IQE has great potential. Will it deliver?
Some of you may recall IQE (LSE: IQE) from dot-com days when its shares hit almost £8. Since then, this manufacturer of advanced semiconductor wafers for chip manufacturers has seen its share price drop precipitously.
Of course the price of a share rarely reflects its true value. Just as 780p was absurdly expensive price back in September 2000, 17p could be too cheap for a company with cutting edge technology.
Consensus estimates for 2009 are that it will make a pre-tax profit of £2.6m (2008: £1.4m loss) on sales of £53.6m (2008: £60.5m). What's more, pre-tax profits are forecast to increase to £4.6m in 2010.
IQE's current market cap is £74m, so these forecasts translate into a P/E of 30 for 2009 and 17 for 2010. Admittedly therefore, if you buy into this share, you are really buying into a potential growth story.
Its wafers are used in chips that are included in everything from mobile phones to solar cells. The focus is on high growth and high volume markets so I suspect demand for its wafers should increase considerably over the next few years.
Bull points
IQE is already benefiting from the advent of smart devices, such as 'smartphones', which are steadily taking the world by storm.
These smartphones are basically mobile phones that are converging with PCs to deliver portable mobile devices that enable you to do a wide variety of tasks using software applications. You can watch video, edit documents, send emails and make payments in stores. However, as the number of wireless functions these devices perform increases, they require more chips while using less power.
More chips means more wafers, which is where IQE comes in. It supplies most of the major chip companies and it supplies TriQuint, which has three chips in the iPhone.
IQE manufacturers the gallium arsenide wafers used in such chips, which deliver superior performance to silicon chips. In addition, it is developing other new items such as advanced laser products, solar cells for efficient energy generation and solid state lighting devices.
Its purchase of NanoGaN for up to £3.6m in shares looks like a shrewd move, as brought in the technology to produce high-quality gallium nitride substrates. These are used to produce high-quality blue and green lasers, and solid state lighting (SSL) products for industrial, commercial and residential lighting. This could be an important development as these forms of lighting are expected to replace conventional lighting, being both more efficient and powerful.
The purchase price necessitated only £400,000 up front with the balance of £3.2m to be paid according to technical and volume milestones, thereby mitigating the risk of money being tied up before revenues are delivered.
Bear points
On the negative side, net debt was £15.7m at June 2009, but the company predicts this should be lower by the year end due to strong free cash flow generation.
Another minus point is that despite the prospect of making a small profit this year, it has no plans to offer a dividend. The hope would be that one might materialize further down the line.
Of course, the danger with all technology stocks is that it is difficult to assess whether the technology really is superior to that of its rivals. Moreover, it isn't always the case that superior technology wins out in the end, particularly if the competitors' marketing is more effective. There is also the risk that competitors and technology in these areas moves so fast, making it easy to get caught out by the pace of technical change.
House broker Noble reckons IQE is undervalued compared to other UK semiconductor stocks and I think it's probably worth a small punt. It's undoubtedly risky though and I'd certainly recommend that you do your own research before taking any position.
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