Ladislav Kubeš/iStock via Getty Images
Ladislav Kubeš/iStock via Getty Images
DIODE Inc (NASDAQ:DIOD ) is a semiconductor company that has been riding the secular tailwinds of the recent semiconductor boom. It produces over 29,000 products, serving over 50,000 customers, and these products are used across multiple end-user product categories each promising a huge total addressable market. This makes DIOD less susceptible to market fluctuations driven by either specific customers or specific end-user applications.
DIOD is a well-managed company that is financially strong and has been growing its top and bottom line over the years, despite operating in a cyclical industry. DIOD is a profitable growth stock that is anticipated by analysts to keeping growing earnings between 15% to 40% for the next few years, which could potentially provide investors with a nice return in 12-18 months.
At the closing price of $73.76 on 20 May 2022, I believe DIOD offers investors an opportunity to invest in a growing company at a price that is below its fair value.
According to the company's profile page,
Diodes Incorporated, a Standard and Poor's Smallcap 600 and Russell 3000 Index company, is a leading global manufacturer and supplier of high-quality application-specific standard products within the broad discrete, logic, analog, and mixed-signal semiconductor markets. Diodes serves the consumer electronics, computing, communications, industrial, and automotive markets.
Our products include diodes; rectifiers; transistors; MOSFETs; GPP bridges; GPP rectifiers; protection devices; function-specific arrays; single gate logic; amplifiers and comparators; Hall-effect and temperature sensors; power management devices, including AC-DC converters and controllers, DC-DC switching and linear voltage regulators, voltage references, and LED drivers; along with special-function devices, such as USB power switches, load switches, voltage supervisors, and motor controllers. Diodes also has timing, connectivity, switching, and signal integrity solutions for high-speed signals.
The company's strategy is stated in its market focus, which is on
high-growth, end-user applications in the following segments:
It is clear why the company invests in these markets as there are wide user applications in all of these. Almost everyone would know at least one person with a smartphone, a smartwatch, an oven, a car, a laptop, or a tablet, who stores information in the cloud, etc.
Diode Inc has performed consistently well over different time frames. By consistently, I am referring to a general uptrend in terms of top-line revenue (green bars) and gross income (red bars).
DIOD operates in the cyclical semiconductor industry so it is not unusual to see some cyclicality in terms of its net operating cash flow. What is important to note it has been trending higher over the years, having increased from $14.9 million in 2021 to $338.5 million in 2021.
Free cash flow per share and earnings per share have both demonstrated double-digit increases over the past five years, 24.6% and 73.28% CAGR respectively. According to the analysts' forward consensus estimates as recorded on Seeking Alpha, DIOD is expected to grow its free cash flow per share by 40.26% and its earnings per share by 44.09%.
Yes, current liabilities have also increased over the same period but the growth in operating cash flow at a CAGR of 16.89% outpaces the growth in current liabilities (14.97%). Plus, its total current assets of $1.2 billion (pale green bars) are more than sufficient to pay off all the current liabilities of $471 million (pale green bars) and long-term debts of $287 million (blue bars) at once, so this is definitely a financially sound company that is in no danger of going out of business.
As mentioned, DIOD operates in the cyclical semiconductor industry and serves over 50,000 customers through its 29,000 products. The end-markets are mainly industrial (23%), communications (16%), consumer (19%), computing (30%) and automotive (12%).
As you are well aware, semiconductor industry participants both big and small go through periods of boom and bust, periods when demand outstrips supply, leading to a boom and the inevitable increase in capacity, which in turn leads to a period of excess supply that results in a drop in unit prices, reduced earnings, and lackluster stock performance. Therefore, it is important to note at which point of the cycle the semiconductor industry is currently in.
According to research from World Semiconductor and Trade Statistics (WSTS) and Semiconductor Industry Association (SIA) Factbook (page 2),
Worldwide semiconductor sales increased from $139.0 billion in 2001 to $555.9 billion in 2021, a compound annual growth rate of 7.18 percent per year. According to the World Semiconductor Trade Statistics (WSTS) Fall 2021 Semiconductor Industry Forecast, worldwide semiconductor industry sales are forecasted to reach $601 billion in 2022 and 633 billion in 2023.
That consistent growth is good news indeed. And more recently in Q1 2022, semiconductor sales ramped up as the much-publicized chip shortage due to supply chain issues continued to drive demand with record sales in the $10-12 billion per week range.
Among the markets that DIOD targets are logic, analog and power, and based on the Weekly Semiconductor Sales Growth chart from Techinsights, despite the deceleration that started in June 2021, the growth for logic (amber) and analog and power (maroon) is still strong at around 20% each.
Also, according to the IC Supply/Demand Heat Map from Techinsights, the demand for Analog and Power is still tight as of Q1 2022.
DIOD has strategically adjusted its product mix to redirect efforts to increase its market share in the Computing and Automotive end-markets, rising from just 26% of total sales in 2019 to 32% in 2021, a 23% pivot in a mere three years. DIOD's acquisition of Pericom, a mixed-signals integrated circuit maker supports the company's growth ambitions in the Computing and Consumer end-markets.
In the 2021 annual report (page 34), it was reported that:
Contributing to the Company's growth in net sales has been the success of our focused expansion initiative in the automotive market where revenue grew over 59% when compared to year 2020, generating an 8-year CAGR of 30%. Additionally, our Pericom product line continued to set new revenue records, achieving 5 consecutive quarters of growth.
Perhaps that is too strong a word but just think about where do all these semiconductor products go to? There are countless use-cases, from expensive electric vehicles, smartphones, laptops, desktops, and high-definition televisions, to everyday products like led light bulbs, rice cookers, sensor-operated soap dispensers, ovens, air conditioning units, elevators, etc. There are also use cases in aviation and the military and those fall under the category "government".
Take for instance the automobile market, the market segment that DIOD is directing more attention to.
Cars need numerous semiconductor chips to help the users control everything from the windows to the airbags, braking system, fuel management, and even parking assistance technology. According to a report by the Economist Intelligence Unit (EIU) titled "Automotive in 2022", the author believes that the "recovery in global automotive markets will continue in 2022, with new-vehicle sales racking up similar growth rates to those of 2021." Furthermore, the author "expects new-car sales to rise by 7.8%, year on year, while sales of new commercial vehicles (CVS) will increase by 7.1%. This will take total sales back past 2019 levels, reversing the pandemic-induced slump of 2020."
The author acknowledged that the global shortage of semiconductors, a key automotive component, will continue to hit automakers’ ability to service rebounding demand, and believe that the chip crunch to last well into 2022 before easing in the second half of the year.
And the fastest-growing subsegment of the automobile market would be the electric vehicle market. According to Allied Market Research, the global electric vehicle market was valued at $163.01 billion in 2020, and that was projected to reach $823.75 billion by 2030, registering a CAGR of 18.2% from 2021 to 2030.
DIOD is capturing the growth in this segment. In the latest 10Q (page 20), the company stated:
Net sales increased approximately $69.0 million, or 16.7%, for the three months ended March 31, 2022, compared to the same period last year. This increase was driven primarily by revenue growth in the automotive and industrial end markets along with continued growth in our Pericom-branded products... Strong revenue and margin performance continues to be driven by records achieved in the automotive end market, which reached 13% of revenue, the industrial market, as well as for our Pericom products
The products DIOD make are critical in making sure that expensive end-products like automobiles can be actually manufactured. This article clearly illustrates the situation faced by car manufacturers in 2021 when they could not build a car that can be sold for $50k because they did not have a $5 component. I am not referring to high-tech 3-5nm chips but even without the older 200nm chips, stuff could not be built.
The investor presentation slide that comes next illustrates the functionalities that DIOD's products enable in a typical automobile.
And this is not the only growth end-market that DIOD is targeting. It has its eyes on the huge smartphones, laptops, and desktops markets as well.
Take for instance smartphones. Sales of the products in these categories were rising up till the time of the pandemic, which naturally caused a slowdown due to lockdown and supply chain issues. The figures as of 2021 have already started to pick up.
Sales of desktop PCs, laptops, and tablets are experiencing a similar trend and have started to pick up from the slumps of 2021.
And DIOD has certainly captured part of this global growth in these devices. According to the recent 10Q, the Communications, Consumer and Computing segments remain robust totaling 61% of total sales.
In fact, these three segments are responsible for 26% of the year-on-year increase in net sales, equivalent to the percentage increase in sales in the automotive segment.
With the economy opening up, there is a slowing down of chips in some categories with procurement managers stocking up inventory, moving from a "just in time" to a "just in case" procurement model to preempt a similar chip shortage situation akin to that in 2021.
So does this spell the start of the end for companies like DIOD?
I refer you to the Annual IC Sales Growth chart below by Techinsights. Although we are off the peak period dubbed "The Great Shortage" on 2 July 2021, demand remains high and seems to be plateauing akin to the period between 2013 to 2015 rather than plunging like in some of the previous cycles after peaking (see 22 December 2017 and 26 February 2010).
I believe there is still room to grow in this semiconductor cycle to carry positive sales forward for the next 12-18 months. That view is supported both by the data from the Annual IC sales Growth (above) and the Q1 2022 Weekly IC Sales Trend (below) from Techinsights which has been tracking weekly IC sales since 2007. IC sales remained strong and in fact showed a reversal towards the end of Q1 2022. That reversal could be due to a further supply chain crunch with the lockdowns across some 45 cities in China, container congestion in the world's busiest port of Shanghai, and the terrible ongoing war in Ukraine that has impacted half of the world's neon gas production which is used in the lithography step of the complex chip-making process, and if these unfortunate situations do not come to an end soon, the supply-chain issues can continue to create uncertainties that make it difficult for procurement managers to return to a "just in time" procurement model.
Finally, from the "Weekly IC Sales Track since 2007" graph below, you can see that a typical cycle lasts 2-3 years. We are currently around 1-year into this cycle so there may be another 1-1.5 years left before sales revert back to or even dip below the historical average sales trend.
I will continue to track this sales trend and update this article in the comments section if necessary.
DIOD is a conflicting stock. The SA author who covered DIOD extensively in the past few quarters is MarketGyrations, pointed out the strong fundamentals of this company for the recent four quarters while giving it a hold rating.
MarketGyrations wrote the following in Oct 2021:
In terms of earnings, DIOD is doing fine. DIOD has been breaking records in recent quarters and Q2 FY2021 was no different. Not only did DIOD surpass estimates for the top and the bottom line, but it also broke existing records while doing so. Q2 revenue increased by 52.6% YoY to $440.4M, a new all-time high. Pericom revenue was a standout once again.
In terms of end markets, computing accounted for 30% of revenue, industrial 22%, consumer 19%, communications 17% and automotive 12%. As for the bottom line, GAAP EPS increased by 205% YoY to $1.22 and non-GAAP EPS increased by 122.2% YoY to $1.20, both record highs. EBITDA increased by 79.8% YoY to $99.4M, which is also a new record.
The same author noted the following exactly a year ago in April 2021:
It's worth pointing out that the stock has done very well in recent years. The stock has been in an uptrend for years as shown in the chart below. While DIOD has gone through some ups and downs, it has consistently managed to end the year higher than where it started the year. The stock has more than quadrupled in the last five years. Such a track record should not be dismissed.
Insider selling has been rampant although to be fair, the most recent insider transaction indicated a buy from Francis Tang, Senior Vice President World Wide Discrete Products.
A discerning investor should also be aware of other risk factors by perusing pages 24 to 26 of the most recent 10Q.
Like I said in the beginning, I believe that DIOD is undervalued at the current price of $73.76. I examined DIOD over a 12-year time frame, starting from 2010, as that was the time when smartphones really started to take off, thanks to Steve Jobs and Apple (NASDAQ:AAPL). During this period, DIOD average P/E was around 23.28. As of closing on 20 May 2022, it traded at a blended P/E of 12.63 which is far below average P/E. The blended P/E takes into account the P/E TTM of 12.91 and forward P/E of 11.48.
DIOD does not trade in the P/E 11-12 range much. In previous down cycles, the few times DIOD ever traded at these levels are shown below:
At the current blended P/E of 12.63, I believe that DIOD is ready to rebound because the fears of the imminent semiconductor downturn have already been factored into the stock price, which partially explains its 32% price decline since it peaked in December 2021 when it was trading near its historical average which for DIOD is considered rich.
Between the 15% annual growth rate for the next five years by the analysts who report their forecast to Yahoo Finance, or the 18.5% long-term annual growth rate forecasted by FactSet analysts or the 40% growth rate by the folks at S&P Market Intelligence, I chose the more conservative 15% growth rate to do a projection.
In this P/E base case scenario, I assumed that
... and I arrived at the possibility that DIOD could return 22.78% annualized.
From the Price-to-sales perspective, DIOD trades at a P/S of 1.8 which is close to its historical P/S average of 1.73.
In this P/S base case scenario, I assumed that
... and I arrived at the possibility that DIOD could return 6.99% annualized.
Assuming both scenarios have a 50% chance of happening, I average the two final prices of $102.75 and $82.26 and got the possible 18-month price target of $92.505, representing a 25.4% upside (or 16.9% annualized) by December 2023.
I do not copy investment ideas the way Monish Pabrai describes his "shameless cloning strategy". Rather, I sought to learn from my betters and I feel better when I am investing alongside much more experienced investors.
I like the fact that several whales have found DIOD, a tiny $3.3 billion market cap company interesting enough to increase their stakes in it over the past 2-3 quarters.
Well-known value investor and author of "The Little Book that Beats the Market" Joel Greenblatt invested $1.94 million into DIOD in the last three quarters. His average entry price in all of these times are higher than the current price of DIOD. It is interesting to note that Greenblatt has traded DIOD over a dozen times since 2014 and had netted gains of 146% to date, so he knows a thing or two about the best times to buy DIOD.
Another whale who invested in DIOD in the last two quarters is Ken Griffin, founder and Chief Executive Officer of Citadel, a global alternative investment firm. He has traded DIOD over 30 times and made 100% gains so far. Again, all his entry price were above DIOD's current price.
When I can invest into the shares of companies that professional and successful investors are currently holding, and at a lower cost basis than them, that gives me a greater sense of what my margin of safety could be since it is less likely that these folks will be selling their stake at a loss.
DIOD is a small semiconductor company that I believe is flying under the radar of many retail investors who are fixated mainly on the large-cap names in the same sector. DIOD is well-run, profitable, and nimble with an experienced CEO Dr. Keh-Shew Lu at its helm since 2005. He has guided the company for close to 2 decades of impressive growth. $10,000 invested in DIOD since the start of 2002 would have turned into $73,336, a return that beats the S&P 500.
DIOD is a growth stock that is anticipated by analysts to keeping growing earnings at double-digit rates between 15% to 40% for the next few years, and that could potentially provide investors with a nice return in 12-18 months. That is entirely possible with the company riding the secular tailwinds of the growing automobile and electric vehicle market, as well as gaining market share in the huge computing, consumer and communication end-markets. DIOD is well-capitalized and has the funds to fuel further growth through strategic acquisitions.
Buying in a company that operates in a cyclical industry can be difficult. Since DIOD is trading at a P/E of 12.63 as of 20 May 2022, a price multiple close to the lowest it has ever been in its past, and considering the average P/E for DIOD is 23.28, that suggests that DIOD could be near or at its bottom so starting a position at this price provides a margin of safety.
However, DIOD is not a buy-and-forget-about-it type of stock. This is a contrarian idea that requires close attention and monitoring as the thesis is based on the premise that demand for DIOD's products will continue to stay strong while some prevailing wisdom seems to suggest the reopening of the global economy spells doom for semiconductor chip makers with increasing chips inventory, reduced demands for gaming consoles and computing devices since people will be going out more and spending more of their discretionary income on experiences rather than on stuff. Investors should take note that DIOD operates in the cyclical semiconductor industry and if the supply chain crunch is resolved earlier than anticipated, that could imply further deceleration in the demand for its products. Hence, I would suggest trading this with a 12-18 month time frame in mind.
This article was written by
Disclosure: I/we have a beneficial long position in the shares of DIOD either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.