Semiconductor Demand And Medical Devices Will Drive Moderate Long-Term Earnings Recovery

Catalysts

About XP Power

XP Power designs and manufactures specialist power conversion solutions for industrial technology, semiconductor manufacturing equipment and health care applications.

What are the underlying business or industry changes driving this perspective?

• Although orders are recovering and book to bill has moved back above one, lingering uncertainty around the exact timing and slope of the industrial technology and health care volume rebound means factory utilization could remain suboptimal for longer, which may limit the pace of revenue growth and delay a full return to mid 40s gross margins.
• Despite structural growth in semiconductor manufacturing driven by AI, electrification and data center expansion, XP Power is exiting China and cycling exceptional high voltage demand. This could cap its participation in wafer fabrication equipment investment cycles and keep earnings growth below end market growth rates.
• While the shift toward higher value engineered solutions and complex medical and analytical applications supports pricing power, the longer qualification cycles and customer specific development effort increase execution risk and could pressure net margins if project conversion or ramp up is slower than anticipated.
• Although new capacity in Vietnam and the upcoming Malaysia facility are designed to improve cost efficiency and resilience, phasing this capacity into a still normalizing demand environment raises the risk of near term underutilization and incremental depreciation, which may weigh on operating margins and cash returns.
• While the company has demonstrated strong cash conversion through inventory reduction and supply chain efficiencies, the need to rebuild working capital to support future growth and fund around GBP 20 million of annual capital expenditure may limit the pace of net debt reduction and constrain upside to earnings per share.

Assumptions

This narrative explores a more pessimistic perspective on XP Power compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming XP Power's revenue will grow by 5.5% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from -5.9% today to 7.5% in 3 years time.
• The bearish analysts expect earnings to reach £20.3 million (and earnings per share of £0.72) by about December 2028, up from £-13.6 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as £41.5 million.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 19.0x on those 2028 earnings, up from -18.6x today. This future PE is greater than the current PE for the GB Electrical industry at 17.2x.
• The bearish analysts expect the number of shares outstanding to grow by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.91%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• If the cyclical downturn truly is ending and orders continue to recover from the current 31% year-on-year growth, with book-to-bill already back above one, revenue could accelerate faster than expected as destocking fully unwinds and normal order intake resumes. This could drive higher top line growth and lift earnings.
• Management’s demonstrated ability to hold gross margins at around 41.4%, despite revenue running roughly 30% below the 2023 peak, combined with additional cost savings and supply chain efficiencies, could allow a move back toward mid 40s gross margins and close to 20% operating margins. This would materially improve net margins and earnings.
• Structural growth in XP Power’s core end markets, including industrial technology growing at around 7.5% over the medium term and medical devices expected to grow above 6% per year to 2030, together with an $850 million live project base and $625 million active pipeline, may translate into sustained share gains and organic growth. This could support a rising revenue and earnings trajectory.
• The secular expansion of semiconductor demand toward a forecast one trillion dollar end market by 2030, driven by AI, data growth and electrification, alongside XP Power’s entrenched designed in positions and high barriers to entry in wafer fabrication equipment, could result in outsized growth in the semi segment. This may boost revenue, improve gross margin mix and increase recurring earnings over time.
• Continued operational execution, including deleveraging that has already halved net debt year-on-year, strong cash conversion at 290% and new capacity in Vietnam and Malaysia with favorable tariff structures, may strengthen the balance sheet and support profitable scalability. This could enhance free cash flow and reduce financial risk to earnings.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for XP Power is £9.0, which represents up to two standard deviations below the consensus price target of £11.55. This valuation is based on what can be assumed as the expectations of XP Power's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of £15.0, and the most bearish reporting a price target of just £9.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be £271.4 million, earnings will come to £20.3 million, and it would be trading on a PE ratio of 19.0x, assuming you use a discount rate of 9.9%.
  
• Given the current share price of £9.06, the analyst price target of £9.0 is 0.7% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.