IQE’s reduced guidance for FY19 revenues of £136–142m (vs £140–160m previously) reflects primarily the greater than anticipated disruption to its major US wireless customers as a result of the US/China trade war. There is good evidence to support a recovery in the medium term: the qualification of products and tools in the Asian supply chain for both 3D sensing and wireless RF is encouraging, while exposure to 5G remains attractive. However, the timing of a recovery is difficult to gauge and with Q120 expected to be seasonally quiet we downgrade our FY19 and FY20 revenue estimates by 5.3% and 15% respectively, with FY19 EPS reduced from a 0.5p profit to a 0.8p loss and FY20 EPS reduced from 2.3p to 0.3p.
The weakness stems largely from the disruption to wireless handset supply chains caused by the US/China trade war, particularly the Huawei US ban. IQE’s revenues for its wireless (RF) products have historically been US weighted and IQE had already adjusted guidance due to trading disruption, but this has been greater than expected, exacerbated by destocking. The company also highlights that demand for Indium Phosphide lasers for the datacom/telecom market has remained weak, with demand reductions from one particular US player in this arena also a major factor.
Looking through this disruption, there is evidence to support a firm trading recovery. IQE’s global footprint means it can address both the US and Asian supply chains. It has qualified three tools for the Asian wireless market at its Taiwanese facility and is qualifying two more with a Taiwanese OEM. IQE remains well positioned to benefit from 5G and management reports good progress in developing switches and filters for the 5G market. In photonics/3D sensing, orders from IQE’s major VCSEL customer have been consistently strong. Management is confident the business has retained its lead in 3D sensing, reporting good progress across a number of Android supply chains, including two recently announced Android product qualifications.
Our estimate changes (detailed overleaf) reflect continued growth in photonics but a slight reduction in wireless revenues in 2020 due to the uncertainty in timing of a recovery in this business line. While we forecast of losses for FY19 and a marginal profit for FY20, the company’s EV/sales rating is now a discount to peers. We still believe that IQE has built a capability set to drive sustained, more diversified growth. Further progress in the Asian/Android supply chains will be key to building investor confidence in this and driving a recovery in the share price.