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Is the market right to be so bearish on growth stock IQE?

According to shorttracker.co.uk, global advanced wafer products supplier IQE (LSE: IQE) is the fourth most hated stock on the market. The only companies more despised at the current time are pet product retailer Pets at Home, Frankie & Benny’s owner Restaurant Group, and department store chain Debenhams. For a company with supposedly tremendous growth opportunities, this is certainly an interesting position to be in. But is such bearishness justified?

Revenue up, profit down

Today’s interim numbers were, predictably, something of a mixed bag. 

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Despite strong currency headwinds, revenue rose 4% to £73.4m in the first six months of 2018 with the mid-cap reporting growth in all three of its primary markets. Sales at both its Wireless and Infrared divisions rose 11% compared to the same period in 2017. The standout performer, however, was Photonics, with sales growth of 30%.

On the downside, pre-tax profit slumped 21.2% to £7.6m, before adjustments. Exclude currency headwinds, accelerated customer qualification programmes, and ongoing investment in its Newport Foundry, pre-tax profit would have been up by 14.4% to £11.1m, according to the company. With regard to the new facilities, IQE revealed that five reactors had now been installed, with another two delivered this month. Initial production is scheduled to begin towards the end of 2018.

CEO Dr Drew Nelson appeared more than satisfied with the progress, stating that IQE was now “successfully engaged with over 20 companies” in the VCSEL wafers market for consumer applications. 

While recognising that the aforementioned expenditure had “impacted first half profitability,” he went on to speculate that this would eventually result in “strong increases in revenue, margin expansion, and profitability” as, and when, 3D sensing becomes more mainstream, particularly in smartphones. The company, he said, was looking toward next year’s “further multi-customer ramp” with “considerable anticipation.

Although management will always accentuate the positive, this certainly doesn’t feel like the sort of business that should be attracting so many short-sellers. 

Squeeze ahead?

IQE’s shares were down sharply in early trading. By lunchtime, however, the stock was down by less than 1%, suggesting that many investors (as opposed to traders) were actually fairly happy (or at least not shocked) with today’s report and the fact that no changes were made to its guidance on trading in H2.

You do begin to wonder whether IQE will be the next Ocado. Once as despised as IQE, the latter’s stock is up 300% since last November as many shorters hurried to close their positions following the announcement of a number of partnerships with some of the world’s biggest retailers.

While time will tell as to whether IQE can replicate this performance, it does seem overly harsh to label this a ‘jam tomorrow‘ business. It has revenue, profits and, in sharp contrast to the £41.9m of net debt on the balance sheet at this time last year, now boasts a net cash position of £40.6m. Yes, its stock looks initially expensive at 27 times predicted earnings, but a PEG ratio well below 1.0 implies that this could still be great value if IQE is able to increase earnings at the rate analysts expect.

In sum, I’m content to continue holding for the long term. The share price may remain under pressure for a while yet but, in my view, there’s nothing in today’s results to suggest an immediate exit should be considered.

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Paul Summers owns shares in IQE. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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