Shares in high-technology chip manufacturer IQE (LON:IQE) today plunged almost 40% as a trading update revealed that the company had been adversely hit by the Huawei black-listing by the US among other things. Anyone invested here would have seen a volatile ride to say the least, and today is another test:
The share price here has always been volatile, because of the back-story. For a few years, IQE have been a classic ‘jam tomorrow’ story. Heavily operationally leveraged, we are always mindful of the future that one day their chips will be in huge demand and that their profits will increase heavily as there are only marginal costs attached to these extra sales.
That has led to some quite punchy valuations at times. In late 2017, it was valued at 175p a share, with a market cap approaching £1.5bn which was quite remarkable. But that was the measure of potential people saw in this. As we can see today, that price is approaching just a quarter of that.
IQE has issued profit warnings before this year which are pretty much par for the course: lumpy concentrated orders being delayed.
The warning comes in a Trading Update. It doesn’t start so badly:
IQE expects to deliver revenue of £65m to £68m for the first half of FY2019 (consensus £68m). As previously guided, the first half of 2019 has been impacted by a weak smartphone handset market, particularly affecting the Wireless Business Unit. In addition, IQE has also experienced a reduction in Indium Phosphide laser revenues for the datacom market due to a customer specific issue outside of IQE’s control. This has been partially offset by new qualifications and revenue streams coming into production at our Taiwan facility where we have invested in capacity and which offer increased customer diversification.
This also rehashes things we already knew:
On 24th May 2019 IQE announced, as a response to external geo-political uncertainties, that the Group may experience some delay to orders and the potential for adjustment of supplier managed inventory levels, predominantly in its Wireless Business Unit.
It seems the market has deteriorated further:
IQE is operating in an increasingly cautious marketplace and has very recently received a reduction in forecasts from a number of chip customers, in Wireless and also in Photonics, impacting anticipated revenues for the second half of FY2019.
As a result of the above and with the expectation that uncertain market conditions will continue in the short-term, IQE now expects to deliver revenues in the range of £140m to £160m for FY2019 at prevailing exchange rates (consensus £175m).
This is a larger impact than the previously guided risk related specifically to Huawei, due to the far-reaching impacts on other companies and supply chains that are now becoming evident.
The bottom line for profit is quite ominous:
Given the reduction in expected revenues, IQE expects to remain profitable in 2019 but with Adjusted Operating Profit margin significantly below the previous guidance of over 10%.
Last year was a poor year in relative terms for IQE and it seems that this will reoccur this year. There are plenty of adjustments so the real result may be even worse.
.It is perhaps unfair to say that IQE are all jam tomorrow, as clearly they have been delivering profits, both on adjusted and statutory grounds. Before 2018 there was being great progress being made on both fronts, with almost £20m being made in 2015. However, none of this has been returned to shareholders in terms of dividends. In fact, things have gone the other way: capital expenditures have exceeded cash flows:
In order to pay for this, profits have been used, as well as equity issued. The share count has gone up by roughly 150m in the past six years. This is not the bonanza it seems, as the share price was only really elevated for a year and a bit of that. Still, it has allowed the company to bolster its balance sheet. A £94m issue in the 2017 swung the balance from net debt to net cash.
That position was £20.8m at the time of the last financial report. With a high level of capex here, it does seem that in short time debt will return. An equity raise this time around will not be as effective due to the lower share price.
The balance sheet looks OK. As we may expect from a company that develops proprietary products there is a large amount in intangibles but this is outweighed by a larger amount of property, plant and equipment. With the debt cleared, current assets are bigger than all liabilities.
There seems to be a flipside of this which is related to the valuation: there are a lot of total assets in play here to produce a relatively low return. It seems that as development continues, the amount of assets will continue to rise.
No doubt there will be a few groups of holders here with different viewpoints. The longer term investors would have still seen a decent gain on their stake. Anyone coming later to the party would likely have been stopped out or seen larger paper losses due to the volatility of the share price.
One reason for this is the valuation, which had clearly gotten ahead of itself in 2017. Even now with today’s warning in place the company is still worth £350m and assuming the company recovers, still puts it on a valuation multiple of the mid 20s.
So whether this can be considered value depends on the personal viewpoint on the company. If this warning is reversible and revenues and profits can continue on the previous trajectory it could be a bargain price as the technology becomes adopted. Alternatively, IQE itself could become a takeover target although geo-political risks have increased in recent times.
Having being burned before, I must admit to not understanding fully the products here, and as such am not sure whether this can justify a huge valuation. I do suspect that many market participants feel the same and as such there will be large moments in the price either way. 3/5.