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Research: TMT
IQE’s revenues grew by 35% year-on-year during H120 to a record £89.9m, taking the group from a £1.9m adjusted operating loss in H119 to a £4.3m adjusted operating profit. We upgrade our FY20 estimates in line with management’s guidance. The resultant 15% revenue upgrade changes the outcome from a loss to £3.1m adjusted PBT.
IQE |
Interim results |
Tech hardware & equipment |
8 September 2020 |
Share price performance
Business description
Next events
Analysts
IQE is a research client of Edison Investment Research Limited |
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IQE’s revenues grew by 35% year-on-year during H120 to a record £89.9m, taking the group from a £1.9m adjusted operating loss in H119 to a £4.3m adjusted operating profit. We upgrade our FY20 estimates in line with management’s guidance. The resultant 15% revenue upgrade changes the outcome from a loss to £3.1m adjusted PBT.
Record revenues in H120 despite pandemic |
Year end |
Revenue (£m) |
EBIT* |
PBT* |
EPS* |
DPS |
P/E |
12/18 |
156.3 |
16.0 |
14.0 |
1.38 |
0.0 |
44.6 |
12/19 |
140.0 |
(4.7) |
(7.0) |
(2.46) |
0.0 |
N/A |
12/20e |
165.6 |
5.0 |
3.1 |
0.28 |
0.0 |
222.3 |
12/21e |
178.2 |
12.0 |
10.9 |
1.05 |
0.0 |
58.5 |
Note: *EBIT, PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.
Record first half revenues return group to profit
In line with June guidance, group revenues grew by 35% year-on-year during H120 to a record £89.9m. Wireless revenues jumped by 51% to £45.5m as IQE’s long-standing customers benefited from major design wins and investment in 5G infrastructure. Additionally, we believe IQE took market share in Asia. Photonics revenues rose by 22% to £43.4m. Production for IQE’s major vertical cavity surface emitting laser (VCSEL) customer was consistently strong throughout the period. Given the high proportion of fixed costs, the strong year-on-year revenue growth took the group from a £1.9m adjusted operating loss in H119 to a £4.3m adjusted operating profit. Net debt reduced by £8.6m during H120 to £7.4m at the end of June (excluding £48.1m IFRS 16 lease liabilities). Cash generated from operations more than trebled year-on-year to £15.1m, while capital expenditure was only £1.1m as the major infrastructure investment programmes all completed in FY19.
Estimates upgraded
Given the strong performance for the year to date and positive trading updates and outlooks from key customers, management has provided guidance for FY20. This is for revenues of at least £165m, which is a year-on-year increase of over 18%, with an adjusted EBIT of at least mid-single digits. We have updated our FY20 and FY21 forecasts accordingly, while noting that this guidance assumes an atypically weaker second half performance, reflecting the uncertainty in the global economy.
Valuation: Share price above pre-pandemic levels
IQE’s share price has more than recovered the ground lost during the panic selling in March. At current levels IQE is trading at a premium to the mean of the sample of companies engaged in manufacturing VCSEL epitaxy. Given IQE’s broader product portfolio we believe it is reasonable for IQE to trade on multiples that are at the upper bound of this sample. However, we believe that further share price improvement will require greater visibility of how handset demand will be affected by any pandemic induced recession and whether the switch to 5G and the availability of as yet unknown ‘killer apps’ will be sufficient motivation for cash-strapped consumers to justify upgrading their handsets.
H120 performance
Record first half revenues return group to profit
In line with June guidance, group revenues grew by 35% year-on-year during H120 to a record £89.9m. While this result was flattered by £2.5m of forex tailwind, the Q120 performance was slightly ahead of internal expectations and trading in Q2 was strong, with no disruption to production from coronavirus related lockdowns or any significant impact on the supply of materials. Wireless revenues jumped by 51% to £45.5m. H119 wireless revenues were adversely affected by customers destocking in response to the uncertainty caused by lengthening smartphone replacement cycles and by the disruption to global semiconductor supply chains caused by Huawei’s addition to the US Bureau of Industry and Security’s Entity List. In contrast, during H120 IQE’s long-standing wireless customers have benefited from major design wins and investment in 5G infrastructure. In addition, we believe that IQE is taking market share in Asia. Photonics revenues rose by 22% to £43.4m. Production for IQE’s major VCSEL customer was consistently strong throughout the period.
Given the high proportion of fixed costs, the strong revenue growth took the group from a £1.9m adjusted operating loss in H119 to a £4.3m adjusted operating profit. The adjusted cost of sales increased by £14.3m to £70.4m and adjusted indirect costs rose by £2.5m to £15.0m. £2.3m of the cost increases relate to an increase in amortisation, the remainder primarily to ramping up production in the Newport facility and taking on all of the costs of Singapore JV when the group increased its ownership of the JV to 100% in October 2019. The group incurred £7.5m exceptional costs, which are described in Exhibit 1. £1.1m of these exceptional costs were cash items.
Exhibit 1: H120 P&L breakdown of exceptional items
Category |
Value* (£m) |
Details |
Share-based payments |
0.3 |
|
Exceptional legal fees |
0.7 |
Fees incurred defending a non-core patent. The arbitration hearing in September determined entirely in IQE’s favour. |
Impairment of intangible assets |
6.5 |
Impairment of cREO patent and development costs that are not related to filters, following a decision to focus cREO activity on the filter market. |
Onerous contract provision |
1.8 |
Cost of minimum guaranteed future royalty payments to Translucent agreed when the cREO technology was acquired. These are still payable although the date when IQE will start to generate revenues from commercial exploitation of the technology has been delayed. |
Source: IQE. Note: *Before adjustment for tax.
Strongly cash generative now expansion programme complete
Net debt reduced by £8.6m during H120 to £7.4m at the end of June (excluding £48.1m IFRS 16 lease liabilities). Cash generated from operations more than trebled year-on-year to £15.1m despite the £1.1m exceptional cash-cost related to legal fees (see Exhibit 1). Capital expenditure dropped from £19.0m to £1.1m. This is because the programmes to build infrastructure at the Mega Foundry in Newport, South Wales, and expand capacity in Taiwan and Massachusetts all completed in FY19. Newport Mega Foundry already has bays for an additional 10 reactors, so future investment will be primarily only in reactors rather than the supporting infrastructure and thus proportional to incremental revenue development. Capitalised development expenditure fell from £4.8m in H119 to £2.6m reflecting a more disciplined, commercially orientated new product development process.
During H219 management agreed a £30m asset financing facility, increasing total available facilities to around £57m. This will provide support if the longer-term impact of the coronavirus is to reduce demand for new mobile phones. During H120 management has negotiated an agreement with HSBC to relax debt covenants in December 2020 and June 2021. This is a precautionary measure to ensure continued access to debt facilities in severe downside scenarios.
Exhibit 2: Revenue analysis and top-line estimates
2018 |
2019 actual |
2020e |
2020e New |
2021e |
2021e New |
|
Wireless (£m) |
87.9 |
68.2 |
61.3 |
79.8 |
68.1 |
81.3 |
Photonics (£m) |
66.8 |
69.8 |
80.2 |
83.7 |
94.7 |
94.7 |
CMOS++ (£m) |
1.6 |
2.1 |
2.1 |
2.1 |
2.1 |
2.1 |
Total (£m) |
156.3 |
140.0 |
143.7 |
165.6 |
164.9 |
178.2 |
Growth |
||||||
Wireless |
-22% |
-10% |
17% |
11% |
2% |
|
Photonics |
4% |
15% |
20% |
18% |
13% |
|
CMOS++ |
29% |
0% |
0% |
0% |
0% |
|
Total |
-10% |
3% |
18% |
15% |
8% |
Source: IQE data, Edison Investment Research estimates
Outlook and estimates
Given the strong performance for the year to date and positive trading updates and outlooks from key customers, management has introduced guidance for FY20. This is for revenues of at least £165m, which is a year-on-year increase of over 18%, with an adjusted operating profit of at least mid-single digits. We have updated our FY20 and FY21 forecasts accordingly.
■
Wireless segment demand: There remains considerable uncertainty as to how demand for IQE’s epitaxy will develop over the remainder of the forecast period. In July Skyworks provided guidance of double-digit sequential revenue growth during the quarter ended September 2020, citing strong demand related to design wins for its front-end Sky5 platform in handsets for Samsung, Oppo, Vivo, Xiaomi, Motorola and other Tier-1 players. A week later RF chip manufacturer Qorvo provided guidance of sequential revenue of at least 17% for the same quarter, noting long-term drivers in 5G handsets and infrastructure. In August research house IDC predicted that the worldwide smartphone market would decline 9.5% y-o-y in 2020, then grow by 9% in 2021 and return to pre-COVID-19 levels in 2022. This view is much less pessimistic than the 21% drop in global wholesale smartphone revenues during FY20 predicted by Strategy Analytics in April.
In our opinion IQE should outperform the global smartphone market in FY20 for several reasons: (1) IQE suffered from severe inventory destocking during FY19, which has reversed; (2) its long-standing wireless customers have benefited from major design wins and (3) IQE itself is, we believe, taking market share in Asia. In addition, IQE also supplies epitaxy for wireless infrastructure and is therefore likely to be a beneficiary if individual governments opt to invest in 5G infrastructure as part of post-pandemic stimulus packages. There is already some evidence of this in Asia. We model 17% year-on-year growth in wireless revenues for FY20 as a whole, followed by modest (2%) growth during FY21. The guidance implies that H220 performance will be weaker than that for H120, although the second half is usually stronger one,
■
Photonics segment demand: We assume that IQE will continue to be the major supplier of epitaxy for the original VCSEL customer, which we have previously assumed is part of the Apple supply chain. While the details of the iPhone12 have not yet been announced, concept illustrations posted by PhoneArena suggest that it will contain a LiDAR system, potentially for use in virtual reality/augmented reality applications. If so, the number of VCSELs per phone will increase by around 1.5 times, which is consistent with IQE’s comment that the continued growth is related to content gain. Our view of 20% segmental growth for FY20 as a whole, which is only a modest decline in revenues from H120 to H220, is supported by content gain in this major supply chain. This gives both upside and downside risk to our segmental estimate, depending on whether the iPhone12 launch this autumn, which has already been pushed back from the usual September to late-October, is delayed any further and whether consumer appetite for the potential new features and ‘killer apps’ is sufficient to encourage them to upgrade their phones.
■
Cost base: We increase our estimates for indirect costs in line with H120 levels. This, together with a change in the underlying FY21 tax rate from 18% to 19%, cancels out the higher revenue estimate in FY21.
■
Capital expenditure: Our estimate of £10.0m capex for FY20 is at the upper end of management guidance. The actual amount will depend on how quickly management expects the market to grow in FY21 and beyond.
■
Capitalised development costs: We have cut our FY20 and FY21 estimates from £10.0m to £6.0m in line with H120 levels.
Exhibit 3: Changes to estimates
FY19 |
FY20e |
FY21e |
|||||
Actual |
Old |
New |
% change |
Old |
New |
% change |
|
Revenue (£m) |
140.0 |
143.7 |
165.6 |
15.2% |
164.9 |
178.2 |
8.1% |
Adjusted PBT (£m) |
(7.0) |
(6.2) |
3.1 |
N/A |
11.6 |
10.9 |
-6.2% |
Adjusted EPS (p) |
(2.46) |
(0.83) |
0.28 |
N/A |
1.13 |
1.05 |
-6.7% |
Capitalised R&D (£m) |
10.0 |
10.0 |
6.0 |
-40.0% |
10.0 |
6.0 |
-40.0% |
Property, plant and equipment (£m) |
31.9 |
9.0 |
10.0 |
11.1% |
9.0 |
10.0 |
11.1% |
Net (cash)/debt excluding finance leases at year end (£m) |
16.0 |
22.7 |
10.3 |
-54.4% |
6.5 |
(2.6) |
N/A |
Source: Company accounts, Edison Investment Research
Given that future demand for both wireless and photonics epitaxy will be determined by the severity of any global recession caused by the coronavirus pandemic, we have prepared a sensitivity analysis showing the impact on FY20 adjusted operating loss of alternative year-on-year changes in wireless and photonics revenues. This is shown in Exhibit 4.
Exhibit 4: Sensitivity analysis – adjusted operating profit FY21 (£000s)
FY21 wireless revenue growth/decline |
||||||
5% |
2% |
0% |
-2% |
-5% |
||
FY201 photonics revenue growth |
0% |
6,377 |
4,819 |
3,781 |
2,742 |
1,185 |
5% |
9,102 |
7,544 |
6,506 |
5,467 |
3,910 |
|
10% |
11,826 |
10,269 |
9,230 |
8,192 |
6,634 |
|
13% |
13,543 |
11,985 |
10,947 |
9,909 |
8,351 |
|
15% |
14,551 |
12,993 |
11,955 |
10,917 |
9,359 |
|
Source: Edison Investment Research
Research: Financials
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