Diodes Incorporated

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Diodes Incorporated is a global manufacturer and supplier of high-quality semiconductor products, offering a wide range of discrete, logic, analog, and mixed-signal semiconductor solutions, primarily used in the automotive, industrial, computing, consumer, and communication markets.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Diodes Incorporated (DIOD) operates within the semiconductor industry, a sector known for its cyclical nature and intense competition. The company designs, manufactures, and markets a broad portfolio of semiconductor products used in various electronic applications.

  • Revenue Distribution: DIOD serves diverse markets, including:
    • Industrial: Industrial applications are a significant revenue source for DIOD, including equipment, instruments, energy, and factory automation. In 2022, sales from the Industrial end market were 25%, in 2021 was 23% and in 2020 this was 18%
    • Automotive: The automotive segment has been growing in recent years due to increased technological integration in vehicles, which was 34% in 2022, 32% in 2021 and 28% in 2020.
    • Computing: Computing segment includes servers, PCs, and data centers, and was 18% in 2022, 17% in 2021 and 2020.
    • Consumer: The consumer market segment, which includes electronic devices, appliances, and gaming, was 18% in 2022, 18% in 2021 and 19% in 2020.
    • Communications: This segment includes all kinds of communication devices, from mobile phones, networking, and the internet infrastructure, contributed 10% to revenue in 2022, 11% in 2021 and 15% in 2020.
  • Competitive Landscape: The semiconductor market is highly competitive, with numerous players, both large and small, vying for market share. Key competitors range from large integrated device manufacturers like NXP Semiconductors and Texas Instruments to specialized companies. The industry has high fixed costs and is often subject to commoditization of products, intense pricing pressure, fast product cycles, and strong influence from suppliers and customers.
  • What Makes Diodes Different:
    • Broad Product Portfolio: DIOD’s wide range of semiconductor components spanning discrete, logic, analog, and mixed-signal solutions allows them to address many customer requirements.
    • Emphasis on Quality and Reliability: DIOD focuses on quality control and durability of its products and has achieved certifications in quality and availability in the supply chain.
    • Vertically Integrated Model: While not completely vertical, they manufacture a large portion of their chips, allowing more control over supply, costs, and quality.

Financial Analysis

  • Revenue Trends: The company has shown a growth in revenue from $1,109.5 million in 2020 to $1,949 million in 2022 but the first three quarters of 2023 was at $1,573 million indicating lower than the previous periods.
  • Margins: The gross margins have fluctuated but have been in the 32 to 34% range, and operating margins at around 15 to 17%. The company expects margins to continue to increase with higher revenues and by cutting back on costs.
  • Capital Allocation: As the company scales they are investing heavily in expanding production facilities and building out new products. In 2022, the company incurred approximately $144.3 million in capital expenditure. Most of these investments are intended to drive future growth. The company has allocated approximately 30% of its revenue to capex spending.
  • Key Financial Metrics:
    • Return on Invested Capital (ROIC): The ROIC has shown variability, but is generally positive. It was at 19.1% in 2021, but has decreased to 13.3% in 2022.
    • Debt: The company maintains a manageable debt level with a target debt to enterprise value at around 45%. However, the recent acquisitions of smaller companies (for example, the acquisition of Lite-On) and their debt has caused it to increase to 54% as of June 2023. They plan to continue to retire debt to reach their long-term goals.

Moat Analysis

  • Moat Rating: 2/5: DIOD has a narrow moat, based on the following:
    • Switching Costs: Some of DIOD’s products, particularly custom solutions for industrial and automotive applications, may involve moderate switching costs for customers, such as the costs of retraining employees. This helps to create some stickiness with their customer base.
    • Economies of scale: Scale gives DIOD a cost advantage over its smaller peers.
    • Product differentiation: Diodes specializes in very specific products that may be differentiated and more profitable.
  • Justification: While Diodes has some competitive advantages, these advantages may not offer long-term protection. The switching costs are relatively low for most applications. The company’s business is not unique and has numerous other competitors. Therefore, they do not have the pricing power that a company with a wide moat might have.

Moat Risks

  • Commoditization: The company’s products, for example the discrete segments, are inherently vulnerable to commoditization, and the company is unable to raise prices significantly even when demand grows.
  • Intense Competition: A highly competitive and cyclical market can affect pricing, market share, and overall performance. Companies could also lose their customers quickly with the advent of a better technology.
  • Technological Disruption: Rapid changes in technology and customer preferences can quickly make existing products obsolete.
  • Economic Cycles: The semiconductor industry is subject to economic cycles. Downturns can lead to lower demand and pricing pressure.
    • Supply Chain Issues: The company sources parts and materials from all over the world. A disruption in their supply chain can significantly affect revenue and the overall ability to deliver.

Business Resilience While the semiconductor industry is cyclical, Diodes maintains several business characteristics to create better resilience:

  • Strong customer base: They have a strong and diversified customer base and serve many different industries, which cushions the blow during any industry slowdown.
  • Good quality of management: Management is transparent, and gives out good outlooks and has been proactive in increasing production in anticipation of growing markets.
  • Product development: The company has an R&D department that is constantly working on new products in several of their product lines, showing innovation in the business.

Understandability: 3/5

  • While the basic business model is easy to grasp - designing and selling semiconductor components - the technicalities of the industry and the company’s position in it may not be known to the average investor. The number of different product lines also adds complexity. * The company’s financials are relatively easy to follow, which helps in understanding the overall business.

Balance Sheet Health: 4/5

  • Positive aspects:
    • The company has healthy operating cash flow and has sufficient ability to pay off current liabilities.

    • The company has been deleveraging, and although it has increased in the past few quarters, the company still has a manageable debt position.

    • Points of Concern:
      • The company’s equity capital ratio has slightly fallen in recent periods due to the company’s acquisitions.
      • The company carries significant goodwill in the balance sheets due to recent acquisitions which may or may not pan out.

Recent News and Developments

  • Acquisition of the Power and Analog Business of onsemi: The company has recently acquired another company to further increase revenue and profitability. The management is focusing on long-term growth through accretive acquisitions.
  • Inventory Correction: Management has stated that the market is still undergoing an inventory correction phase which has caused a decrease in demand and lower revenues. Management has been optimizing operations and expects a full rebound once inventories are depleted.
  • Capital Allocation: Management is prioritizing spending on R&D, and they plan to continue investing in new product development, as well as capacity for more production in the coming years.
  • Pricing environment: Management has stated that price competition is increasing, which may put pressure on revenues and profitability.
  • Macro Conditions: Management noted concerns about a global economic slowdown.