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IQE looks vulnerable

Revenue forecasts came down last month
July 4, 2019

The nightmare scenario for a company that has just completed a large capital project is a sharp drop-off in demand. All the more so when that company operates in a notoriously cyclical industry. Unfortunately, that is the situation semiconductor minnow IQE (IQE) finds itself in as the industry grapples with the US-China trade dispute. IQE supplies epitaxial wafers to a number of chip companies in global supply chains, some of which supply Huawei, which has been blacklisted by the United States Department of Commerce.

IC TIP: Sell at 55.90p
Tip style
Sell
Risk rating
High
Timescale
Medium Term
Bull points

Net cash

Hopes for 5G

Bear points

Ravaged by trade war

Supply chain disruption

Poor cash flows

Rising stock levels

Supply chain disruption in the photonics division (light science) at the end of 2018 followed a substantial customer inventory correction in the first half, which has left IQE needing to unwind stock. This is expected to harm first-half profitability and management recently abandoned a 10 per cent operating margin target. IQE finished last year with inventory equivalent to 23 per cent of revenues. The ratio has been rising steadily over the past five years from 15 per cent. 

Selling excess stock would be challenging in a soft market anyway, but even more so in a sector where rapid technological advancement causes products to become obsolete quickly.  

To keep pace with technology, semiconductor companies have to invest. Last year was a record for capital investment across the industry, as it was for IQE which nearly trebled capital expenditure to £30.4m as it ploughed cash into a new photonics foundry in Newport.

IQE has a poor record for generating free cash flow. Its current net cash position is the product of a £95m placing at 140p in 2017. As the chart illustrates, free cash flow has fallen over the past five years. While capex is due to fall this year, the recent heightened spending makes it particularly unwelcome that the company last month guided that full-year revenue would be between £140m and £165m, below a consensus of £175m.

 

IQE (IQE)    
ORD PRICE:55.9pMARKET VALUE:£442m 
TOUCH:56.0-55.9p12-MONTH HIGH:115pLOW:41.3p
FORWARD DIVIDEND YIELD:NILFORWARD PE RATIO:37 
NET ASSET VALUE:40p**NET CASH:£20.8m 
Year to 31 DecTurnover (£m)Pre-tax profit (£m)*Earnings per share (p)*Dividend per share (p)
201613320.63.0nil
201715524.53.4nil
201815614.01.4nil
2019*1475.80.0nil
2020*18320.21.5nil
% change+24+248--
NMS:20,000    
BETA:0.94    
*Peel Hunt forecasts, adjusted EPS and PTP figures
**Includes intangible assets of £122m, or 15.9p a share