Photonics growth supports upgrades

IQE 16 December 2016 Update

IQE

Photonics growth supports upgrades

Trading update

Tech hardware & equipment

16 December 2016

Price

38.00p

Market cap

£257m

Net debt (£m) at end June 2016

33.6

Shares in issue

675.3m

Free float

88%

Code

IQE

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

26.7

39.5

120.3

Rel (local)

23.3

35.0

93.0

52-week high/low

38.0p

16.2p

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 lasers, infrared semiconductors, power electronics and CPV solar cells.

Next event

FY16 results

21 March 2017

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 has announced that it will exceed current market expectations for both FY16 revenue and adjusted operating profit. This is primarily driven by strong growth in the photonics business, with a helping hand from sterling’s weakness, and highlights the benefits of IQE’s diversification strategy. We upgrade our FY16 and FY17 estimates, while maintaining a conservative stance and raise our valuation range from 40-45p to 45-49p.

Year end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

12/14

112.0

16.2

2.42

0.0

15.7

N/A

12/15

114.0

17.6

2.60

0.0

14.6

N/A

12/16e

129.0

20.3

2.88

0.0

13.2

N/A

12/17e

130.0

21.9

3.11

0.0

12.2

N/A

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

Photonics growth and forex effects benefit FY16

While trading was strong in multiple markets throughout FY16, with wireless revenues returning to growth, photonics remains the fastest growing business. The two key applications: vertical cavity surface emitting lasers (VCSELs), which are used in data communications, consumer and industrial applications; and indium phosphide (InP), which is used in fibre to the premises and other short-haul optical networks, are experiencing strong demand. Revenues also benefited from weakness in sterling throughout FY16. We raise our FY16 revenue and profit estimates to reflect these positive factors.

Photonics growth set to continue

Growth in photonics revenues is expected to continue. For example, Philips Photonics recently announced that it was to double VCSEL production capacity at its site in Ulm to reflect the huge potential for the devices in many applications. A recent report by Zion Research noted that the global VCSEL market was worth $760m in 2015 and forecasts 21.3% CAGR between 2016 and 2021. For IQE, confidence in continued growth in photonics revenues is underpinned by the progress made on customer qualifications for photonics applications during FY16. At this stage, our FY17 estimates model only relatively modest constant currency year-on-year revenue and profit growth.

Valuation: Photonics growth key to further re-rating

Although the share price has more than doubled from the low of 16.25p in June 2016, our analysis, which is based on peer group multiples, indicates that IQE’s rating remains undemanding relative to its peers. Our revision to the indicative valuation range of 45-49p (previously 40-45p) is based on the 2016 earnings upgrade, peers re-rating upwards and IQE’s diversifying revenue profile. Continued newsflow about photonics growth and stable wireless demand should help reduce the remaining discount to peers.

Estimates

We have made several adjustments to our estimates in response to the information in the trading update:

We have upgraded our FY16 revenue estimates by 6% to reflect the trading update, which noted that H2 revenues would be higher than H1. Our estimate implies a 49/51% H1/H2 split. As a high proportion of the group’s revenues are denominated in currencies other than sterling, this has a beneficial impact.

Management is anticipating strong growth in photonics volumes related to the progress made in customer qualifications during FY16. However, given the lack of forward visibility, we are taking a cautious stance at this stage, modelling only a small uplift in revenues in constant currency for FY17. The full year results in March will be the first opportunity to review this.

Our FY16 PBT and EPS estimates increase by 7% and 6% respectively. This reflects the fact that the majority of group costs are denominated in currencies other than sterling, as well as some reinvestment back into the business. As a result, our FY17 EBIT and EPS estimates are unchanged.

Our FY16 net debt estimate rises from £30.5m to £39.1m. This reflects higher capex (£18.0m vs £14.5m including capitalised R&D costs) and higher receivables (£33.0m vs £24.0m) resulting from weak sterling and a strong finish to the year. Our FY17 net debt estimate rises from £10.1m to £19.1m, reflecting the higher debt level at the end of FY16 and higher capex (£12.0m vs £9.5m). The higher capex costs are attributable to the investment required to support photonics growth While photonics epitaxy may be manufactured using the same tools as wireless epitaxy, the photonics wafers are significantly more complicated. This means that investment needs to be made in modifying the tools to cope with the increased complexity and in additional equipment to check on the quality of the output.

Exhibit 1: Revision to estimates

EPS (p)

PBT (£m)

Revenue (£m)

Old

New

% chg.

Old

New

% chg.

Old

New

% chg.

2015

2.60

17.6

114.0

2016e

2.73

2.88

+5.5

19.0

20.3

+6.8

122.0

129.0

+5.7

2017e

3.11

3.11

N/A

21.9

21.9

N/A

127.8

130.0

+1.7

Source: Edison Investment Research

Valuation

Although the share price has more than doubled from the 16.25p low in June, IQE’s rating still remains undemanding relative to its peers. This level of discount does not, in our opinion, appear justified, given that the factors which previously held the share price back (see below) have disappeared. Our indicative valuation range of 45-49p (previously 40-45p) is based on a comparison of IQE’s multiples with those of the peer group mean. Selecting the 45-49p range places IQE on multiples that are close to the mean of our sample. The uplift in the valuation is a combination of the upward revisions to our FY16 profit estimates and an increase in the sample means. We suggest that the increase in sample means is linked to investor positivity about the photonics sector, in which IQE is a significant participant. Further newsflow confirming photonics growth and stable wireless demand should help close the remaining valuation gap.

Exhibit 2: Multiples of listed peers

Company

Market cap

Current EV/Sales (x)

Next
EV/Sales (x)

Current EV/
EBITDA (x)

Next EV/
EBITDA (x)

Current P/E
(x)

Next P/E
(x)

Epitaxy

 

 

 

 

 

 

Visual Photonics Epitaxy Co

£219m

3.0

3.2

8.7

7.8

15.4

16.1

IntelliEPI Inc

£68m

2.6

2.4

12.2

10.1

22.3

18.4

Land Mark Optoelectronics Corp

£609m

10.0

8.9

16.3

13.7

24.0

21.8

SOITEC

£744m

4.4

3.6

26.1

19.8

91.3

42.9

Wireless

 

 

 

 

 

 

 

Broadcom

£56,845m

4.5

4.2

9.6

8.6

12.7

11.7

Qorvo Inc

£5,509m

2.4

2.2

7.3

6.6

11.9

9.6

Skyworks Solutions Inc

£11,248m

3.7

3.4

8.6

7.7

12.5

11.0

Opto-electronics

 

 

 

 

 

 

 

II-VI Inc

£1,577m

2.2

2.0

12.0

10.3

29.2

21.8

EMCORE Corp

£181m

1.5

1.4

12.1

10.0

20.8

18.1

Mean

 

3.0

2.8

10.8

9.4

18.6

16.1

IQE at 37.75p

£255m

2.2

2.1

8.7

8.3

13.1

12.1

IQE at 45p

£304m

2.5

2.5

10.2

9.7

15.6

14.5

IQE at 49p

£331m

2.7

2.7

11.0

10.5

17.0

15.8

Source: Edison Investment Research. Note: Grey shading indicates exclusion from mean. Calculated on historic debt. Prices at 14 December 2016.

We believe that a number of factors contributed to the substantial discount between IQE and its peers during H116. These included uncertainty over both the prospects for the wireless business and the timing and rate at which revenues in new non-wireless fields would grow. The company’s net debt and deferred consideration liability, together with the suppressing effect on cash flows of the RFMD wafer discounts, probably had an impact as well.

With regard to concerns about the wireless market, the interim results and recent trading update confirm that the destocking that bedevilled H215 is over and the market is growing again, albeit at a modest rate compared with five or six years ago. In addition, reliance on the wireless sector is reducing because of strong growth in photonics revenues and the creation of a new revenue stream from licence income. The announcement in both the interims and the trading update of strong growth in photonics gives reassurance that the contribution from this sector is here to stay. While there remains considerable uncertainty as to just how large revenues from this sector could become, our estimates treat the substantial growth that may result from existing photonics development programmes converting to volume deliveries as upside to FY17 performance. As revenues from volume photonics projects, as well as material revenues from power electronics or advanced solar are excluded from our FY17 estimates, there is no reason to apply a discounted multiple to reflect downside risk to earnings from these sectors.

Examining the potential cash flow and balance sheet concerns, both of these disappeared during H216. The RFMD wafer discount finished in H216, improving cash conversion and the deferred consideration balance was eliminated in full by the end of September 2016.


Exhibit 3: Financial summary

£'000s

2014

2015

2016e

2017e

Year End 31 December

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

112,011

114,024

129,003

130,034

Cost of Sales (Inc D&A + SBP)

(80,459)

(81,585)

(93,699)

(93,627)

Gross Profit

31,552

32,439

35,304

36,407

EBITDA

 

 

27,009

29,001

32,070

33,688

Depreciation and Amortisation

(9,391)

(10,024)

(10,200)

(10,800)

Operating Profit (before amort. and except.)

 

 

17,618

18,977

21,870

22,888

Acquired Intangible Amortisation

(1,101)

(1,208)

(1,208)

(1,208)

Exceptionals

(7,892)

5,398

0

0

Share based payments

(1,458)

(2,001)

(2,001)

(2,001)

Operating Profit

7,167

21,166

18,661

19,679

Underlying interest

(1,429)

(1,403)

(1,543)

(1,020)

Exceptionals

(495)

(387)

0

0

Profit Before Tax (norm)

 

 

16,189

17,574

20,327

21,868

Profit Before Tax (FRS 3)

 

 

5,243

19,376

17,118

18,659

Tax

(3,247)

773

500

500

Profit After Tax (norm)

16,701

18,066

20,327

21,868

Profit After Tax (FRS 3)

1,996

20,149

17,618

19,159

Average Number of Shares Outstanding (m)

650.8

662.6

670.1

675.3

EPS - normalised fully diluted (p)

 

 

2.42

2.60

2.88

3.11

EPS - (IFRS) (p)

 

 

0.25

3.00

2.60

2.84

Dividend per share (p)

0.0

0.0

0.0

0.0

Gross Margin (%)

28.2

28.4

27.4

28.0

EBITDA Margin (%)

24.1

25.4

24.9

25.9

Operating Margin (before GW and except.) (%)

15.7

16.6

17.0

17.6

BALANCE SHEET

Fixed Assets

 

 

160,999

174,207

180,799

180,791

Intangible Assets

82,079

86,843

87,135

87,427

Tangible Assets

66,588

65,154

71,454

71,154

Other

12,332

22,210

22,210

22,210

Current Assets

 

 

48,323

48,909

58,528

67,196

Stocks

18,276

21,215

23,760

24,260

Debtors

24,463

23,050

33,000

34,200

Cash

5,584

4,644

1,768

8,736

Other

0

0

0

0

Current Liabilities

 

 

(46,667)

(48,050)

(47,857)

(48,357)

Creditors

(31,947)

(44,809)

(44,616)

(45,116)

Short term borrowings

(14,720)

(3,241)

(3,241)

(3,241)

Long Term Liabilities

 

 

(41,480)

(28,032)

(41,032)

(28,032)

Long term borrowings

(22,115)

(24,626)

(37,626)

(24,626)

Other long term liabilities

(19,365)

(3,406)

(3,406)

(3,406)

Net Assets

 

 

121,175

147,034

150,438

171,598

CASH FLOW

Operating Cash Flow

 

 

14,861

20,971

13,882

32,488

Net Interest

(1,428)

(1,403)

(1,543)

(1,020)

Tax

1,258

(459)

500

500

Capex

(9,426)

(10,002)

(18,000)

(12,000)

Acquisitions/disposals

0

0

(11,691)

0

Financing

278

544

977

0

Dividends

0

0

0

0

Net Cash Flow

5,543

9,651

(15,876)

19,968

Opening net debt

 

 

34,351

31,251

23,223

39,099

HP finance leases initiated

0

0

0

0

Other

(2,443)

(1,623)

0

0

Closing net debt

 

 

31,251

23,223

39,099

19,131

Source: Company accounts, Edison Investment Research

Edison, the investment intelligence firm, is the future of investor interaction with corporates. Our team of over 100 analysts and investment professionals work with leading companies, fund managers and investment banks worldwide to support their capital markets activity. We provide services to more than 400 retained corporate and investor clients from our offices in London, New York, Frankfurt, Sydney and Wellington. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2016 Edison Investment Research Limited. All rights reserved. This report has been commissioned by IQE and prepared and issued by Edison for publication globally. 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. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US 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. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. 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. This document is provided 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.
Edison has a restrictive policy relating to personal dealing. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. 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. 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 (ie 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. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2016. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

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

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

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

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

Edison, the investment intelligence firm, is the future of investor interaction with corporates. Our team of over 100 analysts and investment professionals work with leading companies, fund managers and investment banks worldwide to support their capital markets activity. We provide services to more than 400 retained corporate and investor clients from our offices in London, New York, Frankfurt, Sydney and Wellington. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2016 Edison Investment Research Limited. All rights reserved. This report has been commissioned by IQE and prepared and issued by Edison for publication globally. 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. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US 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. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. 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. This document is provided 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.
Edison has a restrictive policy relating to personal dealing. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. 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. 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 (ie 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. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2016. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

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

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

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

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

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