Power play: two reasons to buy XP

When one considers how the electronics industry has changed our world over the past half century it is usual to marvel at the inventions of the transistor and the microchip.
But there is one component that all electrical or electronic devices cannot do without: the power supply.

Power supply design is not generally regarded as being at the glamorous end of electrical/electronic engineering. And graduate electronics engineers prefer to focus on the sexy areas of the discipline: opto-electronics, communications, processor design and the like. However, it is the resulting lack of knowledge about power supplies in mid-tier electronics businesses that has been driving business at London-listed power supply maker XP Power.

The group supplies power supply systems to customers who do not have in-house power supply expertise, helping them to design-in suitable power supplies that meet their costs and technical requirements.

XP is focused on four key sectors: industrial equipment (which accounted for 48 per cent of sales in 2005), communications (25 per cent), medical devices (18 per cent) and military equipment (9 per cent). US customers account for around 55 per cent of the group’s revenue, while the rest comes from Europe.

Because of its heavy dependence on the industrial market, XP saw fewer revenues last year from the US, where the group complained of lacklustre demand from the industrial market during the second half. In particular, demand from makers of semiconductor manufacturing equipment was adversely affected due to a slow down in the sector.

However, the demand from XP’s industrial customers is set to pick up this year. In December, technology researcher Gartner Group said that, after 2005’s softening, the worldwide market for semiconductor capital equipment was set to grow by 8.4 per cent in 2006.

Overall, results published in early February showed that the group’s US revenue declined by £1.8 million to £37.7 million in 2005, but its revenue from Europe (including the UK) grew by 16.5 per cent to £31.8 million. Total turnover for last year was greater by 4 per cent at £69.5 million.

Pre-tax profits came in 20.3 per cent greater at £7.7 million (2004: £6.4 million), which translated to earnings per share of 30.1p (2004: 23.4p). Meanwhile, dividends for 2005 amounted to 16p per share.

Looking ahead, the consensus forecast suggests that the group will produce an EPS of 36p this year, rising to 40.2p in 2007. This means that, at its current share price (457p), XP is trading at 13 times this year’s estimated EPS and just 11.4 times 2007’s earnings.
A share that trades at 11.4 times earnings while growing its earnings at around 12 per cent per annum is not especially cheap, but we still think XP is worth buying for two reasons.

The first is that the group has a strategy of expanding the amount of its own intellectual property included within the products it sells. This should lead to increased gross margins, which would mean profits increasing even if revenues stood still. Certainly, the 12 per cent earnings growth estimated for 2007 looks somewhat conservative given that 2005 saw EPS improve by 28.5 per cent and 2006 is due to produce growth of 19.6 per cent.

The second reason is that the power supply manufacturing industry has seen some consolidation recently, with the $500 million takeover of XP’s US rival Artesyn by Emerson Network Power. That is not to say that XP is a definite bid target, but any consolidation in an industry is usually a good sign.

Meanwhile, XP’s predicted dividend payments of 17.4p and 18p for this year and the next should not be sniffed at. Buy.