As flagged in the June trading update, IQE’s H119 performance was affected by wireless customers cutting back inventory levels in response to lengthening mobile phone replacement cycles and the ongoing trade war between the US and China. Encouraged by the successful qualification, commencement of initial production and receipt of additional orders of wireless products destined for Asian supply chains, as well as the commencement of initial vertical cavity surface emitting laser (VCSEL) production for a second major customer at its new foundry in Newport, Wales, management has reiterated its FY19 guidance. We therefore leave our estimates unchanged.
Wireless revenues fell by 29% y-o-y during H119 to £30.1m. Although Photonics revenues (which include those previously categorised as attributable to infrared products) grew by 18% to £35.5m, reflecting multiple VCSEL ramp-ups, this was not sufficient to offset the wireless slowdown. Group revenues decreased by 9% yo-y to £66.7m. As most of the costs are fixed, the drop in revenue resulted in an adjusted operating loss of £1.9m vs an adjusted operating profit of £7.6m in H118. The group moved from £20.8m net cash at end December 2018 to £0.8m net debt at the end of June 2019 as management continued to invest for future growth. Capitalised development expenditure totalled £4.8m and capex £19.0m. This included completing the infrastructure phase at the Newport Mega Foundry in Wales as well as capacity expansion in Taiwan and Massachusetts.
Management has reiterated the revised FY19 guidance issued in the trading update in June. This is for revenue in the £140–160m range at an adjusted operating margin significantly below the original guidance of 10%.
If we restrict our peer-based comparison to the three listed companies (IntelliEPI, LandMark Optoelectronics and Visual Photonics) offering epitaxy for VCSELs, then IQE is trading below the range for these three stocks with respect to the year 2 EV/EBITDA ratio and below the mean with respect to the year 2 P/E ratio. Taking this approach, we see scope for share price recovery once semiconductor supply chains have stabilised and the current period of destocking is over, supporting revenue growth during FY20 accompanied by improved capacity utilisation and a substantially higher operating profit margin.