Revenue diversification driving growth

IQE 21 July 2016 Update

IQE

Revenue diversification driving growth

Trading update

Tech hardware & equipment

21 July 2016

Price

22.0p

Market cap

£148m

Net debt (£m) at 31 December 2015

23.2

Shares in issue

672.3m

Free float

88%

Code

IQE

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

20.6

0.0

(8.3)

Rel (local)

12.8

(3.8)

(7.0)

52-week high/low

26.75p

16.25p

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, infra-red semiconductors, power electronics and CPV solar cells.

Next events

Interim results

13 September 2016

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 ability to apply its epitaxial IP to multiple market segments is expected to deliver year-on-year revenue growth of over 15% for H116. In yesterday’s trading statement, management states that the group is on track to achieve full-year expectations. We leave our estimates unchanged, noting that this confirmation of growth through diversification should help catalyse an upwards rerating of the shares.

Year end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

12/14

112.0

16.2

2.42

0.00

9.1

N/A

12/15

114.0

17.6

2.60

0.00

8.5

N/A

12/16e

122.0

19.0

2.75

0.00

8.0

N/A

12/17e

127.8

21.9

3.16

0.00

6.7

N/A

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

Demonstrating benefits of diversification strategy

The key driver of the strong H116 revenue growth is the Photonics business. This is expected to show double-digit growth during H116, as multiple applications have started to transition to volume production. Growth is being driven by an increasing demand for VCSELs (vertical cavity lasers) in data communications, gesture recognition in consumer devices and industrial heating applications and for InP (indium phosphide) lasers in fibre optic communication systems. Photonics revenues are typically higher margin than those derived from wireless applications, so this trend is expected to have a beneficial impact on profits as well. Reassuringly, wireless revenues showed a small year-on-year increase, suggesting that the segment has stabilised. The move to leverage IP through involvement in JVs is also paying off, with licence income expected to total c £3.5m for the period.

Trading update provides support for estimates

A 15% increase in H116’s revenues (£53.2m to £61.2m) puts IQE in a good position to achieve our FY16 estimates. The business is typically weighted towards the second half because of customer ordering patterns. Moreover, the progress made on new product development and qualifications during H1 should result in additional volume business in H2. Brexit is not expected to have a material impact other than currency fluctuations – over 90% revenues are denominated in US$.

Valuation: Diversification key to rerating

IQE’s rating is undemanding and remains at a substantial discount to its peers. In our March note we identified the potential catalysts for an upwards rerating of the shares as continued revenue diversification, improvement in cash conversion as the RFMD wafer discount tapers off (completing FY16) and strengthening of the balance sheet as the final tranche of deferred consideration for Kopin is paid (completed H116). With wireless revenues stable and all three of these catalysts now present or close, the start of an upwards rerating should not, in our opinion, be far off.

Exhibit 1: Financial summary

£'000s

2014

2015

2016e

2017e

Year End 31 December

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

112,011

114,024

122,043

127,836

Cost of Sales (Inc D&A + SBP)

(80,459)

(81,585)

(89,092)

(92,042)

Gross Profit

31,552

32,439

32,952

35,794

EBITDA

 

 

27,009

29,001

31,169

34,469

Depreciation and Amortisation

(9,391)

(10,024)

(10,800)

(11,600)

Operating Profit (before amort. and except.)

 

 

17,618

18,977

20,369

22,869

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

17,160

19,660

Underlying interest

(1,429)

(1,403)

(1,343)

(1,007)

Exceptionals

(495)

(387)

0

0

Profit Before Tax (norm)

 

 

16,189

17,574

19,027

21,862

Profit Before Tax (FRS 3)

 

 

5,243

19,376

15,818

18,653

Tax

(3,247)

773

500

500

Profit After Tax (norm)

16,701

18,066

19,027

21,862

Profit After Tax (FRS 3)

1,996

20,149

16,318

19,153

Average Number of Shares Outstanding (m)

650.8

662.6

669.7

671.1

EPS - normalised fully diluted (p)

 

 

2.42

2.60

2.75

3.16

EPS - (IFRS) (p)

 

 

0.3

3.0

2.4

2.9

Dividend per share (p)

0.0

0.0

0.0

0.0

Gross Margin (%)

28.2

28.4

27.0

28.0

EBITDA Margin (%)

24.1

25.4

25.5

27.0

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

15.7

16.6

16.7

17.9

BALANCE SHEET

Fixed Assets

 

 

160,999

174,207

171,699

168,391

Intangible Assets

82,079

86,843

87,135

87,027

Tangible Assets

66,588

65,154

62,354

59,154

Other

12,332

22,210

22,210

22,210

Current Assets

 

 

48,323

48,909

48,328

75,690

Stocks

18,276

21,215

22,000

23,900

Debtors

24,463

23,050

24,000

27,000

Cash

5,584

4,644

2,328

24,790

Other

0

0

0

0

Current Liabilities

 

 

(46,667)

(48,050)

(42,857)

(45,757)

Creditors

(31,947)

(44,809)

(39,616)

(42,516)

Short term borrowings

(14,720)

(3,241)

(3,241)

(3,241)

Long Term Liabilities

 

 

(41,480)

(28,032)

(28,032)

(28,032)

Long term borrowings

(22,115)

(24,626)

(24,626)

(24,626)

Other long term liabilities

(19,365)

(3,406)

(3,406)

(3,406)

Net Assets

 

 

121,175

147,034

149,138

170,292

CASH FLOW

Operating Cash Flow

 

 

14,861

20,971

18,741

32,469

Net Interest

(1,428)

(1,403)

(1,343)

(1,007)

Tax

1,258

(459)

500

500

Capex

(9,426)

(10,002)

(9,500)

(9,500)

Acquisitions/disposals

0

0

(11,691)

0

Financing

278

544

977

0

Dividends

0

0

0

0

Net Cash Flow

5,543

9,651

(2,316)

22,462

Opening net debt/(cash)

 

 

34,351

31,251

23,223

25,539

HP finance leases initiated

0

0

0

0

Other

(2,443)

(1,623)

0

0

Closing net debt/(cash)

 

 

31,251

23,223

25,539

3,077

Source: IQE, Edison Investment Research

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Germany

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United Kingdom

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