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Is the IQE share price an unmissable buy after 30% crash?

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The share price of semiconductor manufacturer IQE (LSE: IQE) was down by more than 30% at the time of writing after the company warned that 2019 profits would be significantly lower than previously expected.

IQE says that “a weak smartphone market” has resulted in reduced orders for wireless chips. The firm’s photonics division is also seeing lower forecast orders, which is likely to result in lower orders during the second half of the year.

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Chief executive Drew Nelson believes that the US government restrictions placed on Chinese firm Huawei are having “far-reaching and long-last impacts” on the market in which IQE operates. In May, the company said this issue could affect up to 5% of revenue, but in today’s update, management has admitted that the total hit is now expected to be larger.

Profit collapse?

IQE now expects to report revenue of between £140m and £160m for 2019, compared to previous forecasts of £175m. Based on the mid-point of £150m, that’s a reduction of about 14%.

That may not sound too bad, but lower volumes mean that profit margins will fall too. The company says that its adjusted operating profit margin is now expected to be “significantly below” its previous guidance of at least 10%.

Management hasn’t specified how far margins are expected to fall. But based on the use of the word ‘significantly’ I’d expect a revised figure somewhere between 5% and 8%.

Using the mid-point of 6.5% as an example, my sums suggest that IQE’s adjusted operating profit is now likely to be about 45% lower than expected — I’d estimate about £10m.

It’s worth remembering that profits slumped in 2018, too.

Year

IQE adj. operating profit

2017

£26.5m

2018

£16.0m

2019

c.£10m (estimate)

Can the firm return to growth? It’s not clear to me. However, I thought that IQE shares looked expensive before today’s announcement, and in my view they still do.

I estimate that at 50p, the shares are probably trading on about 45 times 2019 forecast earnings. That’s too high for me, especially as this capital-intensive business has never paid a dividend. I’m going to continue to avoid this stock.

A quality engineer I’d buy

IQE’s high-tech products and jargon-filled press releases may seem exciting. But the firm appears to be struggling to convert this hype to cold hard cash.

One engineering firm that takes the opposite approach is Castings (LSE: CGS). As its name suggests, this 112-year old company makes metal parts for manufacturers, with more than 80% going to the automotive sector.

Castings has had its problems over the years. Most recently its CNC Speedwell machining division has come unstuck. But throughout the time I’ve been following this stock it’s remained robustly profitable, with a big net cash balance and a reliable dividend.

The latest figures from the firm suggest that trading is improving. Revenue rose from £133m to £150m last year, while adjusted pre-tax profit climbed from £12m to £15.3m. The firm’s foundries are said to be busier and more profitable, while new management is working hard to fix problems at CNC Speedwell.

Although a cyclical downturn is a risk, demand for commercial vehicles is said to remain strong. This is supporting Castings’ order book.

The shares trade on 12.5 times forecast earnings, with a dividend yield of 3.4%. I’d prefer to pay a little less, but this looks a fair price to me for income investors.

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Roland Head 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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