Intensifying industry competition and heavy reliance on a concentrated customer base expose Onto to margin compression and revenue volatility risks.
  
• Expanding demand for advanced packaging, product diversification, strategic acquisitions, and regional manufacturing are strengthening Onto Innovation's market share, revenue stability, and operational resilience.

Catalysts

Engages in the design, development, manufacture, and support of process control tools that performs optical metrology and inspection worldwide.

• The rapid acceleration in AI, high-performance computing, and specialty device markets has driven robust short-term demand for Onto Innovation's inspection and metrology tools, but as global semiconductor supply chains become increasingly localized due to geopolitical pressures and ongoing tariff changes, Onto faces a significant risk of elevated operating costs and potential market access restrictions. These factors threaten to erode future operating margins and limit long-term revenue growth.
  
• While Onto is highly exposed to expanding wafer volumes from new chip fabrication in the US and Europe, intensifying environmental regulations and increased scrutiny on energy-intensive manufacturing may force the company and its customers into costly compliance investments, directly squeezing net margins and reducing profitability over time.
  
• Although the company is expanding its product portfolio with advanced tools and the pending acquisition of Semilab product lines, the semiconductor equipment industry is seeing heightened competition and signs of commoditization, particularly in inspection and metrology. This could result in ongoing price pressure and force Onto to compete primarily on cost, undermining long-term gross margins and earnings.
  
• A heavy reliance on a few leading chipmakers and major OSATs for advanced logic packaging revenues exposes Onto to significant customer concentration risk, and any loss or reduction in orders from these key accounts – caused by shifting technology alliances or sustained overcapacity in the semiconductor industry – would drive revenue volatility and damage long-term earnings power.
  
• Despite strong near-term growth driven by AI packaging and advanced node spending, persistent global constraints on semiconductor demand from trade tensions, export controls, and cyclical industry overcapacity could flatten the overall market Onto serves, capping growth opportunities over the next decade and increasing the probability of pronounced revenue and earnings declines in periods of industry correction.

Onto Innovation Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Onto Innovation compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Onto Innovation's revenue will grow by 5.8% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 19.3% today to 28.5% in 3 years time.
• The bearish analysts expect earnings to reach $350.1 million (and earnings per share of $5.97) by about August 2028, up from $199.9 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 16.1x on those 2028 earnings, down from 26.0x today. This future PE is lower than the current PE for the US Semiconductor industry at 28.5x.
• Analysts expect the number of shares outstanding to decline by 0.79% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 10.09%, as per the Simply Wall St company report.

Onto Innovation Future Earnings Per Share Growth

Risks

• The accelerating adoption of AI logic packaging, 2.5D/3D integration, and high-value advanced packaging is driving strong customer demand for Onto Innovation's Dragonfly and 3Di platforms, positioning the company to capture increased revenue as these secular trends persist and expand.
  
• The recent acquisition of synergistic product lines from Semilab is expected to be immediately accretive to both gross margin and operating margin and is projected to increase earnings per share by over 10% in the first year, supporting long-term profitability and earnings growth.
  
• Onto Innovation's portfolio continues to diversify across advanced nodes, specialty devices, co-packaged optics, and materials characterization, reducing customer concentration risk and enabling more stable overall revenue streams even as end markets fluctuate.
  
• Data from multiple customers and end-market applications indicates Onto is expanding its wallet share and displacing incumbents, suggesting the company's innovation is translating into tangible market share gains, which would drive revenue and potentially higher earnings over time.
  
• The company's region-for-region manufacturing strategy to mitigate tariff exposure, alongside strong cash flows and a robust balance sheet, suggests improved operational resilience and enhanced margins, providing a buffer against global supply chain volatility and supporting stable or expanding net margins in the long run.

Valuation

• The assumed bearish price target for Onto Innovation is $90.0, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Onto Innovation's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $160.0, and the most bearish reporting a price target of just $90.0.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $1.2 billion, earnings will come to $350.1 million, and it would be trading on a PE ratio of 16.1x, assuming you use a discount rate of 10.1%.
• Given the current share price of $105.93, the bearish analyst price target of $90.0 is 17.7% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.