Analog Devices (ADI) is a semiconductor company focused on the analog market selling a wide range of products (over 75,000) into a diversified set of more than 125,000 customers.
The analog semiconductor market is the most attractive part of the industry, as the products are in most cases designed specifically for particular end-customer products and add a significant part of the value of the end product but are a very small part of the end cost. This results in ADI’s products typically having a long life cycle (over 7 years) and also pricing (as the cost is small and replacement is difficult). ADI’s largest two end markets are industrial equipment and autos, both of which have structural growth drivers. In industrial equipment, newer generations of machinery have significantly more functionality built into them at the machine level (rather than the remote computer systems that control them), and in autos, the move towards Electric Vehicles is driving a step change in semiconductor content. These trends should drive 7-10% revenue growth per annum over the cycle, providing a supportive medium term revenue backdrop.
Analog semiconductors have properties which do not require leading edge manufacturing capability, which enables ADI to have strong cash generation and attractive gross margins (74% in 2022). In addition, ADI has pioneered technology sharing arrangements with leading Taiwan based fabrication company, Taiwan Semiconductor Manufacturing Company (TSMC), such that ADI does around half of its own manufacturing and outsources the other half to TSMC. The manufacturing processes used are interchangeable, which enables ADI to take back a larger share of production in house in periods of weaker demand, hereby significantly lowering margin volatility over the cycle. We believe that ADI’s strong margins and ongoing cash generation are sustainable and with strong medium term growth outlook driven by the structural drivers in its end markets.
ADI has robust management of its main ESG risks, over a five-year period the company reduced water usage by 7% despite 70% revenue growth, and management have targets to increase the rate of water recycling in its operations. It also targets 50% reduction in Greenhouse Gas emissions by 2025. The company also stands to benefit substantially from the ongoing growth in Electric Vehicles, which is a significant driver of increased semiconductor content in cars.