IQE’s ability to apply its epitaxial IP to multiple market segments is expected to deliver year-on-year revenue growth of over 15% for H116. In yesterday’s trading statement, management states that the group is on track to achieve full-year expectations. We leave our estimates unchanged, noting that this confirmation of growth through diversification should help catalyse an upwards rerating of the shares.
The key driver of the strong H116 revenue growth is the Photonics business. This is expected to show double-digit growth during H116, as multiple applications have started to transition to volume production. Growth is being driven by an increasing demand for VCSELs (vertical cavity lasers) in data communications, gesture recognition in consumer devices and industrial heating applications and for InP (indium phosphide) lasers in fibre optic communication systems. Photonics revenues are typically higher margin than those derived from wireless applications, so this trend is expected to have a beneficial impact on profits as well. Reassuringly, wireless revenues showed a small year-on-year increase, suggesting that the segment has stabilised. The move to leverage IP through involvement in JVs is also paying off, with licence income expected to total c £3.5m for the period.
A 15% increase in H116’s revenues (£53.2m to £61.2m) puts IQE in a good position to achieve our FY16 estimates. The business is typically weighted towards the second half because of customer ordering patterns. Moreover, the progress made on new product development and qualifications during H1 should result in additional volume business in H2. Brexit is not expected to have a material impact other than currency fluctuations – over 90% revenues are denominated in US$.
IQE’s rating is undemanding and remains at a substantial discount to its peers. In our March note we identified the potential catalysts for an upwards rerating of the shares as continued revenue diversification, improvement in cash conversion as the RFMD wafer discount tapers off (completing FY16) and strengthening of the balance sheet as the final tranche of deferred consideration for Kopin is paid (completed H116). With wireless revenues stable and all three of these catalysts now present or close, the start of an upwards rerating should not, in our opinion, be far off.