Currency headwinds affect H121 performance

IQE 8 September 2021 Update
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IQE

Currency headwinds affect H121 performance

H121 results

Tech hardware & equipment

8 September 2021

Price

46p

Market cap

£369m

Net cash (£m) at end June 2021 (excluding £52.6m lease liabilities)

0.9

Shares in issue

802.2m

Free float

88.1%

Code

IQE

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(8.9)

(13.5)

(25.2)

Rel (local)

(9.7)

(15.1)

(39.7)

52-week high/low

88.3p

43.3p

Business description

IQE is the leading supplier of epitaxial compound semiconductor wafers globally. The principal applications include radio frequency semiconductors, devices for optical networks, vertical cavity surface emitting lasers and infrared semiconductors.

Next event

FY21 results

March 2021

Analysts

Anne Margaret Crow

+44 (0)20 3077 5700

Dan Ridsdale

+44 (0)20 3077 5729

IQE is a research client of Edison Investment Research Limited

IQE’s H121 results are in line with management guidance given in March that H121 revenue and EBITDA would be similar to H120 levels on a constant currency basis. However, currency headwinds resulted in an 11.5% year-on-year reduction in revenues and a 28.9% drop in adjusted EBITDA. Noting that the recovery in demand for epitaxy for 5G infrastructure applications is not now likely until FY22, we have revised our FY21 estimates, cutting PBT from £2.5m to £0.1m, while leaving our FY22 estimates unchanged.

Year end

Revenue (£m)

EBITDA
(£m)

PBT*
(£m)

EPS
(p)

DPS
(p)

P/E
(x)

12/19

140.0

16.2

(7.0)

(2.46)

0.00

N/A

12/20

178.0

29.9

3.2

0.29

0.00

158.6

12/21e

169.5

27.4

0.1

(0.04)

0.00

N/A

12/22e

185.4

39.0

6.8

0.63

0.00

73.0

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

H121 performance flat in constant currency terms

As flagged in the July trading update, H121 group revenues were £79.5m on a reported basis. The reported result was £10.3m lower than H120, which had been a record, reflecting £8.1m FX headwinds. On a constant currency basis, revenues fell by 2.5% year-on-year. Strong growth in wireless epitaxy for handsets was offset by a reduction in materials for 5G infrastructure. In the photonics segment, while the group has maintained its strong market share in VCSELs, the reduction in the size of VCSEL chips used for facial recognition technology in handsets led to a decline in the volume of epitaxial wafers required. EBITDA was affected by around £4.7m of FX headwind. Since adjusted EBITDA fell by £4.7m to £11.6m on a reported basis, the result was similar to H120 (£16.3m) on a constant currency basis.

FY21 performance to equal FY20 at constant currency

Management guidance for FY21 predicts group revenues and adjusted EBITDA similar to FY20 on a constant currency basis, at around £178m revenues and £30m EBITDA. This guidance assumes that demand for 5G handsets continues to be strong and that production of photonics epitaxy for VCSELs is stable. It also assumes that demand for 5G infrastructure applications will remain subdued until FY22. In July we noted potential downside to our estimates if infrastructure roll-outs were delayed to 2022. As this delay now seems the likely outcome, we are reducing our FY21 estimates, while keeping FY22 adjusted numbers broadly unchanged.

Valuation: Recovery dependent on 5G roll-out

IQE’s share price has fallen by over 30% since the FY20 results in March. At current levels, IQE is trading at a discount to the mean EV/EBITDA multiples of the sample of companies engaged in manufacturing VCSEL epitaxy. However, we believe share price recovery will require greater visibility of the timing of 5G infrastructure roll-out and of how many iPhone 13 models launched later this year will have world-facing time of flight (ToF) functionality.

H121 performance flat in constant currency terms

Wireless performance supported by handset demand

Wireless revenues declined by £3.9m year-on-year during H121 to £41.6m on a reported basis but in constant currency segmental revenues were slightly higher (0.9%) than H120. Continued strong growth (30% year-on-year) in GaAs (gallium arsenide) epitaxy for 5G handsets and Wi-Fi 6/6E routers offset a 53% year-on-year reduction in GaN-on-SiC (gallium nitride on silicon carbide)l materials for 5G infrastructure.

Rising demand for material used to make power amplifiers in handsets is consistent with statistics from the International Data Corporation (IDC), which reported global handset shipment growth of 19% year-on-year during H121 and an 12% increase compared with H119. The reduction in demand for 5G infrastructure applications reflects a temporary slowdown in new deployments in China. A report published by Grand View Research in July 2021 notes the coronavirus pandemic has delayed the implementation of 5G infrastructure because of disruption to the trials and testing required for verification of the stability and processing performance of 5G standalone networks and because some telecom regulatory authorities have postponed their 5G spectrum auctions. Despite these delays, the report predicts global market growth with a CAGR of 49.8% between 2021 and 2028, with demand driven by vehicle and connectivity, telehealthcare, delivery of ultra-high definition video, seamless video calls and augmented reality/virtual reality gaming, making deployment a question of ‘when’, not ‘if’.

Adverse impact of smaller VCSEL chip sizes

Photonics revenues dropped by £7.0m year-on-year to £36.4m on a reported basis but the decline was only 7.6% in constant currency. Management notes that the group is maintaining its strong market share in VCSELs. Since adoption of VCSELs in Android phones is still minimal and we have previously inferred that IQE’s major VCSEL customer is involved in the Apple supply chain, we now infer that the group is maintaining its share within the Apple supply chain. However the reduction in the size of VCSEL chips used for facial recognition technology in handsets was only partly offset by deliveries of increasing numbers of VCSEL chips for world-facing LiDAR applications as the application is included in more iPhone models. As a result, VCSEL revenues fell by 26% year-on-year. This reduction was partly offset by continued strong demand for epitaxy used in advanced sensing applications in the defence and security markets.

Group H121 performance as flagged in July trading update

As flagged in the July trading update, group revenues were £79.5m on a reported basis. The reported result was £10.3m lower than H120, which was a record, reflecting the FX headwinds commented on by management in March. These FX effects reduced reported revenue by £8.1m as the majority of revenues are earned in US$. On a constant currency basis, revenues fell by 2.5% year-on-year. Around half of the group’s costs are denominated in US$, so EBITDA was affected by around £4.7m of FX headwind. Since adjusted EBITDA fell by £4.7m to £11.6m on a reported basis, the result was similar to H120 (£16.3m) on a constant currency basis. Performance was therefore consistent with the guidance management issued in March that H121 revenue and EBITDA would be similar to H120 levels on a constant currency basis. Reported operating loss (after adjusting for share based payments and restructuring costs) was £0.9m (£4.3m profit H120). Taking into consideration c £4.2m FX headwind, this gives a year-on-year drop of c £1.0m, of which c £0.9m was attributable to increased depreciation and amortisation charges. The group would have generated a positive adjusted operating result in constant currency.

We note the company uses a typical layered hedging approach to smooth the effects of FX movements on receipts from customers, which are primarily denominated in dollars, when these are converted to pay for the sterling-denominated part of the cost base. This hedging does not make any difference to the reduction in reported revenues and EBITDA observed in H121, which are reporting variances.

Investment in new reactors consumes cash

Net cash (excluding finance lease liabilities) reduced by £1.0m during H121 to £0.9m at the period end. Cash generated from operations was £4.7m lower year-on-year at £10.4m as the prior year period was distorted by the reversal of impairments of intangible assets, non-cash provision movements and inventory write-downs. Capital expenditure was substantially higher than the prior year period (£6.1m vs £1.1m) because of advance payments on reactors for delivery in H221, while investment in capitalised R&D was lower (£1.8m vs £2.6m) reflecting a more disciplined approach to resourcing projects. (In this regard, we note that losses from the CMOS++ segment reduced year-on-year, demonstrating a more focussed approach to this long-term but strategic activity as well.) Management has announced that it has placed orders for three new (we estimate totalling more than £9m) and three refurbished Aixtron reactors for delivery in H221. These will increase capacity at the group’s facility in Taiwan by over 20%, supporting wireless growth from FY22 onwards. The group is also investing in capacity to support the multi-year strategic partnership with a major semiconductor foundry to develop epitaxy for 5G small cells and to support production of longer wavelength VCSELs that can be placed under an OLED screen, thus eliminating the “notch” in smartphones. This additional capacity is not expected to generate material revenues until FY23.

Management changes

In November 2020 Dr Drew Nelson, IQE’s founder and CEO, announced his intention to step aside from his current role once a successor had been found. A preferred candidate with relevant international semiconductor market experience has been identified, so Drew has stepped down as CEO and become a non-executive board member with the title of president, acting in an advisory and ambassadorial role for the business. He will also devote more of his time to the further development of the Compound Semiconductor Cluster in South Wales. Chairman Phil Smith has temporarily moved from a non-executive to an executive role to prepare the group for the new CEO appointment.

Outlook: Management expects FY21 performance to be similar to FY20 at constant currency

Management has provided guidance for FY21 for the first time, predicting group revenues and adjusted EBITDA similar to FY20 on a constant basis, that is around £178m revenues and £30m EBITDA on a constant currency basis. This guidance assumes that demand for 5G handsets continues to be strong and that production of photonics epitaxy for VCSELs and advanced sensing applications in the defence and security markets is stable. This view is supported by a report issued in June 2021 by IDC, which predicts that the worldwide smartphone market will reach a total of 1.38bn units in 2021, up 7.7% from the 1.28bn units shipped in 2020, following which shipments will reach 1.54bn units in 2025, giving a CAGR of 3.7% between 2020 and 2025. The guidance treats any uplift in VCSEL production related to unusually high uptake of the iPhone 13 as upside. It also assumes that demand for GaN-on-SiC epitaxy will remain subdued until FY22, treating a potential recovery in Q421 as upside. In July we noted potential downside to our estimates if infrastructure roll-outs were delayed to 2022. As this delay now seems the likely outcome, we are reducing our FY21 estimates, while keeping FY22 adjusted numbers broadly unchanged.

Changes to estimates

Exhibit 1: Revisions to estimates

FY20

FY21e

FY22e

Actual

Old

New

% change

Old

New

% change

Revenue (£m)

178.0

175.0

169.5

-3.1%

185.4

185.4

0.0%

Adjusted PBT (£m)

3.2

2.5

0.1

-97.1%

6.8

6.8

0.0%

Adjusted EPS (p)

0.3

0.2

(0.04)

N/A

0.6

0.6

0.0%

Capitalised R&D (£m)

5.4

8.0

8.0

0.0%

6.0

6.0

0.0%

PPE (£m)

5.0

25.0

25.0

0.0%

10.0

10.0

0.0%

Net (cash)/debt excluding finance leases at year end (£m)

(1.9)

4.7

11.5

143.9%

(11.8)

(3.9)

-67.3%

Source: IQE accounts, Edison Investment Research

We make the following changes to our estimates:

Revenues: We reduce our FY21 revenue estimate by £5.5m to reflect a delay in 5G infrastructure deployments.

Share-based payments: We increase these in line with H121 levels.

We leave our FY21 capital expenditure estimates unchanged as this is within management’s guidance, which it has reiterated, of £20–30m. We also leave our FY21 estimate of investment in capitalised R&D unchanged as this is within management’s guidance of £5–8m. This guidance was reduced from £7–10m, reflecting management’s more focused approach to R&D.

Valuation: Share price recovery dependent on the pace of 5G infrastructure deployment

Exhibit 2: Peer valuation

Name

Market cap ($m)

EV/sales 1FY (x)

EV/sales 2FY (x)

EV/EBITDA 1FY (x)

EV/EBITDA 2FY (x)

P/E 1FY (x)

P/E 2FY (x)

Epitaxy

LandMark Optoelectronics

731

8.0

6.2

14.9

11.7

31.4

22.8

Soitec

8,298

8.6

6.9

27.4

21.3

53.6

40.7

Visual Photonics Epitaxy

920

6.6

5.9

17.7

15.6

26.7

23.3

WIN Semiconductors

5,453

6.0

5.3

14.5

11.7

28.1

21.3

Opto-electronics

II-VI

6,501

2.2

2.0

8.6

7.7

16.6

13.7

EMCORE

285

1.4

1.2

7.5

6.3

11.2

9.9

Lumentum Holdings

6,472

3.3

3.0

9.7

8.8

15.3

13.4

Mean – Epitaxy and Opto-electronics

5.2

4.4

14.3

11.9

26.1

20.7

LandMark Optoelectronics

731

8.0

6.2

14.9

11.7

31.4

22.8

Visual Photonics Epitaxy

920

6.6

5.9

17.7

15.6

26.7

23.3

Mean – VCSELs

7.3

6.1

16.3

13.6

29.1

23.0

IQE

523

2.2

2.0

13.7

9.6

N/A

74.5

Source: Refinitiv, Edison Investment Research. Note: Prices at 7 September 2021.

We include a comparative valuation of IQE versus its broader (but imperfect) peer group below. At current levels, IQE is trading at a discount on an EV/sales and EV/EBITDA basis with regards to both the larger sample and the sample of companies engaged in manufacturing VCSEL epitaxy. It is trading above the upper bound of both samples with regards to P/E multiples. IQE has a broader product portfolio than its VCSEL peers. In addition, it can manufacture on multiple sites, which gives it relative resilience to US-China trade disputes. For these reasons, we believe it is reasonable for IQE to trade on EV/EBITDA and P/E multiples that are at the upper end of the VCSEL sample. However, we believe share price recovery will require greater visibility of the timing of 5G infrastructure roll-out, which will determine when GaN-on-SiC epitaxy sales start to pick up. It will also depend on how many iPhone 13 models launched later this year will have world-facing ToF functionality and when Android phones start adopting the technology, as these factors could potentially boost demand for VCSEL epitaxy.

Exhibit 3: Financial summary

£'000s

2019

2020

2021e

2022e

Year end 31 December

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

140,015

178,016

169,475

185,442

Adjusted Cost of Sales

(119,145)

(144,689)

(140,444)

(148,227)

Adjusted Gross Profit

20,870

33,327

29,031

37,215

EBITDA

 

 

16,246

29,919

27,374

38,953

Depreciation and Amortisation

(22,289)

(24,533)

(25,500)

(30,000)

Operating Profit (before amort. and except.)

 

 

(4,676)

5,386

1,874

8,953

Acquired Intangible Amortisation

0

0

0

0

Exceptionals

(14,897)

(10,638)

0

0

Share based payments

771

(265)

(1,500)

(1,500)

Operating Profit

(18,802)

(5,517)

374

7,453

Underlying interest

(1,606)

(2,165)

(1,800)

(2,200)

Exceptionals and losses from JVs

(4,540)

3,788

0

0

Profit Before Tax (norm)

 

 

(7,019)

3,221

74

6,753

Profit Before Tax (FRS 3)

 

 

(24,948)

(3,894)

(1,426)

5,253

Reported tax

(10,180)

1,001

(14)

(1,283)

Profit After Tax (norm)

(19,010)

2,702

60

5,470

Profit After Tax (FRS 3)

(35,128)

(2,893)

(1,440)

3,970

Average Number of Shares Outstanding (m)

787.2

797.2

801.6

802.2

EPS - normalised (p)

 

 

(2.46)

0.29

(0.04)

0.63

EPS - (IFRS) (p)

 

 

(4.51)

(0.41)

(0.22)

0.45

Dividend per share (p)

0.0

0.0

0.0

0.0

BALANCE SHEET

Fixed Assets

 

 

300,047

277,161

284,661

270,661

Intangible Assets

118,456

105,772

106,272

104,772

Tangible Assets

136,557

126,229

133,229

120,729

Other

45,034

45,160

45,160

45,160

Current Assets

 

 

72,533

94,125

78,995

102,810

Stocks

30,668

30,887

30,645

35,564

Debtors

33,065

38,575

37,145

40,645

Cash

8,800

24,663

11,205

26,601

Other

0

0

0

0

Current Liabilities

 

 

(32,646)

(48,545)

(44,016)

(47,078)

Creditors

(27,529)

(37,546)

(33,017)

(36,079)

Short term borrowings (including lease liabilities)

(5,117)

(10,999)

(10,999)

(10,999)

Long Term Liabilities

 

 

(69,491)

(62,306)

(57,306)

(57,306)

Long term borrowings*

(67,631)

(58,765)

(53,765)

(53,765)

Other long term liabilities

(1,860)

(3,541)

(3,541)

(3,541)

Net Assets

 

 

270,443

260,435

262,334

269,086

CASH FLOW

Operating Cash Flow

 

 

8,948

35,457

26,342

33,596

Net Interest

(671)

(1,142)

(1,800)

(2,200)

Tax

(151)

(993)

0

0

Capital expenditure and capitalised R&D

(41,834)

(10,402)

(33,000)

(16,000)

Acquisitions/disposals

10

(1,363)

0

0

Financing

712

240

0

0

Dividends

0

0

0

0

Net Cash Flow

(32,986)

21,797

(8,458)

15,396

Opening net debt/(cash)*

 

 

(20,807)

63,948

45,101

53,559

HP finance leases initiated

0

0

0

0

Other

(51,769)

(2,950)

0

0

Closing net debt/(cash)*

 

 

63,948

45,101

53,559

38,163

Closing net debt/(cash) excluding finance leases

 

15,970

(1,923)

11,535

(3,861)

Source: IQE accounts, Edison Investment Research. Note: *Including finance leases from FY19 onwards.


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This report has been commissioned by IQE and prepared and issued by Edison, in consideration of a fee payable by IQE. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

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This report has been commissioned by IQE and prepared and issued by Edison, in consideration of a fee payable by IQE. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

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Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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