XIACY - Innovative AIoT Strategy: Xiaomi's Path To Enhanced User Experience

2023-11-11 01:39:44 ET

Summary

• Xiaomi's stock has increased 28% since February 2023 and has broken out above its technical resistance level.
• The company has demonstrated strong profitability growth through its IoT and value-added services segments.
• Xiaomi is leading in upgrading its IoT devices with AI assistants, positioning itself as an early beneficiary in AI technology.

Recap: Xiaomi's Performance Since February 2023

We initiated a Buy rating on Xiaomi ( XIACF ) ( XIACY ) in February 2023 . The stock has increased 28% since then and broken out above its technical resistance level. Xiaomi is scheduled to report its third-quarter earnings on November 20. We will review Xiaomi's recent progress for investors and what investors should expect from its third-quarter earnings report.

Investment Thesis: Why We're Bullish on Xiaomi

We were bullish on the company because we believe it is cycle-resistant given its large user base and diverse revenue streams.

Its results have demonstrated that it was able to return to strong profitability growth amid a weak smartphone market through growth in its IoT and value-added services segments.

The company was able to improve gross margins across all business segments and maintain a clean inventory position. This has put them in an advantaged position to pivot from defense to growth.

Xiaomi is also leading in upgrading its IoT devices by incorporating AI assistants with large language models. We think Xiaomi is an early beneficiary in AI technology as AI empowers its ecosystem.

Financial Review: Xiaomi's Momentum

The company accelerated its top-line and bottom-line growth sequentially, excluding the fair-value adjustment in its preferred equity investments. This demonstrates its growth momentum is building.

Market Share Leader

Xiaomi maintained its #3 ranking in the global smartphone market share after Samsung and Apple. Considering Xiaomi doesn't have a presence in the US market, its position is actually quite strong. The company has been actively expanding product categories outside of smartphones through its AIoT strategy. Xiaomi has been successful in the TV segment in China. We consider TVs to be a mature but strategic market for consumer electronics, as TV comprises a large percentage of entertainment time spent by consumers. Xiaomi's success in TVs sets a strong foundation for the company to remain relevant and differentiate itself from other smartphone peers.

Gross Margin Expansion

The company continued to expand gross margins across its three business segments. Despite weakness in overseas smartphone markets (primarily India) impacting its top-line growth, Xiaomi was able to improve its gross margin by expanding its high-end market share in China.

Its average selling price ("ASP") in China increased by 24% and its market share of smartphones in the RMB4,000-RMB6,000 price segment in China increased to 12.7% from 6.2% last year. This suggests its brand image is improving among Chinese consumers. The success of its high-end strategy will also benefit the company in expanding products and services going forward.

User Base Growth

Despite its smartphone unit sales being dragged down by the weak global market, Xiaomi continued to expand its user base, as its monthly active users ("MAU") of MIUI reached a record high of 606 million, a 10.8% increase year-over-year. This suggests that despite Xiaomi facing headwinds in the smartphone market over the past several quarters, its ecosystem has continued to grow. Therefore, internet services revenue should continue to grow and become a stable revenue stream to offset volatility in product sales that result from fluctuating consumer cycles.

Inventory Management

In addition, Xiaomi decreased its inventory by 28% compared to last year. This is faster than its revenue growth rate. This implied that the business is in a clean inventory position and prepared to transition from defense to growth mode.

AIoT Strategy: Enhancing Customer Experience

The company was optimistic about its AIoT strategy as this can improve the overall experience for its customers. Initially, Xiaomi executed its IoT ecosystem through partnerships with third parties to develop consumer products like refrigerators, TVs, and air conditioners. Xiaomi focused on improving functions and adding new capabilities to these products to differentiate from peers. For example, the company helped consumers have a customized experience by storing and consolidating consumer data in the cloud across devices. The emergence of generative AI has helped Xiaomi in smoothing the consumer experience across devices and increasing functionality.

Furthermore, Xiaomi announced the launch of its Hyperconnect platform to help developers create seamless experiences across Xiaomi devices. For instance , by enabling cameras to recognize objects in video, users can find their pets at home or program temperature adjustments based on the number of people occupying a space. These illustrations demonstrated how adding AI technology to IoT devices improves the product's functionality. This enhances Xiaomi's AI ecosystem's overall user experience.

Another example is that Xiaomi's AI assistant speakers can detect music and adjust flash lighting to create an immersive experience for customers.

Xiaomi was already renowned for its large IoT consumer ecosystem. The company was also early to market in launching its AI-assistant speaker, ahead of OpenAI, Google, Amazon, or Apple. This provides Xiaomi with a great head start and first-mover advantage in monetizing and building a large ecosystem powered by AI technology.

Valuation

The company's stock currently trades at a P/S ratio of 1.45x, in line with its historical levels.

From a forward-looking perspective, the stock does not seem expensive considering the expected average revenue growth of 11% over the next two years. Its P/S ratio based on 2024 and 2025 estimates are 1.27x and 1.15x respectively. Therefore, despite the stock increasing 28% since our initial coverage, we think there is still upside potential.

Risks

There are some big-picture risks that could impact Xiaomi's stock price, like the slowing economy in China and globally. The latest inflation data out of China does seem concerning - consumer prices there actually dropped 0.2% in October compared to a year ago. That could signal some weakness ahead for China's economy.

At the same time, we noticed something interesting in the past few quarters - Xiaomi's own financials haven't moved in lockstep with the broader Chinese economy. Despite the weak environment, they've managed to keep revenue and earnings stable. We think it's because their business is pretty diversified beyond just China, plus they've been expanding more internationally. So that might help insulate them from any domestic slowdown. We'll have to keep watching how it plays out, but so far they seem to be charting their own course.

IoT could be a new growth area for Xiaomi in China as they start building more AI into connected devices. We think those smart home and wearable products have the potential to really take off over the next few years.

Plus, their internet services business outside of China seems to be gaining momentum and becoming a larger portion of total internet revenue. That overseas piece provides some nice stability to balance out the ups and downs of hardware sales.

So between the IoT opportunity and the steady growth of international internet services, we believe Xiaomi has some promising new drivers that should help continue growing the business.

Conclusion

We believe Xiaomi has a strong brand and upside potential to expand its ecosystem. The company has maintained a clean inventory position and continued to expand its share in the high-end smartphone market while leading in the TV segment. Despite ongoing uncertainties around the global and Chinese economies, we think the company can continue to grow with the support of its strong user base. We maintain our Buy rating on Xiaomi.

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