Shares of IQE (LSE: IQE) fell as much as 6.7% in early trading today after the aspiring growth company posted a 9% fall in first-half revenue and a 45% slump in adjusted earnings before interest, tax, depreciation and amortisation (EBITDA).
However, the shares have rallied somewhat from the low — trading 2.6% down at 50.5p, as I’m writing — and with a new note out from Edison Investment Research forecasting EBITDA will soar over 90% next year, could now be a great time to buy?
First-half factors
The leading supplier of advanced wafer products and material solutions to the semiconductor industry, IQE said revenue for the first half of the year was “impacted by a weak smartphone handset market and reductions in demand in the context of a technology market slowdown, international trade tensions and fall in demand from a major InP laser customer.”
The bigger fall in EBITDA was due to high fixed costs and under-utilisation of facilities scaled for higher volumes, producing negative operating leverage. The company said it expects EBITDA margins to remain low in the second half of the year, but that the group is positioned well “for future growth and margin expansion as volumes increase, driven by the growth opportunities in 5G and connected devices.”
Second-half outlook
IQE had previously downgraded its expectations for 2019 in a trading update in June. First-half revenue of £66.7m came within the reduced guidance range of £65m-£68m.
Some analysts and commentators had feared IQE could issue a further revenue and profit warning today. However, management reiterated the full-year revenue guidance of £140m-£160m it had given in June.
While this is encouraging, it may be remembered that last year’s guidance was utterly decimated less than seven weeks before the year-end. Furthermore, the company today cautioned that three key factors affect this year’s revenue outlook:
- Continued uncertainty related to the geopolitical landscape, the effects on global technology markets and, in particular, the confidence for supply chains to rebuild inventory.
- The market for smartphone handsets in the second half of 2019.
- The speed of formation of new Asian supply chains, the associated product qualifications and volumes of initial orders.
I think these factors represent quite a high downside risk to management’s revenue guidance for the year, and Edison’s adjusted EBITDA forecast of £22.5m (compared with £7.4m in the first-half).
At the current share price, IQE’s market cap is £400.4m, and with Edison’s year-end net debt forecast of £14.7m, the Enterprise Value (EV) is £415.1m. As things stand, the EV/EBITDA is a high-looking 18.4. This would not only balloon, if IQE misses this year’s expectations, but also call into question Edison’s forecast of EBITDA sky-rocketing to £42.9m next year.
Cash flows
Finally, let’s turn from revenue and EBITDA (what Warren Buffett’s partner Charlie Munger calls “bullshit earnings”) to cash. IQE burnt through £21.6m in the first half of the year, as it continued to invest for future growth. It moved from net cash of £20.8m to net debt of £0.8m (excluding £49.3m lease liabilities, albeit only £3m due within one year).
I’ve previously noted that after 20 years, IQE’s periods of elevated investment and heavily negative free cash flow have been followed by little meaningful advance in free cash flow in subsequent years. The bottom line for me is that unless this changes, I’m perfectly happy to continue avoiding the stock.