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Research: TMT
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.
IQE |
Short-term VCSEL slowdown hits profits |
Trading update |
Tech hardware & equipment |
15 November 2018 |
Share price performance
Business description
Next events
Analysts
IQE is a research client of Edison Investment Research Limited |
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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* |
EPS* |
DPS |
P/E |
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
|
|
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