Fundamental analysis on XP Power (XPP)

[TheMotorcycleBoy]

Hi folks,

I've been researching XPP of late, we don't currently hold any of it. In addition to a bit of background reading which I may discuss later in Share Ideas, I've done some analysis which I thought I'd share here:


The financial figures sales, profit, are in £ million.

Matt

[doug2500]

FWIW I admire your dilligence but it's not my style. I'm more a roughly right rather than precisely wrong type of investor. I think that level of detail would cause analysis paralysis in me. We're all different though.

I really rate XPP but there's no denying it's been a rocky road recently. More due to sentiment than operation though IMO.

[Alaric]

I've been researching XPP of late, we don't currently hold any of it. In addition to a bit of background reading which I may discuss later in Share Ideas

Over the past two years, the share price climbed to a peak about a year ago, then fell back a long way, but over the past three months has recovered and is climbing again. Is there anything external that might explain this? Takeover rumours and stake building perhaps.

[TheMotorcycleBoy]

FWIW I admire your dilligence but it's not my style. I'm more a roughly right rather than precisely wrong type of investor. I think that level of detail would cause analysis paralysis in me. We're all different though.

Ha ha!

It's what happens if you are a nerdy computer programmer. Basically it's just from a spreadsheet that I've gradually built on and refined for about the past year.

It's at the point now where I have a blank spreadsheet and whenever I want to look at a different firm I just make a new copy and assign it for that company.

But you are definitely correct to assert people's differences, I guess I've always been an analytical sort of person.

Over the past two years, the share price climbed to a peak about a year ago, then fell back a long way, but over the past three months has recovered and is climbing again. Is there anything external that might explain this? Takeover rumours and stake building perhaps.

I'll create a shares ideas topic in a bit to link this to, and mention what I've learnt.

Matt

[TheMotorcycleBoy]

Some more figures:



Noteworthy are the jumps in capex for the final 2 years.

[TheMotorcycleBoy]

I've created a corresponding topic on Share Ideas.

Matt

[dspp]

Matt,

Good analysis of the numbers.

So this is a medium-sized £190m turnover company with a £480m mkt cap, listed as an LSE small cap. It makes £30m profit and ploughs £10m of that into capex, leaving £20m underlying, so about 10% 'real' profit using my very quick eyeball numbers, which fits the 2-4% divi.

The 5-year chart is exciting, not always in a good way : https://www.londonstockexchange.com/exc ... XSSMM.html

It specialises in power electronics which are both bleeding edge and well understood, but since it is not working at a chip-level it is really just a conduit for the device makers to get their stuff to market, and they will prime competitors if it lags in the race. So its products are always about a year or two away from being commoditised (so really it should be reinvesting even more in itself). This is a go-to area for electrification of everything.

If it is well run then it might grow and do some M&A itself. If it is lucky it will be bought out at a premium whilst you hold it. If there is any sort of downturn (or delay in electrification) then it will get hammered.

As part of a portfolio play in the sector it might be interesting. As a pure play it could be lonely.

Do you think you know something about its prospects that are not reflected in the share price ?

Do you think you are close enough to 'gossip' to know better/faster than people who are. Bear in mind where it is headquartered: Asia. Could you trade out of it faster than they can ?

Is there enough upside to take on the risk ?

regards, dspp

[Alaric]

Is there enough upside to take on the risk ?

A specialist engineering company.

As to what they make, it's described on the website
https://www.xppower.com/

There's some background and history there as well.

[dspp]

Is there enough upside to take on the risk ?

A specialist engineering company.

As to what they make, it's described on the website
https://www.xppower.com/

There's some background and history there as well.

Thank you Alaric, I know that. That is why I wrote my pithy summary, "It specialises in power electronics which are both bleeding edge and well understood, but since it is not working at a chip-level it is really just a conduit for the device makers to get their stuff to market, and they will prime competitors if it lags in the race. So its products are always about a year or two away from being commoditised (so really it should be reinvesting even more in itself). This is a go-to area for electrification of everything."

Also I have (on the other page) commented on the recent acquisition as it is in an area I have some professional contact with. This proposal by Matt is interesting, but not without some risks which I have tried to highlight. You may spot other risks & opportunities in this which I have missed.

regards, dspp

[doug2500]

My understanding is that rather than being commoditised, XPP's products are designed into expensive, and sometimes critical, electrical devices. Once designed in it is then too much trouble to change the design so the incomes become a regular flow.

They have moved away from generic power supplies and are now more of a manufacturer than merchant. Their own products, and their higher value more efficient products are the faster growing and more lucrative end of the business.

All this , of course, is widely known so I have no edge at all, I never do. My advantage is simply being a small investor rather than institution.

I'm more than happy to hear a bear case if I've misunderstood, especially from an industry insider.

[dspp]

My understanding is that rather than being commoditised, XPP's products are designed into expensive, and sometimes critical, electrical devices. Once designed in it is then too much trouble to change the design so the incomes become a regular flow.

They have moved away from generic power supplies and are now more of a manufacturer than merchant. Their own products, and their higher value more efficient products are the faster growing and more lucrative end of the business.

All this , of course, is widely known so I have no edge at all, I never do. My advantage is simply being a small investor rather than institution.

I'm more than happy to hear a bear case if I've misunderstood, especially from an industry insider.

In many situations:
- You have to win the design competition.
- You also have to win the manufacture competition.
In the first round you are up against all the other folk making PSUs, all of whom (like XPP) are being fed from the same underlying silicon device houses (e.g. IXYS etc) so competitive advantage is scanty and short-lived. In the second round you are up against almost everybody in the first round, plus the big contract mfg houses such as Foxconn etc. And then you get to do it again. And again. And again. That is why XPP is trying to build advantage. But is it succeeding ?

I do some work in 500kV - 1200kV. The people I work with have pulled out of most sub 400kV segments because it is too commoditised. And believe me it can feel pretty commoditised at 800kV these days. As well as exposed to macro cycles.

I think Fundamental Analysis is great. But then you need to understand the actual industry if you are putting serious money down. And if you put a lot of % stake down with insufficient knowledge you are in the position of someone putting pennies down in front of steam rollers. Yes its fun, and you can get some interesting but minor outcomes, but if you trip up and get unlucky at the wrong moment you could lose everything. So I always ask what is the real underlying business.

regards, dspp

[simoan]

In many situations:
- You have to win the design competition.
- You also have to win the manufacture competition.
In the first round you are up against all the other folk making PSUs, all of whom (like XPP) are being fed from the same underlying silicon device houses (e.g. IXYS etc) so competitive advantage is scanty and short-lived. In the second round you are up against almost everybody in the first round, plus the big contract mfg houses such as Foxconn etc. And then you get to do it again. And again. And again. That is why XPP is trying to build advantage. But is it succeeding ?

I do some work in 500kV - 1200kV. The people I work with have pulled out of most sub 400kV segments because it is too commoditised. And believe me it can feel pretty commoditised at 800kV these days. As well as exposed to macro cycles.

Well, I think the answer to "is it succeeding?" is obvious when you consider the company enjoys operating margins of 20%, and has done so for several years. That doesn't strike me as a company operating in the commoditised, highly competitive industry you describe. My one reservation would be that ROCE has been declining slightly but was still very healthy at 19% for FY2018. It seems to be a company with at least a decent moat with strong customer relationships which are not to be sniffed at.

I think sometimes your own area of expertise can be a hindrance if you are not careful and lead you to miss some great investment opportunities. It's very much a double edged sword. I know that to be the case from my own experience.

All the best, Si

[TheMotorcycleBoy]

My one reservation would be that ROCE has been declining slightly but was still very healthy at 19% for FY2018.

Hi Si,

I've certainly seen from a few of the firms I've analysed that as the years progress the ROCE falls. In an "attempt to try to explain" the decline, I assume this results from them piling on the capex in order to grow.


Looking at the table above I tried to compare ROCE each year against the two most obvious capex measuring KPIs from my numbers. A long capex ramp?

Presumably the cash flows from operations benefitting from at current year's capex do not become realised until later years, and of course if the firm continues to investing again the next year, perhaps one sees a delay in the ROCE figure picking up? Just a theory, mind you.

Matt

[simoan]

I've certainly seen from a few of the firms I've analysed that as the years progress the ROCE falls. In an "attempt to try to explain" the decline, I assume this results from them piling on the capex in order to grow.


Looking at the table above I tried to compare ROCE each year against the two most obvious capex measuring KPIs from my numbers. A long capex ramp?

Presumably the cash flows from operations benefitting from at current year's capex do not become realised until later years, and of course if the firm continues to investing again the next year, perhaps one sees a delay in the ROCE figure picking up? Just a theory, mind you.

Matt

ROCE can fall for a number of reasons but if it's a slow steady decline it is normally a sign that management are unable (for whatever reason) to invest additional capital at the same rate of return, however anything above 20% is a more than decent result. In the case of XPP (certainly for FY 2018) the reason for the decline in ROCE was due to the build up in inventory caused by the need to hold stock for long lead time components needed to make the product. The company made this very clear in the last few sets of results. Unfortunately, although you have a lot of data in your table you don't really see this as there's no entry for working capital! Any build up in working capital will cause a cash outflow and also reduce ROCE. Of course, there has also been an increase in Capex which has reduced FCF, including two acquisitions.

All the best, Si

[TheMotorcycleBoy]

I've certainly seen from a few of the firms I've analysed that as the years progress the ROCE falls. In an "attempt to try to explain" the decline, I assume this results from them piling on the capex in order to grow.


Looking at the table above I tried to compare ROCE each year against the two most obvious capex measuring KPIs from my numbers. A long capex ramp?

Presumably the cash flows from operations benefitting from at current year's capex do not become realised until later years, and of course if the firm continues to investing again the next year, perhaps one sees a delay in the ROCE figure picking up? Just a theory, mind you.

Matt

ROCE can fall for a number of reasons but if it's a slow steady decline it is normally a sign that management are unable (for whatever reason) to invest additional capital at the same rate of return, however anything above 20% is a more than decent result. In the case of XPP (certainly for FY 2018) the reason for the decline in ROCE was due to the build up in inventory caused by the need to hold stock for long lead time components needed to make the product. The company made this very clear in the last few sets of results. Unfortunately, although you have a lot of data in your table you don't really see this as there's no entry for working capital! Any build up in working capital will cause a cash outflow and also reduce ROCE. Of course, there has also been an increase in Capex which has reduced FCF, including two acquisitions.

All the best, Si

Thanks again,

To be honest I'd seen the increase in inventories between FY17 and FY18 because the "feed" into numbers I uploaded to TLF comes from six other pages (for 2013 through to 2018).

I should calculate result for Working Capital and add it to my analysis sheet.

So is your WC formula the same as referred to here:
https://www.investopedia.com/terms/w/workingcapital.asp
https://investinganswers.com/dictionary ... ng-capital

i.e. just current assets - current liabilities?

Matt

[TheMotorcycleBoy]

AR18 explains why the inventories were increased through 2018:

As previously announced, during the first half of 2018 we started to see significant tightening of the supply chain for certain electronic components which resulted in increased lead times and component cost inflation. In response, we went into the market to secure supplies of critical components, at prices beyond our standard costs, in order to ensure we could continue to meet our lead times to customers. Lead times for certain components increased dramatically, in some cases lead times moved from 12 to 52 weeks. The result of these lead time extensions meant we have had to increase our safety inventories significantly. The higher prices we had to pay for components were a drag on gross..

To adjust for the bigger usual capex hit and acquisition costs (i.e. for GHV), I modelled what the hypothetical values for capex, inventory, PPE and goodwill would be by taking 2017 figures and then assuming a 14% growth rate (that's what XPPs sale and equity CAGR are). Armed with these tweaks (well if they don't cook their books, I thought that I would I recalculated the values of ROCE=21.7% and CROCI=15%.

So *hopefully* the underlying business hasn't changed.

Matt