XP Power — A record year

XP Power designs, manufactures and distributes power converter solutions to original equipment manufacturers (OEMs) in the healthcare, technology and industrial markets. The group has headquarters in Singapore and, to remain close to its global customer base, has a sales, design and engineering presence in the US, Europe and Asia. Unlike many in the industry, XP is vertically integrated; its manufacturing facilities in Asia and the US allow the company to maintain quality control, improve flexibility, reduce product costs and minimise lead times.

XP reported 17% revenue growth in FY20, helped by strong demand for critical care equipment in the healthcare sector and a cyclical upturn in the semiconductor equipment sector. Better factory utilisation (despite COVID-19 disruption in Q120) drove gross margin expansion and normalised operating profit increased 31% y-o-y. Lower tax and finance costs further contributed to normalised diluted EPS growth of 40% y-o-y, with EPS 18% ahead of our forecast. Order intake increased 20% y-o-y, resulting in a book-to-bill ratio of 1.11x for FY20. We forecast underlying revenue growth for FY21, although as the dollar has weakened against sterling over the last few months, this translates to a small decline in our reported revenue forecast. We forecast an EPS decline of 14% in FY21e before a resumption in growth of 8% for FY22e.

Over the last year, the shares have gained 79%, reflecting XP’s strong performance on an absolute and, even more so, on a relative basis. On a P/E basis, XP is trading at a premium to both global power converter companies and UK electronics companies, with a dividend yield at the upper end of the range. The company generates EBITDA and EBIT margins at the top end of both peer groups. Strong cash management during the crisis, which reduced net debt by 57% y-o-y, leaves the company well funded to pursue both organic and acquisitive growth.

XP Power has cyclical exposure to global industrial, technology, semiconductor and healthcare markets, so is sensitive to end-demand and product development expenditure in these markets. Visibility of customer volumes is limited and, as such, individual customer orders can be volatile. With the majority of XP’s revenues, manufacturing costs and opex US dollar denominated, currency will continue to add volatility to XP’s reported revenues, although it will have less impact at the net income level. XP also has more limited exposure to the euro/sterling exchange rate; to minimise this the company enters into forward contracts. XP competes with large, global industrial companies and low-cost Asian manufacturers.

XP Power designs, manufactures and distributes power converter solutions to OEMs in the industrial, healthcare, semiconductor and technology markets. Power converters take the high-voltage alternating current output from the mains supply and convert it into various lower-voltage, stable direct current outputs that are required to drive most electronic equipment. XP designs and manufactures the majority of its products. XP’s headquarters are in Singapore and it has volume manufacturing facilities in China and Vietnam and specialist high-voltage, high power and radio frequency (RF) power product manufacturing in the US.

XP was formed as a specialist distributor of power converters in 1988 and listed on the LSE in 2000. In 2002, the board decided to begin developing its own IP and designs, and bought Switching Systems International (US), which designed its own configurable power converters with an outsourced manufacturing model. Since then, XP has continued to develop its own products and brand, built out manufacturing capacity in China and Vietnam and completed the transition from distributor to designer and manufacturer. Recent acquisitions have expanded XP’s product range from low-power AC/DC and DC/DC converters to include high-voltage, low-power converters (EMCO), RF, power products (Comdel) and high-voltage, high-power products (Glassman). XP sells through 27 sales offices and multiple distributors across Europe, Asia and North America and has engineering service functions in Northern California, Germany and Singapore. FY20 revenues were generated in North America (63%), Europe (28%) and Asia (9%).

XP is focused on developing tailored products for applications with high reliability requirements in the technology, industrial, semiconductor and healthcare equipment markets. It avoids developing commodity products for high-volume consumer electronics applications. Products in each end market can have very different lifecycles. For example, a medical device could have a product lifecycle of 10 years or more. Once a power converter is designed into this product, it is likely to remain in it for the full life of the product. On average, the product life cycle is five to seven years. XP’s balanced mix of end customers means it has a fairly high level of revenues that are recurring and exposure to multiple end markets mitigates the risk of individual industry cyclicality.

XP’s focus is on growing the proportion of own-IP, own-manufactured products. This provides control over the quality and cost of product and allows XP to provide customers with tailored solutions. The company operates across two business lines:

The company is vertically integrated; it manufactures power converters and magnetic components in two locations, China and Vietnam, with smaller US facilities acquired through the Comdel and Glassman deals.

XP’s first manufacturing facility was built in Kunshan, China in 2006. In addition to making power converters at this facility, XP also produces magnetic components for prototyping and short lead-time contracts. To reduce exposure to rising Chinese labour costs and gain more control over the manufacturing process, XP expanded manufacturing into Vietnam, at a site near Ho Chi Minh City. The first phase was completed in 2011 and started with the production of magnetic components; XP now manufactures virtually all its magnetics requirements in-house. In 2014, the facility also started manufacturing power converters, starting with some of the less complex converters. In Q119, construction of a second facility was completed (Vietnam II, a similar size to Vietnam I).

To take advantage of the increased capacity in Vietnam, XP was already moving production of less complex power converters (sub 1.5kW) from China to Vietnam. With US tariffs on the import of components manufactured in China rising from 10% to 25% in Q219, XP accelerated this shift. The Vietnam facility is now capable of manufacturing 2,616 different low voltage products (end 2019: 2,080) and we expect volumes produced in Vietnam to continue to increase as more customers qualify the facility. The facility can, or will be able to, manufacture low-voltage/low-power, high-voltage/low-power and RF products as well as provide engineering services. During FY20, products previously manufactured in Minden, Nevada were shifted to this facility, adding the capability to manufacture 476 different high-voltage modules.

The company intends to maintain its China facility, as this is used for some of the more complex converters and is also useful for production of converters for Chinese customers, who will otherwise incur tariffs on products imported from the US.

Through the three US acquisitions, XP inherited facilities in the US for the more complex high-voltage, high-power and RF products. As Comdel and Glassman products are typically more complex than XP’s low-power products (and therefore higher value), it makes sense to retain some of the specialist expertise of the US-based manufacturing facilities. In addition, XP maintains a customer-focused engineering services facility in California.

Having closed EMCO’s Minden facility in Nevada in H220, XP has a facility in Gloucester, Massachusetts where it undertakes final assembly and test of Comdel products (component manufacturing is outsourced within the US) and Glassman’s New Jersey manufacturing facility. The company noted that strong demand for RF products led to supply shortages in 2020 and it is increasing capacity at the Comdel facility to meet current levels of demand.

XP’s strategy to drive revenue and profitability growth and gain market share has been in place and has evolved over a number of years. The current strategy aims to:

Historically, XP designed and manufactured low-power AC/DC converters, supplying voltages up to 120V, with the majority of products sold supplying voltages up to 48V. As competition from low-cost Asian suppliers has increased, XP has started moving along the complexity scale. While it has invested in engineering resource to develop higher-voltage products, it has made the majority of major product additions via acquisition as it is a much faster route.

The chart below shows how the acquisitions have filled out XP’s product range and highlights the addressable markets for the main product types. The three acquisitions expanded XP’s total addressable market by nearly $2bn.

We believe XP has made the major acquisitions required to build its product portfolio. We expect management to focus on integrating the recent acquisitions and maximise the cross-selling potential of those deals. In terms of future M&A, we expect XP to take an opportunistic approach, making bolt-on acquisitions to add to its product or sector offerings.

XP aims to have the most comprehensive and up-to-date product range in its target markets. The company introduced 20 new product families in 2020 (versus 32 in 2019). In 2020, XP spent £19.5m on R&D (pre-capitalisation and amortisation), up 14% from the £17.1m spent in 2019.

XP splits its R&D activities between developing new standard products and developing modifications to existing products to meet specific customer requirements. With competition tending to come from Asian manufacturers of low-complexity converters, XP is focused on serving customers with more complex requirements and undertakes custom design work for large customers. It is moving up the value chain by providing engineering solutions that make it easier for the customer to integrate power solutions into their critical systems, including software and firmware that enables the power solution to communicate with the application controlling it. The company is shifting its R&D focus from low-power/low-voltage products to higher-power, higher-voltage and RF products, in particular looking at applications for RF outside of the semiconductor manufacturing equipment market.

XP has built up its engineering services teams globally to provide this face-to-face support during the design process, and has engineering solutions teams in Europe, North America and Asia.

XP Power has more than 4,500 direct active customers, of which no customer makes up greater than 14% of revenues and no single project makes up more than 3% of revenues. In 2020, the top 30 customers made up 59% of revenues. XP Power supplies power converters to three key markets: industrial technology, healthcare and semiconductors (see Exhibit 5).

XP’s in-house manufacturing helps it sign up blue-chip customers, particularly in the medical equipment and semiconductor equipment markets. Stable and secure power supply is so crucial to the operation of these customers’ products they demand complete control over their supply chain and product manufacture to ensure quality. XP has achieved approved or preferred supplier status at a large number of customers, including all of the main healthcare equipment companies, and is now working to expand its share of business at each customer.

The three US acquisitions increased the potential for cross-selling. As XP’s AC/DC converters often provide the DC input for high-voltage DC/DC converters, there is good cross-selling potential for EMCO. Roughly 95% of Comdel’s revenues and 70% of Glassman’s revenues are generated from the semiconductor production equipment sector. In this market XP, Comdel and Glassman have some customers in common, but they do not overlap in terms of products sold. XP is keen to achieve wider vertical penetration at key accounts with its full range of power solutions.

XP has generated gross margins above 45% and operating margins around 20% since 2010, showing how efficiently the business has been run since shifting to the design and manufacture business model. The company continually looks at ways to maintain and improve this performance. This includes the focus on lean manufacturing, as well as improvements to internal processes to enable XP to share information internally more effectively and provide better customer service. In 2020, the company hired a global supply chain leader and a chief people officer.

In 2018, XP started upgrading its SAP ERP software to SAP S/4 Hana, initially in existing sales operations and the manufacturing facility in Sunnyvale, California. The company delayed implementing the next phase – the manufacturing facilities in Asia – in 2020 due to the disruption caused by COVID-19 and is now planning to roll out the software to this region this year. It will then roll it out to the acquired US facilities in 2022.

In 2009, XP established an environmental committee led by the CEO, which set the goal of leading the industry on environmental matters. XP is a full member of the Responsible Business Alliance. XP incorporated green technologies into the Vietnamese facility and received the Gold Plus rating by the Singapore Building and Construction Authority for non-residential buildings in tropical climates. XP has water and energy saving practices in place throughout the group.

Having manufacturing facilities and products that meet high environmental standards helps XP to win approved supplier status with large OEMs, but its main ongoing contribution to sustainability is to design ever-more efficient power converters. For example, a 95%-efficient product such as the CCM250 only wastes 5% of the input energy, thereby requiring a lower-power input to achieve the same output as a device operating at a lower efficiency. The wasted power is often converted to heat, which in turn requires additional power or physical heat sinks to provide cooling, adding to the upfront and running costs of the product. XP expects that legislation will become more stringent on the efficiency requirements for power converters. Of the 20 new product families introduced in the year, 17 were ultra-high efficiency and/or low standby power designs. Revenues generated from ‘XP Green Power’ products totalled £52.7m in FY20 (+22% y-o-y), 23% of group revenues. In addition, XP sees increasing opportunities to provide solutions for renewable energy systems and controllers and it is already supplying the smart grid market.

As described above, XP has worked to reduce its environmental impact (and that of its customers) for many years. As investors and customers increasingly want to know how companies are addressing the wider range of ESG issues, XP is formalising its approach. In 2020 the company engaged with key stakeholders to better understand which aspects of their relationship with XP were most important to them, with a focus on sustainability in particular. This feedback has been incorporated into XP’s sustainability strategy and will be reported in the FY20 annual report.

Exhibit 6 shows the split of revenues by geography and end market over the last two years and the video in Exhibit 7 below describes in more detail the end markets that XP Power serves.

Key drivers of market growth include:

The strength of the industrial market depends on the health of the global economy. Unsurprisingly, manufacturing companies reported a decline in PMI data from March 2020 as the COVID-19 pandemic started to take hold globally. It rebounded relatively quickly with all regions covered in Exhibit 8 exceeding 50 (the level that marks expansion) from July 2020. The second (or third) wave of the pandemic, which has resulted in lockdowns of varying severity around the world, caused the data to dip slightly in October and November, but all areas remain above 50. We would expect that as lockdown restrictions are gradually relaxed around the world during 2021, demand from industrial companies will slowly recover.

2020 was a year of mixed fortunes for the technology sector. As businesses scrambled to shift their workforces to remote working, sales of PCs and peripherals grew as did demand for data centre servers. From a consumer perspective, devices for home entertainment such as TVs and games consoles were in strong demand, whereas handset sales declined as fewer people felt the need to replace phones.

According to Gartner, the global IT market declined 3.2% in 2020 but is forecast to return to growth of 6.2% in 2021. The semiconductor market benefited from the demand for the devices described above, and according to the WSTS, grew 5.1% in 2020 and is expected to grow a further 8.4% in 2021. This demand helped return the semiconductor equipment market to growth of 15.6% in 2020 (compared to a 9.3% decline in 2019) according to the trade organisation, SEMI. SEMI forecasts further growth of 4.4% in 2021 and 5.8% in 2022.

The changing end demand for semiconductors has resulted in tightness in the supply of certain components. After a significant drop-off in auto sales in H120, demand rebounded in H220 but auto manufacturers have struggled to meet this demand due to a shortage of the type of semiconductor components they require. This has resulted in the temporary shutdown of various auto plants (including GM, Honda and Ford) to allow for component supply to catch up. Customers in other verticals had maintained orders for their requirements through the course of the pandemic, which meant they continue to be prioritised by chip manufacturers.

In the last year, the healthcare sector has focused on testing for and treating COVID-19. This has boosted investment in antigen test-related technology, equipment for critical care (eg ventilators and CPAP machines) and imaging tools to diagnose and monitor the illness (CT and X-ray). At the same time, the focus has shifted away from diagnostics and treatment of non-COVID-19-related illness, reflected in reduced orders for other medical imaging tools and advanced therapy equipment. We expect this to reverse in 2021. Siemens Healthineers reported strong Q121 (ending 31 December 2020) results, with revenue up 13% on a like-for-like basis, as demand for standard procedures normalised and pandemic-related business remained strong. It raised its outlook for FY21 (ending 30 September) from 5–8% to 8–12% like-for-like revenue growth. GE Healthcare saw a 1% organic increase in orders in CY20 and Q420, while organic equipment sales were up 8% in CY20 and up 10% in Q420. Philips saw like-for-like revenue growth of 7% for Q420 and 3% for 2020, with order growth of 7% for Q420 and 9% for 2020. It has guided to 5–6% like-for-like sales growth in 2021, with solid growth expected in Diagnosis & Treatment and Personal Health, slightly offset by lower Connected Care sales (this division includes ventilators and monitors).

XP sees the following addressable markets for its products:

The low market shares that XP has in each area highlights the opportunity the company has to grow revenues by increasing vertical penetration with existing customers as well as signing up new customers.

Exhibit 9 summarises the main competitors in each of the product areas that XP operates in. In the low-power, low-voltage market, XP competes most often with TDK-Lambda and Mean Well and with a number of local Asian suppliers.

XP Power is a global electronics company supplying a broad range of end markets. XP is not immune to economic slowdown, but diversification and the low-cost structure afford XP some earnings resilience versus competitors.

See Exhibit 10 for details of FY20 results versus our forecasts. XP reported revenue growth of 16.7% for FY20, marginally ahead of the revenue reported in its January trading update. Gross profit increased 22.2% y-o-y, benefiting from high factory utilisation and the shift of production from Minden to Vietnam. This more than offset the £0.9m spent to deal with COVID-19 safety measures. This resulted in an increase in gross margin to 47.2% from 45.1% a year ago, ahead of our 46.1% forecast. Normalised operating profit increased 31.4% y-o-y and was 5% ahead of our forecast. It included £0.6m in one-off income relating to the Singaporean Job Support Scheme. The company benefited from a c £2m reduction in travel costs due to COVID-19 restrictions. This drove margin expansion of 2.2pp to 19.7% for FY20. XP reported a total of £5.4m in exceptional costs made up of £1.9m for the ERP upgrade, £2.3m for restructuring, £0.4m in legal costs, £0.3m relating to acquisitions and a £0.5m fair value loss on currency hedges. Net finance costs were lower than forecast and the tax rate of 11% was well below our 20% estimate (due to deductions for share option awards, the use of tax losses and R&D tax credits), resulting in normalised net income 17% ahead of our forecast and 41.3% higher y-o-y. This translated to a 40.4% y-o-y increase in normalised diluted EPS, 18.2% ahead of our forecast. XP announced a final quarterly dividend of 36p (vs our 34p forecast) payable on 28 April to shareholders at 26 March. This resulted in a full-year dividend of 74p, ahead of our forecast.

Operating cash flow of £45.6m was marginally below the £46.2m generated in FY19. A working capital inflow of £10.6m in FY19 reversed to a working capital outflow of £6.2m in FY20. While collections were strong at year-end, the company added to inventory through the year to ensure it had sufficient supply of long lead-time components. Tangible capex declined from £4.7m in FY19 to £4.0m in FY20 as the second Vietnam facility was completed in Q119. Capitalised R&D decreased slightly to £7.7m from £8.0m in FY19. Capitalised costs for the SAP ERP upgrade decreased from £3.6m in FY19 to £3.2m in FY20.

The company revised the terms of its revolving credit facility (RCF) in October 2020. It converted $30m of its $60m accordion to committed facilities, taking committed facilities from $120m to $150m and has extended the repayment date by a year to November 2024. At year-end, it had used $43.5m of this facility. The RCF incurs interest at Libor plus 1.2% for the used portion, and Libor plus 0.4–0.5% for the unused portion. XP closed the year with a net debt position (excluding lease liabilities) of £17.9m, down from £41.3m at the end of FY19. The year-end net debt/EBITDA ratio was 0.32x, well within the banking covenant level of 3x. Based on a target net debt/EBITDA ratio of 1-2x and our FY21 EBITDA forecast, XP has debt headroom of up to £91m.

We wrote this time last year about the challenges XP was facing at its Chinese manufacturing facility, as the Chinese authorities put restrictions in place to get the spread of COVID-19 under control. By 17 February 2020 the facility was open again. The company invested in additional headcount and equipment at the Vietnam facility (which suffered fewer restrictions) to take up some of the slack. XP put in place all necessary safety measures to protect staff and had all facilities operating normally by the end of H120. Supply chain issues were substantially resolved in H120 and the company was able to ramp up production in H220 to deliver, in particular, the orders placed by healthcare customers destined for use in critical care equipment. To improve liquidity during this uncertain time, XP did not pay a final dividend for FY19 or a first quarter dividend for FY20. Dividends were resumed from Q220.

In our view, the main remaining COVID-19 risk is the effect on end-customer demand. We expect healthcare demand to moderate to more normal levels in 2021 as healthcare providers switch their focus back to non-COVID-19 diagnosis and treatment. We expect industrial technology to see demand improve through the year as restrictions are gradually lifted.

XP notes that other than a £0.6m grant received automatically from the Singapore government, it has not furloughed any staff, reduced headcount or taken any other government assistance.

XP received orders worth £258m during the year (+20% y-o-y) resulting in a book-to-bill ratio of 1.11x for the year. For Q420, order intake of £55.9m (-0.7% q-o-q, -4.3% y-o-y) resulted in a book-to-bill of 0.94x for the quarter. XP closed FY20 with a backlog worth £124.1m. Management expects to see another year of underlying revenue growth, although we note the weakness of the US dollar versus sterling means we are forecasting a decline in reported revenues.

As well as introducing FY22 forecasts, we have made the following changes:

There is a limited number of listed power converter companies, as many businesses are part of larger industrial companies, such as TDK or GE. We show below the financial performance of those listed peers and a group of UK-listed companies active in the electronics space. XP clearly generates EBITDA and EBIT margins at the top end of both peer groups. On a P/E basis, XP is trading at a premium to both groups, with a dividend yield at the upper end of the range.