In the event we did get a catalyst as the oversold share price soared by 60 per cent from the summer lows to the autumn highs around 32p as investor sentiment improved no end on the back of an upbeat pre-close trading statement two weeks after my article was published. True, there was profit taking post what was a decent set of interim results in late September; both revenues and cash profits were ahead of analysts' estimates and that was even after taking into consideration upgrades post that pre-close trading update. So, when I last updated the investment case post the half-year results (‘IQE profit taking presents buying opportunity’, 23 September 2013), I had no hesitation in advising that, at 26.5p, the shares were a buy on valuation grounds. The company's share price subsequently rose 17 per cent.
However, IQE's shares are clearly attracting speculative money that is having a major impact on the price, in both directions. And the latest news to impact the company's share price originates from the other side of the Atlantic in the form of third-quarter results from Triquint (TQNT:NSQ) and RF Micro Devices (RFMD:NSQ), two major IQE Wireless customers. Both companies provided more cautious trading updates than expected at the end of last week which prompted investors to sell IQE shares. According to analysts at Canaccord Genuity, Triquant is experiencing "unusual seasonality and expects softer sales in the first half of 2014 versus the second half of this year due to Apple's evolving product release cycle."
That said, it is widely known that Apple (AAPL:NSQ) has a strong second-half bias to product releases and it's hardly a secret that the tech giant is seeing maturing smartphone growth in developed markets. The smartphone market has been more difficult this year than most analysts had predicted 12 months ago. As for RFMD, the company is now guiding towards sequential quarterly revenue growth of between 0 and 5 per cent, largely due to lower shipments to Blackberry. Even so Canaccord still expects RFMD to grow revenue by 13 per cent next year. And let's not forget that RFMD's revenue increased 48 per cent to a record high in the third quarter. Triquint was hardly lagging much behind, lifting sales by a third in the same period, and Canaccord is pencilling in an acceleration of its sales growth next year.
Nevertheless, the broking house did slice 8 per cent from its 2013 revenue estimate for IQE, of which a third was down to the strengthening of the US Dollar. The net effect is that Canaccord now expects IQE to report revenues of £127m, up from £88m in 2012, and adjusted pre-tax profits of £9.6m, up from £8.8m. However, these estimates are completely at odds with those from Pia Tapley at brokerage N+1 Singer who still expects IQE to report sales of £135m, pre-tax profits of £12.3m and EPS of 1.9p, up from 1.5p in 2012.
Having seen revenues jump 84 per cent in the half year to end June 2013, and adjusted pre-tax profits rise 10-fold to £5.1m, I am inclined to side with N+1 Singer especially as IQE already has 0.82p of the 1.9p estimate banked after the first half. And even if you take Canaccord’s uber-conservative numbers at face value, the shares are still only trading on 11 times the brokerage's 2014 EPS estimates, hardly a racy valuation for a company that is still expected to grow net earnings by over 50 per cent next year!
Contract win in the shade
News from the US has undoubtedly taken the gloss off a major contract win for IQE with Philips for epi-wafers used for the manufacturing of Vertical Cavity Surface Emitting Laser. VCSELs are semiconductor laser chips which can be produced in mass scale, in a similar process flow to LED chips, thus opening the way for very cost effective, high performance laser devices, which can be used in a wide variety of applications. These include optical data communication, industrial sensing, illumination, gesture recognition and heating applications.
The initial multi-million pound three-year contract is not only a coup for IQE's photonics business, but also highlights the fact that a number of its products have reached the end of their development phase and are now transitioning to volume production. IQE's photonics operation is currently operating at break-even.
It's the view of technology analyst Pia Tapley at brokerage N+1 Singer that "the photonics end markets are substantial, which provides the opportunity for this business to become as large, if not larger, than IQE’s wireless division." Currently, approximately 85 per cent of IQE's sales are into the wireless communications market, so a ramp up of sales from photonics should help remove some of the volatility we have been seeing in IQE's share price by evening out the sales mix and de-risking the business.
It also seems lost on investors that the costs savings from IQE's two wireless acquisitions made in the past year are coming through - chief executive Dr Drew Nelson confirmed only six weeks ago that the company is on track to achieve recurring annual savings of at least £7m by next year. Some of these cost savings are supportive of the second half numbers.
Oversold
As a result of the mark down in IQE's share price in the past fortnight, during which time the price has slid from 31p to 24.25p, the 14-day relative strength indicator (RSI) is on the floor and with a reading of 30, is as depressed as it was in mid-July when the last major rally started. The minor rallies in both March and April this year commenced from similarly oversold readings on the RSI.
My instinct is that the vast majority of the selling has now taken place and that ahead of a pre-close trading update from IQE, expected in December, this is another buying, not selling opportunity. Moreover, I still believe the shares are undervalued on a bid-offer spread of 24.25p to 24.5p and I maintain a fair value target price of 35p. Both N+1 Singer and Peel Hunt have target prices around 45p, finnCap has a target of 40p and Canaccord's new price target is now 35p, inline with my own.
■ Finally, as a pre-Christmas offer exclusive to Investors Chronicle readers, all telephone orders placed with YPDBooks for my new book Stock Picking for Profit will receive complimentary postage and packaging. This offer is strictly for a limited period, is subject to stock availability and applies to only telephone orders placed until Friday, 15 November 2013.
Please note the book is only being sold through YPDBooks and no other source. Full details of the content of the book is available online at www.ypdbooks.com. If you would like to take advantage of this offer, please contact YPDBooks on 01904 431 213 and quote reference 'ICOFFER'. The book is priced at £14.99. Internet orders will continue to incur the normal postage and packaging cost of £2.75. I have also published an article outlining the content of the book: 'Secrets to successful stock picking'.
MORE FROM SIMON THOMPSON ONLINE....
In the past week I have published 10 other articles last week on the following 14 companies and portfolios:
■ Trifast ('A timely bolt on purchase', 21 Oct 2013)
■ Noble Investments ('Bargain shares update', 21 Oct 2013)
■ Stanley Gibbons ('Bargain shares update', 21 Oct 2013)
■ Cairn Energy ('Bargain shares update', 21 Oct 2013)
■ Eros ('Time for some price action', 22 Oct 2013)
■ PV Crystalox Solar ('Time for some price action', 22 Oct 2013)
■ BP Marsh & Partners ('BP Marsh cashed up to invest', 23 Oct 2013)
■ Moss Bros ('New highs beckon', 23 Oct 2013)
■ Molins ('Smoking away', 24 Oct 2013)
■ Bloomsbury Publishing ('Decision Time', 24 Oct 2013)
■ First Property Group ('On rock solid foundations', 28 October 2013)
■ US Dog share portfolio ('Dog shares barking back', 28 October 2013)
■ Sanderson ('Running bumper profits', 29 October 2013)
