James Faulkner on IQE – Still waiting for a recovery

Investors in IQE are still awaiting a recovery at the world’s largest manufacturer of epitaxial semiconductor wafers.

In a trading statement for the six months ended 30th June 2014, the firm said it expected to report EBITDA of c.£11 million, up 5% on H1 2013, on revenues down 17% at c. £52 million. Revenues were impacted by the decline in Wireless due to customer destocking and the strength of sterling. Net debt is expected to be below £36 million, in line with forecasts.

Wireless demand is said to have begun to recover in Q2, and the firm spoke of seeing positive customer forecasts for the rest of the year. This outlook primarily reflects the acceleration of smartphone adoption in China, new handset launches, and the increasing adoption of new dual band Wi-Fi. 

Meanwhile, IQE expects to see 20% revenue growth in its Photonics business (in constant currency) against H1 2013, reflecting the transition from research and development to high volume production and a number of contract wins announced in the past year. The advanced solar (CPV) business is in the final stages of qualification and remains on track to move from customer qualification to production in H2. 

The company also hopes to transition towards volume production within the next two to three years with its advanced products including gallium nitride materials and compound semiconductor on silicon technologies, with a number of major technical and commercial milestones being delivered during the first half. These advanced technologies are poised to replace silicon and other materials in the rapidly growing markets for energy efficient devices such as LEDs and Power Semiconductors over the next few years.

Investors can be hopeful that today’s update is a signal that the decline in Wireless which has plagued IQE of late is about to abate, with several customers reporting an improvement in trading recently. The strength in Photonics is particularly pleasing as it holds out the prospect of IQE’s revenue profile becoming more diversified over the medium- to long-term, which should help mitigate some of the volatility in trading. Turning to the financials, the reduction in net debt represents a creditable performance in light of one-off reorganisation and restructuring cash costs of approximately £6.5 million during the year to 30th June 2014. However, forex could remain a drag in the second half.

For those who buy into the long-term strategic prospects of the business (and let’s remember, this is a company that Intel has courted in the past), there is a value case here.

At the current 20.25p the company is capitalised at £131.3 million. The shares now trade on 9.6 times consensus earnings forecasts for the current year to December, falling to 7.8 times for 2015. At some point, possibly as soon as H2, the smartphone market will pick up again and IQE’s wireless customers will begin restocking. Should this coincide with some significant growth in IQE’s other end markets, we could begin to see the current valuation looking way out of step. Broker N+1 Singer forecasts a free cashflow yield in double digits for FY15 and FY16.