Metro Bank and IQE: two high-risk stocks I would sell today

Risks abound for investors in Metro Bank plc (LON:MTRO) and IQE plc (LON:IQE), argues G A Chester.

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Challenger bank Metro (LSE: MTRO) and tech firm IQE (LSE: IQE) have been much-touted growth stocks in the past few years. Their shares are currently well off their highs, but I reckon the market has been right to de-rate them. Indeed, I see further downside risk and merit in selling and recycling the cash into more promising growth candidates.

Business model doubter

Metro was founded in 2010, and is pursuing an ambitious branch-opening strategy, with a large part of annual branch rental costs covered by an operation to provide safety deposit boxes. Apparently, this is a market rivals have pulled out of, and I wonder if it could be ripe to come under increased regulatory scrutiny. Either way, I’ve long been unconvinced that Metro is the future of 21st century banking.

In an article in January last year, I wrote that even if I had confidence in the business model, I wouldn’t be prepared to pay the valuation. At the time, this was 150 times forecast 2017 earnings of 23.5p and over 50 times forecast 2018 earnings of a bit above 70p. The share price was north of 3,500p and I suggested, now could be a good time to cash in.”

The fact the company went on to post earnings of just 18.8p for 2017 and 39.4p for 2018, shows how far it has fallen short of earlier growth expectations. And there have been other issues, notably its mis-categorisation of a large number of its higher-risk mortgages, which required an emergency fundraising earlier this month (£375m at 500p a share) to bolster its capital position.

Some long-term supporters have continued to back the bank, and there’s also been talk of private equity interest. However, I remain thoroughly unconvinced by the business and its valuation. A current share price of 790p represents over 30 times the Reuters consensus earnings forecast of 25.74p for 2019.

Finally, at least seven sophisticated hedge funds are currently positioned to profit from Metro’s share price falling, with their disclosable ‘short’ holdings in the stock totalling 10.4%. This makes the bank the third most shorted stock on the London market.

Step-change sceptic

IQE’s president and chief executive, Dr Drew Nelson, founded a company called EPI in 1988, which became IQE in 1999, and listed on the stock market in 2000. It billed itself as “the world’s largest ‘pureplay’ outsource supplier of customised epitaxial wafers to the compound semiconductor industry.”

A real step-change in earnings and free cash flow (FCF) has yet to materialise. Despite spending a total of £166m on capex and £59m on acquisitions over the last 10 years, cumulative FCF for the period stands at minus £33m. Periods of elevated investment and heavily negative FCF have been followed by little meaningful FCF advance in subsequent years. Given two decades as “the leading global supplier” of epi-wafers, I’m sceptical about whether we’ll ever see a step-change in FCF and earnings.

In view of this, I see little value in the shares at a current price of 74p, which represents over 33 times consensus forecast earnings of 2.2p for 2019. Finally, I’m conscious IQE is another grievously shorted stock, with four institutions having disclosable positions totalling 8%.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

G A Chester has no position in any of the shares mentioned. 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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