Yesterday’s trading update confirms that IQE’s FY19 results will be in line with the revised guidance it provided in November when the full extent of the impact of the US-China trade war became visible. We have cut our FY20 revenue estimate by 6%. In IQE’s case the impact of COVID-19 on global handset demand is likely to be softened by gaining share in both the wireless and photonics markets. However, the full effect of the pandemic on the global economy and IQE’s business remains to be seen.
Group revenues decreased by 10% year-on-year during FY19 to £140.0m, in line with management’s reduced guidance published in November. Wireless revenues decreased by 23% because of destocking related to the US-China trade war, which has since reversed. Photonics revenues increased by 4% as strong growth in revenues from the major VCSEL customer were in part offset by reduced demand from a US customer for indium phosphide epitaxy. Since the business is highly operationally geared, the revenue drop caused the group to move from £16.0m adjusted operating profit in FY18 to a £4.7m adjusted operating loss in FY19. After investing in the new South Wales facility making VCSELs, and increasing capacity in Taiwan to serve wireless customers in Asia, the group moved from £20.8m net cash at end FY18 to £16.0m net debt (excluding finance leases) at end FY19.
Given the uncertainty presented by the COVID-19 pandemic, management is not providing any guidance at present, though the business has traded in line with management expectations for Q120. Our estimates, which we have revised downwards, provisionally assume that IQE’s wireless revenues will not reduce by as much as the global handset market in FY20 because new business for a major Taiwanese foundry will help IQE increase its market share. In addition, we expect that the commencement of volume deliveries of VSCEL epitaxy for multiple Android-related supply chains will support photonics growth during FY20.
The share price has fallen by 43% so far this year. At current levels and on our updated estimates, IQE is trading at a substantial discount on a prospective EV/sales basis to the sample of companies engaged in manufacturing VCSEL epitaxy (year one 1.6x vs 4.2x). We see potential for the share price to recover once the impact of COVID-19 on global handset sales and the route to sustainable profitability is clearer.