IQE's confirmation that full year results are expected to be in line with expectations, despite broadening weakness in wireless, was encouraging. This reflects both the progress the company is making in diversifying its revenues and its more measured approach to setting expectations. With the company's rating at a substantial discount to its peers, we believe this continued progress should justify an upward re-rating in the shares.
Weakness in the handset chip supply chain has broadened into Q4, most recently to include those with substantial exposure to Apple, such as Dialog and Imagination Technologies. However, the size of IQE’s market share (around 55% of the global outsourced wireless epitaxy market) reduces its exposure to any individual phone manufacturer even though customer consolidation makes some ‘lumpiness’ in revenues inevitable. Moreover, while market growth is flattening, we believe that the sector should remain an important cash cow for IQE.
The photonics business continues to perform strongly, delivering significant doubledigit revenue growth. A mix of applications contributed to this growth, particularly data centre connectivity, optical communications and a broad range of sensor products. The InfraRed and CMOS++ businesses also performed well. The first pilot production revenues were generated from Solar-related activities for ultimate deployment in the Middle East. Significantly, during FY15 IQE formed joint ventures in Singapore and the UK heralding the start of IP licensing. This additional revenue stream is likely to become more significant longer term if IQE’s technology is deployed in volume applications such as general-purpose LED lighting and solar power. We leave our estimates unchanged, noting that weakness in the wireless sector may persist into 2016.
The reported weakness in the wireless market has weighed down on the share price, which has fallen by 32% since October. IQE’s rating is undemanding and remains at a substantial discount to its peers. If the business progresses to plan, we should see its revenues continue to diversify, cash conversion improve as the RFMD wafer discount tapers off and the balance sheet strengthen as the final tranche of deferred consideration for Kopin is paid. We believe these factors should be a catalyst for an upward re-rating of the shares.