Small Cap Value Report (Fri 10 Nov 2017) - CGS, VLX, IQE

9th Nov '17 by Graham Neary

70 comments 20138 reads

Good morning!

This is the placeholder article, published the night before, to enable early comments and suggestions from readers.

Best,

Graham

Paul has interviewed the CEO and CFO of Tracsis (LON:TRCS) on his personal website. following the publication of their 2017 results. It's available at this link.

Castings (LON:CGS)

Share price: 435p (-5.4%)
No. of shares: 43.6 million
Market cap: £190 million

Half-year report

Checking my notes on this industrial group, I've generally made positive noises on it over the past year, while the market cap has been c. £200 million. Sadly, the outlook has been gradually deteriorating - see how the consensus 2018 EPS forecast has reduced from 35p to less than 30p:

The group has two parts - casting and machining. The machining plant came to the conclusion of a large contract about a year ago, resulting in a lot of excess capacity which needed to be filled again.

This part of the business has failed to recover yet, as today it reports a loss of £1 million (compared to a profit of £0.8 million in the previous year).

If I've interpreted this correctly, it would have achieved breakeven were it not for some one-off costs which have been included in the result:

Following a detailed review of the operation, additional short-term costs have been identified and included in the result for the period. The main areas impacted are stock obsolescence and the recoverability of tooling costs which, when taken with the director severance cost, have reduced group profits by £1.0 million.

The company is straightforward enough not to use any adjusted or underlying measures in these results (something I like about it). That said, perhaps we should bear in mind that stock obsolescence, etc. are somewhat unusual and that without those costs, it would have been approximately breakeven in this side of the business? The lack of an MD remains a serious concern, however.

The foundry part of the business performed fine, revenues up 8% and profit up 10.5% to £6.9 million.

Outlook

I'm a little disappointed with this, as they could have explicitly said that the outlook is now lower than prior expectations. Instead, it is implied:

Demand from our commercial vehicle customer base remains…

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linhurst

11th Nov '17

I was pleased with the Castings(LON:CGS) Interim results.
It appears that demand for trucks is still holding up.
The expected new business on Machining has not been achieved and that side of business is being
streamlined. New experienced management are taking action.
Balance Sheet still strong £19mill cash.
Dividend maintained.
Look forward to sound Company getting over bump in road.

Graham Ford

Si,

I’m a bit confused.

If IQE is not at the cutting edge of epitaxy for compound semi-conductors, who is?

My understanding is that the product life cycle for silicon wafer based semi conductors is coming gradually to an end for some applications as the need for higher speeds and lower power consumption etc. for high end applications increases - e.g. 5G. And that compound semis will become prevalent for that. Is that not the case?

https://5g.co.uk/guides/what-are-compound-semiconductors/

JMichaelCharlton

I'm more than a little confused, I can see and understand Graham's reasons for thinking a short position on IQE might be the best bet. It does seem to be a very volatile stock. Paul seems to be dumping it from his BMUS fund but still holds some. I would'nt mind hearing his comments on the stock. My opinion is that it's probably one for the brave. If all the glue holds up it could be a flyer.
Regards, Mick C

herbie47

Hi Michael,

My reply got lost, so briefly, yes you can miss out but I have picked quite a few shares on dips that have done very well. Bioventix (LON:BVXP) was one actually when it fell to 960p. Tristel (LON:TSTL) was another. I'm sure David Gardner bought something else like Amazon with his money. I do get their Canadian emails but may stop because they are quite annoying. I do have a few of their tips.

mcfly46

paul wrote one of the first replies on this comment section, saying a little about iqe

simoan

Si,

I’m a bit confused.

If IQE is not at the cutting edge of epitaxy for compound semi-conductors, who is?

To be fair, where did I say they were not at the cutting edge of epitaxy for compound semiconductors? I think that's why you're confused. My response was to an assertion that did not differentiate between compound semiconductors and silicon based semiconductors. There is a world of difference between the two. Compound semiconductors are not at the cutting edge of "semiconductor development" so how can IQE be at the cutting edge?

My understanding is that the product life cycle for silicon wafer based semi conductors is coming gradually to an end for some applications as the need for higher speeds and lower power consumption etc. for high end applications increases - e.g. 5G. And that compound semis will become prevalent for that. Is that not the case?

People have been making noises like this for as long as I can remember and yet Moore's Law has relentlessly churned out silicon feature scaling that has got smaller and smaller. If you are invested based on this thesis then you will be waiting a long time and it doesn't seem to be a great reason to hold IQE (LON:IQE). There are problems with compound semiconductors that do not make them a great replacement for silicon. If they did, do you not think Intel, Samsung and TSMC would be throwing vast amounts of money at developing compound semiconductor processes rather than the current small-scale R&D they are performing? And if they did, where would that leave a tiny company in South Wales?

All the best, Si

pka

"There are problems with compound semiconductors that do not make them a great replacement for silicon."

Compound semiconductors do not need to replace silicon for there to be growing demand for the former. My understanding is that there are many applications for which silicon semiconductors do not perform as well as compound semiconductors, particularly those applications that involve converting electric signals to electromagnetic radiation or vice versa. For example, are there many VCSELs (vertical cavity surface emitting lasers) or LED light bulbs that do not use compound semiconductors? Demand for both VCSELs and LEDs is growing rapidly at present.

matylda

For what it's worth Ramridge - I agree and took similar action on Friday morning.

“Compound semiconductors are not at the cutting edge of "semiconductor development" so how can IQE be at the cutting edge?”

Well there is plenty of commentary out there that describe the specific areas where compound semis have superior physical properties to silicon semis. If you want play semantics about the phrase “cutting edge” so be it.

“There are problems with compound semiconductors that do not make them a great replacement for silicon. If they did, do you not think Intel, Samsung and TSMC would be throwing vast amounts of money at developing compound semiconductor processes rather than the current small-scale R&D they are performing? And if they did, where would that leave a tiny company in South Wales?”

No one said they are replacing all silicon semi conductors. They are a niche for specific applications where their properties justify the cost. As new opportunities to use those properties arise and the cost comes down, larger diameter wafers for example, the use of these technologies will grow.

As for the last part of that paragraph, I think you are aware large companies often leave niche applications under served, which provides opportunities for smaller more nimble competitors, who then grow into much larger operations over time.

catalogue

12th Nov '17

Stockopedia covered First Derivatives First Derivatives (LON:FDP) in 2010 - It has been in the news and is an interesting company but there are some strange anomalies such as poor ROCE and a very low operating margin for a software company. If anyone feels like covering it others might be interested.

fanmail

13th Nov '17

It is great to have your input on this and am glad that you have clarified that IQE are (probably?) at the leading edge of development re the epitaxy process for compound semis. I am however interested in developing understanding of your comment that compound semis are not at the cutting edge of semiconductor development. If that is the case what and who is currently at the leading edge of semi development in your opinion? Clearly one of the major risks for IQE is that their IP will be superseded by new technologies so any light you can throw on such threats would be appreciated.

My understanding is that there are many applications for which silicon semiconductors do not perform as well as compound semiconductors, particularly those applications that involve converting electric signals to electromagnetic radiation or vice versa.

Yes, this is correct, but these applications are few and far between, and assume that silicon processes will not improve further. Certainly there will be huge cost advantages to using silicon rather than more expensive compound semiconductors, and so chip makers and equipment vendors will move heaven and earth to use the existing silicon based technology.

For example, are there many VCSELs (vertical cavity surface emitting lasers) or LED light bulbs that do not use compound semiconductors? Demand for both VCSELs and LEDs is growing rapidly at present.

No and they never have - LED's are obviously very old technology and have always been manufactured using III/V compound substrates. VCSELs are clearly a growth area but the point I'm making is that that is about it. If the demand from Apple went away in the next 12 months what would happen? I have a large holding in Apple but I wouldn't want to hold shares in one of their small technology suppliers any more than I'd want to hold shares in a company supplying product to the UK supermarkets.

Well there is plenty of commentary out there that describe the specific areas where compound semis have superior physical properties to silicon semis. If you want play semantics about the phrase “cutting edge” so be it.

But it's not semantics. the reality is that cutting edge silicon technology is miles ahead of compound semiconductors, just the lithography technology itself required to create 3-dimensional features at 10nm wide is quite amazing, and Intel earlier this year announced Fab42 in Arizona for 7nm silicon in a few years time. Compound semiconductor technology is miles behind this.

No one said they are replacing all silicon semi conductors. They are a niche for specific applications where their properties justify the cost. As new opportunities to use those properties arise and the cost comes down, larger diameter wafers for example, the use of these technologies will grow.

But this has been the case for over 20 years and I don't see this changing in my investment lifetime, let alone working lifetime. Yes, it's niche, it's always been niche and it will always be niche.

As for the last part of that paragraph, I think you are aware large companies often leave niche applications under served, which provides opportunities for smaller more nimble competitors, who then grow into much larger operations over time.

Absolutely. And my own company profits from this. But it is a bloody difficult world to live in, particularly if you are a supplier to very large organisations. As someone else mentioned, Apple will be very unhappy with having a single source of VCSEL technology, they will push back hard on price all the way down the procurement chain, and you can bet your life they are actively encouraging competition to create an alternative supply chain.

Hi Simoan, you wrote: "LED's are obviously very old technology and have always been manufactured using III/V compound substrates. VCSELs are clearly a growth area but the point I'm making is that that is about it. If the demand from Apple went away in the next 12 months what would happen?"

I'm afraid that you're very mistaken about this.

LEDs are not very old technology, in the sense that it is only in the last couple of years that the light-conversion efficiency of LED bulbs has improved tothe extent that they are now being widely used for lighting in homes and offices, with an enormous increase in demand.

The demand from Apple for VCSELs won't go away in the next 12 months. It is likely to remain high for years, because all their future models of iPhones and iPads will probably use VCSELs for face recognition and Augmented Reality applications. Demand from other mobile manufacturers such as Samsung for VCSELs is also likely to increase for years. VCSELs will also be used in self-driving cars. VCSELs and other types of lasers that are manufactured from compound semiconductors are used in optical fibres, for which demand is increasing exponentially at present due to their use in the huge data centres that are required to provide services for 'cloud' computing.

Some other applications for compound semiconductors that are growing rapidly at present are for wireless base stations for the next generation of mobile phones, and for efficient power conversion from high to low voltages.

Obviously the market for silicon-based semiconductors is enormous and will continue to be so for the forseeable future. However, the demand for compound semiconductors is growing much more rapidly and from a much lower base.

Clearly one of the major risks for IQE is that their IP will be superseded by new technologies so any light you can throw on such threats would be appreciated.

I wouldn't worry about being the IP being superseded if they have strong patent protection. And it will need to be strong because patent litigation in the semiconductor industry is rife!

I think Graham has brilliantly highlighted the main problem with IQE as an investment in the main article above i.e. cash flow will be constantly eaten up by Capex. IQE operate in an industry which requires constant expenditure to stay in front and so they can't just turn Capex on and off like a tap to release free cash flow. They also seem to have very low historic operating margins for a world leader in technology, particular operating in niche markets - niche normally means high margins to me!

Si

I think you’ll see their margins improve dramatically as the capacity of their production facilities becomes fully utilised and then expanded.

While it is tempting to use their past performance as a guide to the future I think it is a mistake as there is now a much bigger market for their products appearing.

But I’m interested in your view that VCSELs are just about it. Industry commentators are saying that compound semis will be needed for 5G communications. Are they wrong?

But I’m interested in your view that VCSELs are just about it. Industry commentators are saying that compound semis will be needed for 5G communications. Are they wrong?

I don't know, but experience would tell me with 99.9% accuracy that they are wrong. I never listen to "market commentators" because they are normally talking their own book and have a vested interest in building up and "selling" certain technologies, so you have to be very careful. Many of them are academics who have no practical background in semiconductors or business.The bottom line is that in 35 years working in the chip industry (just as with most other industries) I have found 99.9% of predictions by market experts turn out to be completely and utterly wrong.

If I had a pound for every time some great new technology never took off, I'd now be sitting on my super yacht in Monaco...

"If I had a pound for every time some great new technology never took off, I'd now be sitting on my super yacht in Monaco..."

Well, if you'd bought IQE's shares a year ago at 30 pence and sold them at today's closing price of 170 pence, you might not be sitting on a yacht in Monaco, but you would have done much better than the vast majority of investors over the past year!

Yes. I agree in terms of investors.

I was referring to industry commentators in the sense of those who write articles for industry journals and so on rather that investment community commentators. Well, I suppose we won’t have to wait very long to find out.

14th Nov '17

I was referring to industry commentators in the sense of those who write articles for industry journals and so on rather that investment community commentators. Well, I suppose we won’t have to wait very long to find out.

I was talking about industry commentators too. it always amazes me how many people predict things with such certainty amidst so many "known unknowns". I guess the big hope for IQE is the 5G base stations will need to use compound semi devices for power amps as I believe the radios may need to move to using millimeter wave techniques normally only used by the military. However, even then we are not talking massive volume, certainly not iPhone volume, but every little helps!

Small Cap Value Report (Fri 10 Nov 2017) - CGS, VLX, IQE

Castings (LON:CGS)

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Graham Neary

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