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.
Net cash
Hopes for 5G
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: | 55.9p | MARKET VALUE: | £442m | ||
TOUCH: | 56.0-55.9p | 12-MONTH HIGH: | 115p | LOW: | 41.3p |
FORWARD DIVIDEND YIELD: | NIL | FORWARD PE RATIO: | 37 | ||
NET ASSET VALUE: | 40p** | NET CASH: | £20.8m |
Year to 31 Dec | Turnover (£m) | Pre-tax profit (£m)* | Earnings per share (p)* | Dividend per share (p) | |
2016 | 133 | 20.6 | 3.0 | nil | |
2017 | 155 | 24.5 | 3.4 | nil | |
2018 | 156 | 14.0 | 1.4 | nil | |
2019* | 147 | 5.8 | 0.0 | nil | |
2020* | 183 | 20.2 | 1.5 | nil | |
% 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 |