XP Power has now released their interim results for the year ending 2019.
Revenues increased when compared to the first half of last year as a £700K decline in North American revenue was more than offset by a £3.2M growth in European revenue and a £3.2M increase in Asian revenue. Cost of sales was also up to give a gross profit £600K higher. Admin costs were up £1.9M, R&D expenses increased by £1.1M, there was a £600K increase in acquired intangible amortisation, £500K of ERP implementation costs and £1.2M of legal costs which meant the operating profit was £4.4M lower. In addition, finance costs increased by £1.2M but tax expenses reduced by £1.3M to give a profit of £10.3M, a decline of £4.3M year on year.
When compared to the end point of last year, total assets increased by £3.9M driven by a £5.5M recognition of right to use assets, a £3M growth in intangible assets and a £700K increase in property, plant and equipment, partially offset by a £5.3M decline in inventories and a £700K decrease in cash. Total liabilities also increased as a £2.3M decline in borrowings was more than offset by a £5.7M recognition of lease liabilities and a £700K increase in deferred tax liabilities. The end result was a net tangible asset level of £37.7M, a decline of £2M over the past six months.
Before movements in working capital, cash profits declined by £4.2M to £20.1M. There was a cash inflow from working capital and despite interest payments increasing by £1M the net cash from operations came in at £21.2M, a growth of £8.2M year on year. The group spent £2.6M on fixed assets, £4.4M on R&D and £1.9M on software to give a free cash flow of £12.5M. Of this, £10.2M was spent on dividends, £800K on lease payments and £2.4M on repaying borrowings which meant there was a cash outflow of £600K and a cash level of £10.8M at the period-end.
Overall the results reflected tougher trading conditions in Q2. Whilst there was growth in the healthcare, industrial and technology markets, this was offset by a slowdown in the semiconductor market and pressure on gross margins resulting from the increase in US trade tariffs on Chinese goods, historic component price inflation and product mix.
The profit in the European business was £8.8M, a growth of £500K year on year. The business in Europe is very diverse but heavily weighted towards the industrial sector which held up well, although some customers could be building up inventory to buffer against a disorderly Brexit.
The profit in the North American business was £15.6M, a decline of £4.5M when compared to the first half of last year reflecting the difficulty in the semiconductor industry which is not expected to recover before 2020
The profit in the Asian business was £3.3M, an increase of £1.2M year on year driven by a technology sector programme coming back to life and strong performance from RF programmes.
Order intake was down 1% but this was flattered by forex movements and the strength of the dollar so at constant currency, orders were down 7%. Asian orders increased by 11%, European orders by 1% but North American orders were down 12% (19% on a like for like basis). The majority of the semiconductor equipment manufacturing customers are in North America. They enter the second half with an order book of £86.1M, however, which is a £4.6M increase on the year-end.
Gross margin declined by 210 basis points resulting from a combination of the higher component costs incurred in 2018 now being reflected in cost of sales, adverse geographic and product mix and the impact of Section 301 tariffs which they have not been able to fully recover from customers. They expect the tariffs to be resolved in the short to medium term but are working with customers on tariff recovery and mitigation and expect their gross margin to benefit from this in the second half of the year.
The group completed the construction of a second factory on their existing site in Vietnam in Q1 and this is expected to add $130M of manufacturing capacity per year which will increase the capacity in Asia from $170M to $300M. Since the summer of 2018 they have been working to ensure all products less than 1.5kw can be manufactured both in China and Vietnam and with this process now complete, Vietnam is now qualified to produce a total of 1,819 different products. Their Vietnam facility would continue to enjoy a cost advantage over competitors with a predominantly Chinese manufacturing footprint even in the event that the Trump administration decides to levy Section 301 tariffs on power converters produced in Vietnam.
In order to take advantage of their expanded Vietnamese capacity, the group will be transferring the manufacture of all their lower power, high voltage DC-DC modules to that facility. The manufacturing facility in Nevada will close by June 2020. It is expected that this will result in annualised cost savings of £4M and they expect to incur around £1.5M in costs associated with the full closure of the site.
Last year the group saw significant cost inflation and lead time extensions for many of the electrical components they incorporate into their products, particularly Mosfet transistors and multilayer surface mount capacitors. As a result of this, they increased their safety inventories significantly and secured critical components at prices above their standard costs in order to ensure they could continue to support their customers’ production requirements. Since the summer of 2018 they have seen certain component lead times reduce but the supply of certain critical components such as Mosfets remains constrained. They are continuing to manage their component inventory, building in a sufficient margin of safety where possible. There has been a significant focus on reducing inventory were possible, and they have seen factory held component inventory reduce in H1 2019.
Despite being a headwind, the tariffs imposed by Trump on Chinese goods could actually benefit the group as their Vietnam manufacturing plant allows them to offer US customers products which are not subject to the 25% tariffs imposed on power converters from China. The majority of the competition have a predominantly Chinese manufacturing footprint. They have transferred the production of over 1,500 different products from China to Vietnam in the past year and are announcing plans to transfer the manufacture of all their lower power, high voltage DC-DC converters to Vietnam by mid-2020 which should lead to significant cost savings.
Going forward, the board continue to see a robust performance form the healthcare, industrial and technology businesses but a combination of continued softness in the semiconductor equipment manufacturing sector and the task of recovering Section 301 tariffs present the group with a continuing challenge as they enter the second half. The Vietnam facility puts them in a strong position to mitigate 301 tariffs and the qualification of product by their key customers once transferred is key to restoring margins to historic levels. Margins in 2020 will also benefit from the closure of their Minden facility.
They do not see any meaningful upturn in the semiconductor manufacturing sector before 2020, but once the recovery takes hold they expect the combination of recent design wins and the cyclical recovery to produce significant growth in that sector. They remain conscious of potential risks arising from the global macroeconomic challenges but the board expects revenue growth in H2 notwithstanding the current softness in the semiconductor market.
At the current share price the shares are trading on a PE ratio of 14.2 which falls to 13 on next year’s consensus forecast. After a 6% increase in the interim dividend, the shares are yielding 4% which is predicted to remain the same on the full year forecast. At the period-end the group had a net debt position of £50.4M compared to £52M at the year-end.
Overall then this has been a rather challenging period for the group. Profits are down, net tangible assets declined and although the operating cash flow improved with an OK amount of free cash generated, this was due to working capital movements and cash profits deteriorated. The main issue is the reduction in the semiconductor market which is unlikely to change in the short term. Additionally there are raw material issues and Trump’s tariffs are also a short term headwind, although the move of production to Vietnam could present an opportunity here.
The forward PE of 14 and yield of 4% is OK but there is also quirt a bit of debt here which is not really being repaid that quickly. I’m conflicted about this one but think they are a little pricey at the moment.