Start of mass market VCSEL ramp-up

IQE 26 July 2017 Update
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IQE

Start of mass market VCSEL ramp-up

Trading update

Tech hardware & equipment

26 July 2017

Price

104.5p

Market cap

£714m

Net debt (£m) at 31 December 2016

39.5

Shares in issue

683.0m

Free float

88.5%

Code

IQE

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(2.0)

51.1

378.9

Rel (local)

(0.9)

45.4

326.9

52-week high/low

112.3p

22.5p

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

Interims

5 September 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’s pre-close trading update notes a 16% year-on-year increase in wafer revenues in H117, driven by strong double-digit growth in photonics and currency tailwinds. Importantly, the photonics growth heralds the start of a mass-market ramp up in VCSEL (vertical cavity surface emitting laser) wafers for consumer applications, encouraging management to proceed with plans to substantially expand capacity ahead of anticipated demand in H218. We make modest upwards revisions to our estimates, noting the potential for further upgrades as there is greater clarity on photonics volumes.

Year end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

12/15

114.0

17.6

2.60

0.0

40.2

N/A

12/16

132.7

20.6

3.00

0.0

34.8

N/A

12/17e

145.3

23.5

3.27

0.0

32.0

N/A

12/18e

160.3

25.9

3.58

0.0

29.2

N/A

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

Strong photonics growth

The strong photonics growth noted since FY14 has continued into H117. Importantly, part of this growth is attributable to the onset of deliveries of VCSEL wafers for multiple, multi-year contracts addressing mass-market consumer applications. This is in addition to continued work on a range of programmes which also have potential to become volume contracts in future. This includes VCSELs for other consumer applications including 3D sensing, data comms and industrial applications such as heating; InP (indium phosphide) wafers for high-speed data networks and GaN (gallium nitride) wafers for radio frequency and power applications. The 16% y-o-y increase in total wafer revenues to c £70m during H117 was helped by a 10% currency tailwind caused by the devaluation of sterling last June. There was also c £1m licence revenue.

Capacity expansion underpinned by demand

Noting higher levels of expected demand for H218 than it had initially anticipated, the board of IQE has committed to a capacity expansion plan. It is leasing new premises in South Wales and placed orders for the equipment that will initially be required. We note that if deliveries for the current volume VCSEL contracts do not ramp up as expected to utilise this capacity, it will be used to fulfil volume orders for other programmes as they reach the commercialisation phase.

Valuation: Share price reflects further upgrades

The share price has doubled since the interims in March as investors have speculated on the potential impact of volume VCSEL programmes on earnings. As a result, the shares already price in further upgrades. Based on our updated estimates, IQE currently trades at a 2018e P/E of 29x vs a sector average of 19x. In our September results note we plan to present a detailed scenario analysis considering the impact of a faster ramp up in VCSEL volumes on earnings and profit related multiples.

Changes to estimates

We have revised our estimates to reflect:

A modest ramp-up in VCSEL wafer volumes during H217 and into FY18 reflecting the onset of deliveries of VCSEL wafers for multiple, multi-year contracts addressing mass-market consumer applications. Previously our estimates excluded the potential impact of any of the VCSEL development programmes moving into volume production.

Higher fixed costs associated with supporting the ramp-up in VCSEL wafers

Higher levels of capitalised R&D associated with VCSEL activity

Higher levels of capex to support the VCSEL ramp-up

Exhibit 1: Revisions to estimates

Year end December

FY16

FY17e

FY18e

(£m)

Old

New

% change

Old

New

% change

Revenue

132.7

137.0

145.3

6.1%

140.2

160.3

14.3%

EBITDA

31.7

34.5

35.5

2.8%

35.0

39.7

13.2%

Adjusted PBT

20.6

22.5

23.5

4.4%

24.0

25.9

7.6%

Adjusted EPS (fully diluted) (p)

3.00

3.15

3.27

3.7%

3.37

3.58

6.5%

Capitalised R&D

8.1

5.5

11.0

100.0%

5.5

7.5

36.4%

PPE

11.0

6.5

20.0

207.7%

4.5

4.5

0.0%

Net debt

39.5

24.2

44.5

83.9%

5.4

26.9

401.5%

Source: Edison Investment Research

Valuation

Exhibit 2: Multiples of listed peers

Name

Market cap

($m)

EV/sales

FY1 (x)

EV/sales

FY2 (x)

EV/EBITDA

FY1 (x)

EV/EBITDA

FY2 (x)

P/E

FY1 (x)

P/E

FY2 (x)

Epitaxy

VISUAL PHOTONICS EPITAXY CO

385

4.6

4.1

14.1

10.6

22.8

18.6

INTELLIEPI

103

3.3

2.7

14.8

10.2

29.5

19.6

S.O.I.T.E.C.

1,849

5.3

4.1

26.3

17.1

65.7

33.3

Wireless

BROADCOM

103,437

6.6

6.1

12.2

11.3

16.1

14.9

QORVO

8,603

2.8

2.6

8.5

7.6

12.1

10.5

SKYWORKS SOLUTIONS

19,451

5.0

4.5

11.4

10.2

16.7

14.6

Opto-electronics

II-VI

2,393

2.6

2.4

-

-

28.4

23.4

EMCORE

294

1.8

1.7

12.5

10.9

20.2

17.3

Mean

4.0

3.5

14.3

11.1

26.4

19.0

IQE

£714m

5.2

4.7

21.2

19.0

32.0

29.2

Source: Edison Investment Research. Note: Prices at 20 July 2017. EV calculated on historic debt.

IQE’s share price has doubled since the interims in March as investors have speculated on the potential impact of higher volume VCSEL programmes on earnings. As a result, the shares seem to already price in some further upgrades. Based on our updated forecasts, IQE currently trades at a 2018e P/E of 29x compared to a sector average of 19x. We note that SOITEC, which is currently trading on multiples that are at the upper end of our sample, reported a 22% year-on-year increase in revenues (constant currency) for the quarter ended June 2017. This was partly attributable to strong growth in wafers for digital mobile and low power applications including those used in consumer products that are already on the market such as connected watches, personal digital assistants and driver assistance systems. This suggests that IQE’s multiples may be justified if it too is able to achieve stronger revenue and earnings growth than is presented in our estimates, which is feasible given the additional capacity coming on line in H218. The accelerated earnings growth would result in a reduction in EV/EBITDA and P/E multiples. We intend to present a detailed scenario analysis examining the potential impact of a range of different rates of volume ramp up on IQE’s earnings in our September note commenting on the interim results.

Exhibit 3: Financial summary

£'000s

2015

2016

2017e

2018e

Year End 31 December

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

114,024

132,707

145,346

160,303

Cost of Sales (Inc D&A + SBP)

(81,585)

(96,292)

(105,303)

(115,664)

Gross Profit

32,439

36,415

40,043

44,639

EBITDA

 

29,001

31,730

35,462

39,665

Depreciation and Amortisation

(10,024)

(9,611)

(10,000)

(12,300)

Operating Profit (before amort. and except.)

18,977

22,119

25,462

27,365

Acquired Intangible Amortisation

(1,208)

(1,327)

(1,327)

(1,327)

Exceptionals

5,398

1,915

0

0

Share based payments

(2,001)

(2,042)

(3,000)

(3,000)

Operating Profit

21,166

20,665

21,135

23,038

Underlying interest

(1,403)

(1,489)

(2,000)

(1,500)

Exceptionals

(387)

(144)

0

0

Profit Before Tax (norm)

 

17,574

20,630

23,462

25,865

Profit Before Tax (FRS 3)

 

19,376

19,032

19,135

21,538

Tax

773

408

500

500

Profit After Tax (norm)

18,066

21,440

23,462

25,865

Profit After Tax (FRS 3)

20,149

19,440

19,635

22,038

Average Number of Shares Outstanding (m)

662.6

671.5

680.0

683.0

EPS - normalised (p)

 

2.60

3.00

3.27

3.58

EPS - (IFRS) (p)

 

3.00

2.87

2.89

3.23

Dividend per share (p)

0.0

0.0

0.0

0.0

BALANCE SHEET

Fixed Assets

 

174,207

215,154

234,827

233,200

Intangible Assets

86,843

103,972

109,645

111,018

Tangible Assets

65,154

85,001

99,001

96,001

Other

22,210

26,181

26,181

26,181

Current Assets

 

48,909

64,323

68,506

95,557

Stocks

21,215

28,498

34,213

38,755

Debtors

23,050

30,868

34,278

39,163

Cash

4,644

4,957

14

17,639

Other

0

0

0

0

Current Liabilities

 

(48,050)

(46,012)

(48,572)

(50,297)

Creditors

(44,809)

(38,360)

(40,920)

(42,645)

Short term borrowings

(3,241)

(7,652)

(7,652)

(7,652)

Long Term Liabilities

 

(28,032)

(39,021)

(39,021)

(39,021)

Long term borrowings

(24,626)

(36,854)

(36,854)

(36,854)

Other long term liabilities

(3,406)

(2,167)

(2,167)

(2,167)

Net Assets

 

147,034

194,444

215,740

239,439

CASH FLOW

Operating Cash Flow

 

20,971

22,463

28,896

31,963

Net Interest

(1,403)

(1,489)

(2,000)

(1,500)

Tax

(459)

(839)

(839)

(839)

Capex

(10,002)

(19,060)

(31,000)

(12,000)

Acquisitions/disposals

0

(11,250)

0

0

Financing

544

578

0

0

Dividends

0

0

0

0

Net Cash Flow

9,651

(9,597)

(4,943)

17,624

Opening net debt/(cash)

 

31,251

23,223

39,549

44,492

HP finance leases initiated

0

0

0

0

Other

(1,623)

(6,729)

0

0

Closing net debt/(cash)

 

23,223

39,549

44,492

26,867

Source: 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 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 2017 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 2017. “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 12, 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 12, 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 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 2017 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 2017. “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 12, 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 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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