XP Power (LSE: XPP) shares took a massive hit yesterday (Monday 2 October). After closing out last week at a price of 2,360p, they fell to 1,138p – a drop of 51%.
So, what was behind the electronics company’s enormous share price fall? And has the crash here provided me with a buying opportunity?
Why the share price tanked
The share price fall yesterday was down to a trading update that was a little bit concerning.
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For starters, the company – which specialises in critical power control products for the electronics industry – advised that trading in Q3 had been below its expectations, with revenue down 2% year on year (versus +24% for H1).
XP said that the poor performance was due to weakness in China and customers deferring shipments into 2024. Worryingly, it expects these conditions to continue for the rest of the year. As a result, it’s not expecting any growth in operating profit in 2023.
Secondly, the group said that its banking covenants could be breached in the near term due to the fact that its net debt/adjusted EBITDA ratio is close to the limits. Here, it noted that it is initiating dialogue with its lenders to seek covenant and liquidity flexibility for the remainder of 2023 and into 2024. It also said that it is exploring other options to strengthen its balance sheet, and bring leverage back to within its target range of one to two times net debt/adjusted EBITDA.
Finally, the company said that after its Q2 dividend is paid on 12 October, no further dividends will be paid for the 2023 financial year.
It’s worth noting that management was optimistic in relation to the company’s long-term outlook.
“Notwithstanding these short-term challenges, the Board believes XP’s clear strategy leaves the Group well positioned to grow ahead of its end markets, drive further market share gains, improve profitability and deliver strong cash generation,” it wrote in the trading update.
Overall, however, the update was pretty ugly.
Should I buy?
XP Power is a stock I’ve had on my watchlist for a few years now.
I’ve always thought it could be a good way to play the digitalisation theme. In theory, as the world becomes more digital, demand for the company’s products should rise.
After yesterday’s trading update, however, there’s a bit too much uncertainty for me to invest here.
My main concern is the balance sheet. At the end of Q3, net debt stood at £163m. That’s a high amount of debt relative to profits. And we don’t know what the company’s lenders are going to say about this leverage.
Given the large debt pile, XP may need to raise capital to strengthen its balance sheet. If it did raise capital, shareholders would most likely see their holdings diluted significantly.
It’s worth noting that this is not the first time the company has run into some challenges with its debt. Back in January, it advised that it had requested greater flexibility from its lenders. At the time, its lenders said that XP’s net debt/adjusted EBITDA ratio would need to be under three by the end of the year. The company is clearly struggling to achieve this, however.
Given these balance sheet issues, I think there are better small-cap shares to buy for my portfolio today.
