What You Must Know Before Investing In Xiaomi Corp

Xiaomi Corp (HKG: 1810) is one of the world’s major smartphone producers well-known for its low-cost handsets with quality hardware.

However, do you know that Xiaomi also has a thriving Internet of Things (IoT) business and is a major player in the smart TVs sector? 

In this article, we shall delve deeper into Xiaomi’s businesses, latest earnings, historical financials, and competitive strengths.

Business Overview 

Xiaomi operates across three business segments: Smartphones, IoT and Lifestyle Products, Internet Services. 

Xiaomi is the world’s fourth-largest smartphone vendor with an 11% market share in the first quarter of 2020. It consists of two independent brands to meet the needs of different market segments. The Redmi brand focuses on consumers who are price sensitive through products with good specifications and affordable prices. The Xiaomi brand targets the high-end segment with premium phones with top-range hardware.

Xiaomi Smartphone Products. Source: 2019 Annual Results Presentation

The group also sells a wide range of smart devices and lifestyle products that can be connected to its Mi Home app, forming the IoT ecosystem. The main products here include smart TV, wrist band, smart voice assistant, and home electronics items such as fridge and air conditioners. It has one of the world’s largest IoT platforms with 252 million connected devices.

The Internet Services segment encompasses Fintech, advertising, its proprietary Mi User interface, mobile gaming platforms, and e-commerce. Revenue is mainly derived from advertising services and gaming. 

The 2019 revenue breakdown shows that Smartphones occupied 59% of total revenue, followed by IoT with 30% and Internet Services with about 10%. 

Latest Financials 

Xiaomi achieved a strong quarter one result despite the Covid-19 pandemic. Revenue increased by 13.6% year-on-year to RMB49.7 billion. The operating profit of RMB2.3 billion was 35% lower due to increased marketing expenses and foreign exchange losses. 

Gross profit, a key measure of Xiaomi’s hardware cost control, increased by 45% to RMB7.6 billion. This raised its gross margin to 15%. 

Each of Xiaomi’s three segments had higher sales of different degrees. Smartphone revenue grew 12.3%, IoT and Lifestyle Products increased by 7.8%, and Internet Services 38.6%.

Overall, Xiaomi’s results were satisfactory when viewed against the virus outbreak that sent most of China into lockdown in February and March. 

Source: 1Q 2020 Results Presentation

Historical Earnings

Across five years, Xiaomi’s revenue grew at an annual compounded rate of 32% to reach RMB206 billion last year. Gross profit increased at an even faster rate of 80% per annum to reach RMB28 billion. 

Xiaomi had done a good job controlling its cost of goods sold and raising its overall product retail price, judging from its gross margin which increased from 4% in 2015 to 14% in 2019.

Source: 2019 Annual Results Presentation

However, Xiaomi has a patchy record when it comes to cash flow from operations, with 3 years of net outflow in the past 5 years. The figure fluctuated between an outflow of RMB2.6 billion (2015) and an inflow of RMB23.8 billion (2019).

Smartphones Segment

Xiaomi’s adopted its dual-branding strategy one year ago. The management probably realised the need to shed Xiaomi’s image as a low-cost phone vendor by allocating greater marketing resources to the premium segment. 

The strategy seems to work based on Xiaomi’s booming smartphone sales in the first quarter, boosted by the launch of several premium 5G-enabled models. The average selling price of Xiaomi smartphones grew by 7.2% while the gross profit margin jumped from 3.3% to 8.1%. 

Xiaomi was also the only company that bucked the trend of slowing smartphone shipments in quarter one, with a 9% increase. 

IoT and Lifestyle Products Segment

The IoT and Lifestyle Products segment’s 7.8% increase pales in comparison with the fourth quarter of 2019’s 30.5% growth. This is due to the pandemic’s effect on sales of smart TVs and large home appliances. 

Nevertheless, other products in Xiaomi’s diversified product range achieved strong sales growth that offset the impact of TVs and home appliances. These include wireless earphones, smart wristband, and WiFi routers. 

Sales Increase of Key IoT Products. Source: 1Q 2020 Results Presentation

Strengths and Opportunities

Xiaomi’s business model comprises three synergistic segments that create a network effect. High-quality products generate strong sales which convert consumers into users of Xiaomi’s internet services and platforms. They provide valuable data on consumption patterns and preferences that improve the group’s monetisation opportunities, increasing the revenue of internet services. This perpetuates repeat purchase and further increases user stickiness. 

The group’s strong operational efficiency has generated substantial cost savings that allowed for competitive product pricing. Xiaomi utilises mainly online sales channels to reach buyers directly and reduce distribution costs. Its products are sold on Mi Store and Youpin, its self-operated e-commerce platforms, and third-party platforms such as JD.com and Tmall. 

Xiaomi has a first-mover advantage in the booming IoT market. According to iResearch report in Xiaomi’s IPO prospectus, sales of global IoT hardware would grow at a compounded annual rate of 26.1% to reach US$1.55 trillion in 2022. The group started building its IoT business in 2016 and now runs one of the world’s largest consumer IoT platforms. This puts the group in a good position to capture future growth. 

Xiaomi’s Consumer IoT Platform. Source: 1Q 2020 Results Presentation

The Negatives

Xiaomi depends on suppliers for its key hardware components. Notably, Qualcomm is its largest supplier of processing chips, the most crucial component of a mobile phone. This is a major risk in the current political climate where China and the United States are having regular conflicts. If Xiaomi experiences any restrictions on chip exports from Qualcomm, it will impact the quality and availability of its phones.  

Xiaomi’s reliance on smartphone sales has shaped market opinions of it as a hardware company that has high capital expenditure and low margin compared to pure internet services and platforms company. As a result, the market’s valuation of Xiaomi with a price-earnings ratio of 28 is conservative despite its rapid growth. Xiaomi’s smaller business segments need to expand aggressively to have a higher market valuation that benefits the shareholders. 

Conclusion

Xiaomi has performed well in the global smartphone market with its latest premium products and affordable yet good-quality models. It has also built a strong presence in the promising IoT industry.

However, it’s a heavy reliance on smartphone sales subject the group to stiff competition in the industry with players like Samsung, Huawei, and Apple. With technologies advancing rapidly, Xiaomi needs to work relentlessly to defend its market share. 

For a growth stock, investors should be wary of signs of slowing growth in Xiaomi’s revenue and earnings, which can potentially cause a big drop in its share price. 

Hence Xiaomi is suitable for investors with larger risk appetite who are after capital appreciation. Close monitoring of industry trends, market news, and earnings are important for a successful investment with Xiaomi. 

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