IQE on the brink of a turnaround

As we were warned by a series of profit warnings over the last year, it has been a difficult time for semiconductor wafer manufacturer IQE (IQE). Its compound wafers are used to make semiconductors found in smartphones, for sensing and 5G, but demand has faltered during the period under review, even though there are there some green shoots in evidence.

The problem is that its customers have built up their inventories to manage the supply chain disruptions. These inventories need to be worked through before demand for IQE’s wafers picks up again. In the six months to June, year-on-year adjusted cash profit (Ebitda) swung from a £12.3mn profit to a £5.7mn loss.

IQE is currently in consolidation mode, trying to be as efficient as possible, before the market turns in its favour. It has managed to make some yearly savings, with layoffs reducing headcount costs by 10 per cent and non-labour costs set to fall by 20 per cent. Meanwhile, it has reduced its working capital by selling off its inventory and reducing receivables, meaning it generated a £2.4mn cash from operations – despite the operating profit loss.

This has left its balance sheet in a pretty healthy position. Net debt fell to £44mn from £62mn. Meanwhile, refinancing has pushed out most of its debt more than one year away, plus it has a $35mn (£27.3m) undrawn revolving credit facility.

A return to growth is imminent, with IQE saying it expects sequential double digit revenue growth in the second half of the year. Management admits growth has returned slower than expected, but forecast it to pick up in 2024 as supply chains continue to normalise.

House broker Peel Hunt points to the acquisition of two new GaN power customers (IQE’s compound wafers are good for charging electric vehicles) plus a ‘major Chinese automotive customer’ for another part of its business (its wafers are also good at sensing things), as reasons for optimism. The broker is forecasting IQE to make £169mn in revenue by 2025, which would exceed the 2022 performance.

The company is currently trading at a discount to its book value. However, the semiconductor market is notoriously cyclical, which means the best time to buy is when things seem their worse. The improved working capital management suggests IQE is getting a hold of the operational side of the business. When things turn it will start moving upwards but patience is needed. Move to buy.

Last IC View: Hold, 34.5p, 06 Sep 2023