Diodes (NASDAQ:DIOD) Could Easily Take On More Debt

Simply Wall St

Sat, Apr 23, 2022, 8:51 AM 4 min read

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Diodes Incorporated (NASDAQ:DIOD) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Diodes

What Is Diodes's Net Debt?

As you can see below, Diodes had US$301.0m of debt at December 2021, down from US$450.6m a year prior. But it also has US$370.1m in cash to offset that, meaning it has US$69.1m net cash.

debt-equity-history-analysis — NasdaqGS:DIOD Debt to Equity History April 23rd 2022

How Strong Is Diodes' Balance Sheet?

The latest balance sheet data shows that Diodes had liabilities of US$471.0m due within a year, and liabilities of US$420.7m falling due after that. On the other hand, it had cash of US$370.1m and US$358.5m worth of receivables due within a year. So its liabilities total US$163.1m more than the combination of its cash and short-term receivables.

Since publicly traded Diodes shares are worth a total of US$3.31b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Diodes also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, Diodes grew its EBIT by 105% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Diodes can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Diodes may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Diodes produced sturdy free cash flow equating to 75% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

We could understand if investors are concerned about Diodes's liabilities, but we can be reassured by the fact it has has net cash of US$69.1m. And we liked the look of last year's 105% year-on-year EBIT growth. So is Diodes's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 3 warning signs we've spotted with Diodes .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.