The key take for me was that both half-year revenues and cash profits were ahead of analysts' estimates and that was even after taking into consideration upgrades post the pre-close trading update. The performance of Kopin is clearly going well. This company was acquired in a $75m (£47m) deal earlier this year and has significantly extended IQE's market share and leadership in wireless industry supply; added Skyworks Solutions, which has a long-standing supply agreement with Kopin Wireless, to the customer base; and brought in a Taiwanese manufacturing facility to boost IQE's global manufacturing footprint. It has also provided the business with a strong position to access the growing Asian semiconductor market.
Coupled with the acquisition of RFMD, the wireless segment accounted for 85 per cent of IQE's sales of £63m in the period, of which Kopin contributed £15m and RFMD a further £16m. Importantly, the costs savings from the two wireless acquisitions are also coming through and chief executive Dr Drew Nelson confirms that the company is on track to achieve recurring savings of at least £7m per year from next year. It also helps to explain why IQE's revenues jumped 84 per cent in the half year and adjusted pre-tax profits rose 10-fold to £5.1m. And with the benefit of £130m of accumulated tax losses, the company paid no tax on those profits, which is why underlying EPS soared from 0.13p to 0.82p year on year.
Moreover, with cash generation strong - cash inflow from operations more than doubled to £6.3m - IQE produced free cash flow of £1.8m after spending £4.5m on capital expenditure. Net debt at the half-year end stood at £37.7m, or almost £1m lower than Canaccord Genuity had predicted.
The one fly in the ointment is the recent weakness in the global smartphone market. This is mainly due to weaker demand in advance of new product launches, but nonetheless it introduces a degree of uncertainty. Perhaps that's why IQE's share price fell off post results, although it had risen by almost 60 per cent after I highlighted the anomalous valuation in the summer, so a degree of profit taking was always to be expected ('Awaiting a catalyst for a re-rating', 11 Jul 2013).
That said, the shares are still attractively priced to justify a buy rating, trading on 14 times Canaccord's EPS estimate of 1.9p, up from 1.5p in 2012, and on only 8.5 times 2014 earnings estimates of 3.2p. Analyst Alexandra Jarvis at broker Peel Hunt is more aggressive, predicting EPS of 2.3p this year, rising to 3.5p in 2014. Those estimates seem reasonable to me and take account of the planned ramp up in IQE's photonics operation, which is currently operating at break-even. Products here are used in a wide variety of applications, including optical-fibre communications, optical storage (DVDs and CDs), laser printing, solar cells and solid-state lighting. However, the operation is set to benefit from a ramp up of new optoelectric products and, more importantly an adoption of CPV Solar.
Dr Nelson points out that "advances in cell and system efficiency are accelerating the adoption of CPV, which is widely expected to be a $200m-$500m market for compound semiconductor materials in the next three to five years." He adds that "having successfully hit all major technical and operational milestones, and recently posted new world record efficiencies from our production platform, we are now qualified for high volume manufacturing to commence over the coming months." That's one reason why Peel Hunt expect IQE's revenues to rise from around £139m this year to £158m in 2014. Given the operating leverage of the business, this ramp up in revenues will have an accelerated impact on operating margins, which are expected to rise by around one percentage point this year to around 11.6 per cent, before hitting over 15 per cent in 2014.
Interestingly, the share price has fallen on profit taking after last week's results to test the 200-day moving average (around 26.5p), and at a reading of 40 the 14-day relative strength index is now in oversold territory.
For a company set to deliver 133 per cent earnings growth over a two-year period, I believe the shares are seriously undervalued on a bid-offer spread of 26p to 26.5p. I have a conservative target price of 35p, which is significantly less than Canaccord's price target of 65p. Both N+1 Singer and Peel Hunt have target prices around 45p.
32Red worth a punt
Finally, my colleague Julian Hoffman has published a lengthy and first-class analysis of 32Red's (TTR: 60.5p) recent results in a tip last week, highlighting the undervaluation of the company. I agree entirely with his comments and can only reiterate my previous buy advice. My 66p target price is likely to prove conservative and I still rate the shares a strong buy on less than 10 times Numis Securities' EPS estimate of 6.3p, up from 4.1p in 2012, falling to a miserly eight times 2014 earnings estimates of 7.6p.
For good measure, the company remains cash rich. Pro-forma net cash is £4.8m, or 6.7p a share, after adjusting for the 2.5p a share special dividend we banked in July. Strip that out from the current share price and the full-year prospective earnings multiples drops to 8.5, and only seven next year. If that wasn't enticing enough the company also pays out a decent dividend, having raised the half-year dividend by a third to 0.8p, which will be paid shortly. Numis expects the final dividend to be lifted to 1p a share to give a full-year dividend, excluding that special payout, of 1.8p. For 2014, the broking house expects a further rise in the dividend to 2.2p. On that basis, the forward yield is 3 per cent, rising to 3.7 per cent. It also means that dividend cover is very healthy, thereby offering scope for potentially even greater payouts than those forecast.
Importantly, trading since the half-year end supports the investment case; underlying revenues are up 27 per cent in the past 10 weeks alone. On a bid-offer spread of 59p to 60.5p, I remain a buyer.
Finally, as soon as I have had an opportunity to appraise today's half-year results from KBC Advanced Technologies (KBC: 85p), Macau Property Opportunities (MPO: 195p) and an acquisition that Thalassa (THAL: 255p) has just announced, I will publish updated articles on all three companies.
Finally, in response to requests from dozens of readers, I have published an article outlining the content of my new book, Stock Picking for Profit: 'Secrets to successful stock picking'
