Towards the end of H117 one of the numerous development programmes for photonics applications that IQE has been working on moved to volume production. The programme, which we infer relates to 3D sensing in the iPhone X, potentially has a transformational impact on IQE’s performance. Until there is clarity on the rate of roll-out of the new phone however, our estimates, which are unchanged from the trading update in July, model a cautious ramp-up in IQE’s epitaxy sales. The share price is looking for performance substantially ahead of this, which our scenario analysis suggests is achievable. Importantly, even if demand for the iPhone X is muted, IQE is engaged in multiple photonics development programmes with the potential to generate transformational levels of growth.
The strong photonics growth noted since FY14 continued into H117. A 48% leap in photonics revenues and a 10% currency tailwind delivered a 12% y-o-y increase in group revenues during H117 to £70.4m. Adjusted operating profit from the wafer manufacturing operations grew by 32% to £9.6m. However, this was offset by a reduction in licence fees, which benefited from one-off upfront payments in H116, resulting in small (2%) decrease in group adjusted operating profit to £10.6m.
Importantly, part of the H117 growth is attributable to the onset of volume deliveries of VCSEL epitaxy for the iPhone X. This is in addition to continued work on a range of programmes that also have potential to become volume contracts in future. This includes VCSELs for other consumer applications such as hand and body tracking, automotive applications, data comms and industrial applications such as heating; InP (indium phosphide) wafers for high-speed data networks and GaN (gallium nitride) wafers for radio frequency and power applications. This range of applications gives potential for growth without the reliance on the handset market that has bedevilled IQE in the past.
IQE shares are trading on an FY18e P/E multiple of 36.7x which, compared to the average for our broader sample of peers (16.8x), implies an EPS of 8.8p. Our analysis (see Exhibit 5 on page 12) of the impact of a potentially faster VCSEL volume roll-out than that modelled in our current estimates indicates that this earnings run rate is achievable.