XP Power dogged by “increasing lead times and shortages”

XP Power (XPP) entered 2021 in good shape as demand from customers in both the medical equipment and semiconductor industry soared during the pandemic.

Although demand remains strong – it started this year with a record order book of £217mn – it has faced a number of headwinds which weakened profitability and proved to be a drain on cash.

About 80 per cent of revenues come from products manufactured at the company's sites in China and Vietnam, both of which have faced Covid-19 lockdowns and capacity restrictions. Although its Vietnamese factory remained open during lockdowns in the second half of last year, social distancing measures meant staff numbers operating on site were halved.

It was also affected by supply chain shortages that have dogged many manufacturers, most notably in semiconductors.

It increased inventories by 37 per cent to £74mn by building up stock levels to mitigate the impact, but still faced “increasing lead times and shortages” which reduced potential sales and profits, the company said.

A less welcome hit to its bottom line came from to the fact that it has spent more than £10mn in legal fees preparing to defend a claim brought by the US arm of Swiss radio frequency product manufacturer Comet (CH:COTN), which alleges XP Power misappropriated trade secrets.

XP Power argues the case “has no merit” but is continuing to incur costs ahead of a trial date set for next month.

Higher working capital costs contributed to a relatively small cash outflow of £5.1mn last year, compared with an inflow of £2.7mn a year earlier. Net debt also rose by 37 per cent to £24.6m.

Although outgoing chairman James Peters, who co-founded the Singapore-based company 34 years ago and retains a 5 per cent stake, highlighted its “strong cash generation”, capital expenditure is likely to be “abnormally high” at £18m this year as it begins building a third factory in northwest Malaysia. It is expected to open next year.

XP Power’s shares dropped by 8 per cent and are 26 per cent lower than a year ago. It is now trading at a valuation of 20 times earnings, which is in line with its five-year average. Broker Investec expects earnings per share to decline by 11 per cent this year, though, and for free cash flow per share to drop by 59 per cent. Given the prospect of lower profits and the uncertainty surrounding legal costs, we downgrade to hold.

Last IC View: Buy, 5,203p, 2 Aug 2021