IQE’s diversification strategy has delivered a 71% jump in adjusted profit before tax during H116. Strong growth in photonics revenues was a key element of this improvement. This was boosted by a return to growth, albeit modest, in the wireless sector and contribution from licence income. We leave our estimates broadly unchanged, noting that this further confirmation of growth through diversification should support a continued upwards re-rating of the shares.
Wireless back on growth track
Revenues increased by 18% year-on-year (£9.8m) during H116 to £63.0m. This resulted from modest growth in the wireless segment, strong growth in photonics and a contribution from licence income, which did not start generating revenues until H215. Adjusted gross margins rose by 4.2bp to 28.4%, offset by a 17% jump in adjusted SG&A expenses ahead of anticipated growth. Adjusted profit before tax rose by 71% (£4.2m) to £10.1m. Net debt increased by £10.4m to £33.6m (19.5% gearing), primarily because of the £10.7m final payment of the deferred consideration for Kopin and because of the adverse impact of the RFMD wafer discounts on cash conversion which end this month.
Photonics demand indicates future growth
The strong performance in H116 provides support for our estimates, which we leave broadly unchanged. Noting the level of photonics activity, a significant amount of which relates to new product development and qualifications, we expect continued growth and see potential for upgrades to our forecasts over the next 1-2 years. In the longer term, we note the potential for IQE to take share in the power switching market, which management estimates is four times larger than the wireless power amplifier market.
Valuation: Re-rating under way
In our March note we identified the catalysts for an upwards re-rating of the shares as continued revenue diversification, improvement in cash conversion as the RFMD wafer discount tapers off (to be completed September 2016) and strengthening of the balance sheet as the final tranche of deferred consideration for Kopin is paid (completed H116). With a return to growth in wireless revenues and all of these three catalysts now present or very close, the deserved re-rating is under way. However, IQE’s rating still remains undemanding on a fundamental basis and relative to its peers, giving scope for further share price appreciation.