IQE has announced an immediate slowdown in shipments of VCSEL wafers, which materially affects FY18 revenues and profitability, and has issued revised guidance. Although we have cut our EPS estimates by 43% and 24% for FY18 and FY19 respectively, we note this is a short-term problem that does not impact the prospects for photonics growth in the medium term. Our revised estimates give an indicative value of 73p/share.
On Monday, IQE announced that earlier that day one of its customers in the VCSEL supply chain, had received notice from one of its largest customers for 3D sensing laser diodes that it was materially reducing shipments for the current quarter IQE ramped up production for this application (which we previously inferred is for FaceID in new iPhones) during H217, following which production dropped back as the inventory overbuild was worked through, so IQE only started to build-up inventory for this application again this quarter. It now has to cut back production for this application. The temporary dip in production will materially affect FY18 revenues and profitability.
We note that the lull in VCSEL production for Apple is not the result of IQE losing a customer to a competitor, so shipments are expected to resume by Q219. Although Apple warned in June that demand for new iPhone parts could decline by 20% in H218, FaceID is included in three of the models launched in H218, rather than just one model in H217, so we believe consumer demand is less likely to be the cause of the set-back than availability of OLED panels, where Apple is rumoured to have issues. Component availability can be addressed relatively easily, supporting our view that volume production will resume by Q219. We note that IQE is involved in VCSEL ramp-ups for at least eight customers engaged in several market segments, providing alternative sources of photonics growth and reducing the risk of destocking in future.
Using our revised estimates as the basis for a DCF analysis gives an indicative valuation of 73p/share. Modelling segmental growth from FY20 onwards at the high end of management guidance provided in September gives an indicative valuation of 132p/share. We see potential for share price improvement as investor confidence in photonics demand returns.