Short-term VCSEL slowdown hits profits

IQE 15 November 2018 Update
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IQE

Short-term VCSEL slowdown hits profits

Trading update

Tech hardware & equipment

15 November 2018

Price

56.25p

Market cap

£437m

Net debt end June 2019 (£m)

40.6

Shares in issue

776m

Free float

95.5%

Code

IQE

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(30.4)

(45.7)

(68.0)

Rel (local)

(30.6)

(41.2)

(66.2)

52-week high/low

178.8p

56.2p

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 events

Prelims

March 2019

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 an immediate slowdown in shipments of VCSEL wafers, which materially affects FY18 revenues and profitability, and has issued revised guidance. Although we have cut our EPS estimates by 43% and 24% for FY18 and FY19 respectively, we note this is a short-term problem that does not impact the prospects for photonics growth in the medium term. Our revised estimates give an indicative value of 73p/share.

Year end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

12/16

132.7

20.6

2.89

0.0

19.5

N/A

12/17

154.5

24.3

3.36

0.0

16.7

N/A

12/18e

162.5

16.8

1.81

0.0

31.1

N/A

12/19e

194.8

34.1

3.48

0.0

16.2

N/A

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

Short-term impact on revenues and profitability

On Monday, IQE announced that earlier that day one of its customers in the VCSEL supply chain, had received notice from one of its largest customers for 3D sensing laser diodes that it was materially reducing shipments for the current quarter IQE ramped up production for this application (which we previously inferred is for FaceID in new iPhones) during H217, following which production dropped back as the inventory overbuild was worked through, so IQE only started to build-up inventory for this application again this quarter. It now has to cut back production for this application. The temporary dip in production will materially affect FY18 revenues and profitability.

Other volume VCSEL programmes reduce risk

We note that the lull in VCSEL production for Apple is not the result of IQE losing a customer to a competitor, so shipments are expected to resume by Q219. Although Apple warned in June that demand for new iPhone parts could decline by 20% in H218, FaceID is included in three of the models launched in H218, rather than just one model in H217, so we believe consumer demand is less likely to be the cause of the set-back than availability of OLED panels, where Apple is rumoured to have issues. Component availability can be addressed relatively easily, supporting our view that volume production will resume by Q219. We note that IQE is involved in VCSEL ramp-ups for at least eight customers engaged in several market segments, providing alternative sources of photonics growth and reducing the risk of destocking in future.

Valuation: Upside when confidence returns

Using our revised estimates as the basis for a DCF analysis gives an indicative valuation of 73p/share. Modelling segmental growth from FY20 onwards at the high end of management guidance provided in September gives an indicative valuation of 132p/share. We see potential for share price improvement as investor confidence in photonics demand returns.

Revisions to estimates

Exhibit 1: Management revenue guidance

Previous FY18 guidance*

Previous FY18e Edison

New FY18 guidance*

New FY18 Edison

Previous FY19 guidance*

Previous FY19e Edison

New FY19 guidance

New FY19 Edison

3-5 year guidance*

Wireless growth

0-5%

4.0%

8%

4.5%

0-5%

1.5%

-

5.0%

0-10%

Photonics growth

35-50%

40.0%

11%

9.0%

40-60%

40.0%

40-60%

50.0%

40-60%

Infrared growth

5-15%

7.0%

15%+

12.0%

5-15%

7.0%

5-15%

12.0%

5-15%

Licence income

£0m

£0m

£0m

£0m

£0m

£0m

£0m

£0m

£0-2m

Source: Edison Investment Research, company statements. Note: *Constant currency.

Following the announcement on Monday that it had received notice from one of its largest customers for 3D sensing laser diodes, management has assessed the impact on FY18 and FY19 performance. On Tuesday it issued revised guidance, which is summarised in Exhibit 2. It now expects to deliver revenues of around £160m for FY18 and adjusted EBITDA of around £31m. (We infer that the customer is Lumentum, who issued an announcement earlier on Monday.)

Exhibit 2: Changes to estimates

FY17

FY18e

FY19e

Actual

Old

New

Change

Old

New

Change

Revenue (£m)

154.5

176.2

162.4

-7.8%

205.2

194.8

-5.0%

EBITDA (£m)

38.4

44.5

31.2

-29.8%

59.9

50.0

-16.6%

Adjusted PBT (£m)

24.3

30.1

16.8

-44.1%

44.0

34.1

-22.6%

Adjusted EPS (p)

3.36

3.18

1.81

-43.1%

4.55

3.48

-23.6%

Capitalised R&D

16.9

13.0

13.0

0.0%

13.0

13.0

0.0%

PPE

18.0*

33.0

33.0

0.0%

25.0

25.0

0.0%

Net cash

45.6

29.3

22.5

-23.4%

40.2

23.0

-42.7%

Source: Edison Investment Research *Including £6.7m funded through finance leases

Valuation

As the share prices of stocks in this sector are highly volatile at present, we have focussed on a DCF analysis rather than a peer multiples approach. Moreover, for the reasons stated above, we believe that the reduction in VCSEL shipments is temporary and that photonics will continue to grow at 40% or more per annum from FY19 onwards and a DCF methodology captures the impact of this medium-term growth. We present three scenarios: the base case adopts the rate of market growth used in our estimates; the low case adopts the rate implied by the current share price; and the high case adopts the higher bound of the market growth for FY20–FY23 given in management guidance at the Capital Markets Day in September. Our analysis gives an indicative valuation of 73p/share, rising to 132p/share if the upper bound of management guidance is adopted. The current share price is slightly below the lower bound of this range, indicating that investors are taking a more cautious view of photonics growth than our estimates, adopting a level towards the lower bound of FY19 management guidance rather than the middle of the range. Further newsflow on the VCSEL programmes that have recently started production and resumption of shipments on the original volume VCSEL programme should help address this.

Exhibit 3: DCF analysis

FY18e

FY19e

FY20e

FY21e

FY22e

Base case

Wireless growth

4.5%

5.0%

2.0%

2.0%

2.0%

Photonics growth

9.0%

50.0%

40.0%

40.0%

40.0%

IR growth

12.0%

12.0%

7.0%

7.0%

7.0%

Licence revenues (£m)

0.0

0.0

0.0

0.0

0.0

Group revenues (£m)

162.5

194.8

229.0

275.8

340.2

EBIT (£m)

16.7

34.1

51.3

68.9

93.4

Indicative valuation (WACC 10% Terminal growth 2%) 73p/share

Low case

Wireless growth

4.5%

5.0%

2.0%

2.0%

2.0%

Photonics growth

9.0%

41.0%

40.0%

40.0%

40.0%

IR growth

12.0%

12.0%

7.0%

7.0%

7.0%

Licence revenues (£m)

0.0

0.0

0.0

0.0

0.0

Group revenues (£m)

162.5

190.1

222.5

266.7

327.4

EBIT (£m)

16.7

32.5

48.7

65.2

88.2

Indicative valuation (WACC 10% Terminal growth 2%) 67p/share

High case

Wireless growth

4.5%

5.0%

10.0%

10.0%

10%

Photonics growth

9.0%

60.0%

60.0%

60.0%

60.0%

IR growth

12.0%

12.0%

15.0%

15.0%

15.0%

Licence revenues (£m)

0.0

0.0

2.0

2.0

2.0

Group revenues (£m)

162.5

200.0

264.2

357.6

500.3

EBIT (£m)

16.7

35.8

62.4

96.2

149.3

Indicative valuation (WACC 10% Terminal growth 2%) 132p/share

Source: Edison Investment Research

Exhibit 4: Financial summary

£'000s

2016

2017

2018e

2019e

Year End 31 December

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

restated

Revenue

 

 

132,707

154,480

162,449

194,807

Cost of Sales (Inc D&A + SBP)

(98,538)

(115,857)

(116,151)

(137,339)

Gross Profit

34,169

38,623

46,298

57,468

EBITDA

 

 

33,057

38,384

31,238

50,008

Depreciation and Amortisation

(10,938)

(12,025)

(14,527)

(15,932)

Operating Profit (before amort. and except.)

 

22,119

26,359

16,711

34,076

Acquired Intangible Amortisation

(1,374)

(1,429)

(1,429)

(1,429)

Exceptionals

1,962

(385)

0

0

Share based payments

(2,881)

(7,526)

(3,000)

(3,000)

Operating Profit

19,826

17,019

12,282

29,647

Underlying interest

(1,463)

(2,099)

100

0

Exceptionals

(26)

80

0

0

Profit Before Tax (norm)

 

 

20,630

24,340

16,811

34,076

Profit Before Tax (FRS 3)

 

 

18,363

14,920

12,382

29,647

Tax

(340)

(435)

(2,229)

(5,336)

Profit After Tax (norm)

20,692

24,823

14,582

28,739

Profit After Tax (FRS 3)

18,023

14,485

10,153

24,310

Average Number of Shares Outstanding (m)

671.5

689.5

751.7

776.0

EPS - normalised (p)

 

 

2.89

3.36

1.81

3.48

EPS - (IFRS) (p)

 

 

2.66

2.09

1.34

3.12

Dividend per share (p)

0.0

0.0

0.0

0.0

BALANCE SHEET

Fixed Assets

 

 

214,043

224,836

254,880

275,519

Intangible Assets

103,972

108,513

113,057

116,196

Tangible Assets

85,001

90,875

116,375

133,875

Other

25,070

25,448

25,448

25,448

Current Assets

 

 

64,323

111,559

95,470

114,812

Stocks

28,498

33,707

36,940

44,299

Debtors

30,868

32,240

36,050

47,501

Cash

4,957

45,612

22,479

23,012

Other

0

0

0

0

Current Liabilities

 

 

(51,522)

(44,916)

(44,589)

(53,123)

Creditors

(43,870)

(44,916)

(44,589)

(53,123)

Short term borrowings

(7,652)

0

0

0

Long Term Liabilities

 

 

(39,021)

(666)

(666)

(666)

Long term borrowings

(36,854)

0

0

0

Other long term liabilities

(2,167)

(666)

(666)

(666)

Net Assets

 

 

187,823

290,813

305,095

336,542

CASH FLOW

Operating Cash Flow

 

 

22,463

29,717

23,867

39,733

Net Interest

(1,489)

(2,125)

100

0

Tax

(839)

(5,844)

(1,100)

(1,200)

Capex

(19,060)

(28,190)

(46,000)

(38,000)

Acquisitions/disposals

(11,250)

0

(3,846)

0

Financing

578

94,912

3,846

0

Dividends

0

0

0

0

Net Cash Flow

(9,597)

88,470

(23,133)

533

Opening net debt/(cash)

 

 

23,223

39,549

(45,612)

(22,479)

HP finance leases initiated

0

0

0

0

Other

(6,729)

(3,309)

0

0

Closing net debt/(cash)

 

 

39,549

(45,612)

(22,479)

(23,012)

Source: Company accounts, Edison Investment Research


Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. 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. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2018 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 Investment Research Pty Ltd (Corporate Authorised Representative (1252501) of Myonlineadvisers Pty Ltd (AFSL: 427484)) and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. 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 2018. “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

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. 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. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2018 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 Investment Research Pty Ltd (Corporate Authorised Representative (1252501) of Myonlineadvisers Pty Ltd (AFSL: 427484)) and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. 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 2018. “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

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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