Infineon ready to re-rate

Over recent years, Infineon has had its fair share of problems, including depressed trading in Europe and in its industrial segment, which resulted in falling revenues in 2013. But there are now clear signs that things are changing. In its second quarter to the end of March, sales were up 14 per cent on the previous year at €1.05bn (£0.85bn) while profits after tax surged to €124m from €33m a year earlier, helped by a €25m revaluation of its work-in-progress inventories. Even excluding the impact of one-offs, profitability surged, with underlying operating margins coming in at 13 per cent compared with 7.4 per cent a year earlier. Meanwhile, the book-to-bill ratio is running at 1.3 times, suggesting there is plenty of potential in the pipeline.

A number of factors have come together to power this growth, which is not expected to ease up any time soon. For example, Infineon's automotive business, which accounts for 45 per cent of revenues, is benefiting from consumers clamouring for new, high-end cars with better safety and comfort features, which means more electronics. At the same time, demand is finally picking up in Europe as the economy struggles off the floor, which is adding to already strong conditions in the US and China. The automotive division's sales were up 14 per cent year on year in the second quarter compared with the preceding three months, to €484m.

Meanwhile, Infineon's industrial sales leapt by 28 per cent over the same period to €185m. Demand from the industrial market tends to lag the broader economy, which means that Infineon's order book is only filling up now and sales remain well below peak levels. There are a number of consumer electronics trends that are expected to benefit the group's power management division, such as the use of more microphones in devices. Other long-term niche market trends that Infineon should benefit from include the growing popularity of renewable energy and greater use of semiconductors to boost energy efficiency.

This strong demand on its own is helping to lift profitability, but the company also has a number of its own margin-boosting plans up its sleeve. It has committed to reduce capital spending from 15 to 13 per cent of revenue from 2015 onwards, which will feed through to margins in the form of a lower depreciation charge. Importantly, the company believes investments already made into a 300mm semiconductor fabrication plant (or 'fab' in tech jargon) means the spending reduction will not compromise its target of 8 per cent sales growth. New technology, higher productivity and more outsourcing of manufacturing also mean its operations can become more economical. Liberum reckons that put together all these factors will lead to underlying operating margins soaring from just below 10 per cent last year to 21 per cent by 2018.