Xiaomi Q2 21 – The hoover

Xiaomi is cleaning up.

• Xiaomi reported cracking Q2 2021 results underpinned by the ongoing collapse of Huawei, but it still does not make anything like enough money to make the valuation interesting.
• Q2 2021 revenue / net income was RMB87.8bn / RMB8.3bn comfortably above consensus at RMB81.7bn / RMB5.1bn.
• The vast majority of this strength came from smartphones where Xiaomi has fared much better than its rivals in terms of hoovering up all of the market share that Huawei is losing.
• According to Counterpoint Research, Xiaomi’s global share in smartphones has increased from 10.9% in FY 2020 to 16.2% in Q2 2021 while Huawei has fallen from 10.3% to 2.2% over the same period.
• Most of this strength has come from China where Xiaomi’s share has improved from 11.5% in FY 2020 to 16.8% at the end of Q2 2021 but some share was also taken elsewhere.
• IoT devices also grew well which is likely to be due to smartphones underpinning the IoT ecosystem that Xiaomi is building which is really only present in China.
• Outside of China, Xiaomi has no ecosystem of any real description and is just another handset maker competing on price and specification to deliver the Google Ecosystem.
• However, news on monetising the ecosystem was not so great as internet services revenues grew by only 19.1% meaning that a lot of work still needs to be done to earn a proper return from its smartphones.
• Furthermore, the profitability of its core business remains very weak once one removes the fair value write-ups that Xiaomi is enjoying from its ecosystem partners who are experiencing revenue growth.
• Core operating margin is now 6.0% compared to 3.1% which is a good improvement but still well below where the valuation of this company demands that it should be.
• Xiaomi has a market capitalisation of RMB620bn / ~US$80bn but is only expected to generate around RMB20bn in net profit in 2021 growing to RMB24bn in 2022.
• This puts the company on 31.0x 2021 PER and 25.8x 2022 PER which I think is still too high despite its excellent progress in supplanting Huawei.
• To justify upside, one has to have confidence in Xiaomi’s ability to substantially expand its profitability and it is here that my faith continues to fall short.
• Furthermore, the regulatory shadow has yet to touch Xiaomi although I suspect when it does, its impact will be much less than it has been for the others.
• This is because Xiaomi is predominantly a hardware manufacture and does not have very much to do with AI or data or the other areas where scrutiny is hitting the hardest.
• It also does not have very good margins and so is less exposed to accusations of causing wealth inequality and its founder keeps a pretty low profile.
• Hence, I think that any regulatory discount should be much less for Xiaomi than it is for many of the others.
• However, the company still does not make anything like enough money to justify its valuation and it is not growing the internet services business (which has high margins) fast enough to justify the share price.
• The headlines look good, but the fundamentals continue not to stack up to justify looking at this in any depth.
• My bruised and battered position in Alibaba has more upside now than it ever did as I think the regulatory shadow is not coming back to give it another kicking and the fundamentals remain very sound.
• This remains the only position I have in Chinese technology.