XIACY - Xiaomi: Watch Indian Market's Performance And R&D Spend

2023-06-15 06:32:01 ET

Summary

• Xiaomi's share of smartphone shipments in India, a key market for the company, declined in Q1 2023.
• Xiaomi is expecting to spend more on R&D for full-year FY 2023, but the increase in investments isn't expected to drive faster sales growth in the short term.
• My Sell rating for Xiaomi stays unchanged due to my concerns about XIACF's Indian market performance and its guidance for higher R&D costs.

Elevator Pitch

My rating for Xiaomi Corporation's ( OTCPK:XIACF ) [1810:HK] shares is a Sell. With my earlier August 2, 2022 write-up , I reviewed worldwide smartphone shipment and market share data and highlighted key downside risks for XIACF.

I touch on Xiaomi's challenges in the Indian market and highlight the company's increased R&D (Research & Development) spend in this latest article. Considering these two key negative factors, I continue to assign a Sell rating to Xiaomi.

Indian Market In The Limelight

South China Morning Post recently reported on June 14, 2023 that there hasn't been any meaningful progress in Xiaomi's "legal fight in India over New Delhi's decision (in April 2022) to freeze around US$670 million of funds" based on its sources.

Recent developments relating to the matter haven't been favorable. In April this year , Xiaomi failed to get an Indian court to return the company's monies. Last week, a June 10, 2023 Reuters news article mentioned that "India's financial crime agency" had recently sent "notices" to "Xiaomi, Deutsche Bank ( DB ), HSBC ( HSBC ) and Citigroup ( C )" over (XIACF's) alleged illegal remittances."

Based on recent news flow, the probability of Xiaomi getting back its funds in India within a short period of time appears to be pretty low.

It isn't just about Xiaomi's cash being "trapped" in the Indian market. XIACF's actual sales performance in India hasn't been as good as what one would have hoped for.

At the company's recent Q1 2023 results call on May 24, Xiaomi stressed that "from the business perspective, in India, today, Xiaomi is still very healthy." But data from various research firms suggests that Xiaomi has lost ground to competitors in the Indian market in recent times.

Counterpoint Research's data points to XIACF's share of the Indian smartphone market contracting by approximately -7 percentage points YoY in Q1 2023 and its ranking in India falling from first to third in the past one year (between Q1 2022 and Q1 2023). Separately, IDC's research implies that Xiaomi's smartphone shipments for the Indian market dropped by -41.1% YoY in Q1 2023. As per IDC data, the company's India smartphone market ranking (16.4% share of Indian shipments) fell from first in the first quarter last year to fourth in the first quarter of this year.

China-India relations have been rocky in recent times, and it is likely that Xiaomi's challenges in the Indian market are attributable to tensions between both countries to some extent. Based on a June 7, 2023 CNN report , there are currently "few or no accredited journalists on the ground in each other's country (India and China)", which is a clear indication of how much ties between both countries have turned for the worse.

It is worthy of note that foreign markets accounted for 49.2% of Chinese technology company Xiaomi's top line for fiscal 2022 as indicated in its annual report . In its FY 2022 annual report, XIACF only referred to Europe and India as the major international markets for the company. In other words, while Xiaomi doesn't disclose the specific sales contribution from India, it will be reasonable to assume that the Indian market is a substantial revenue contributor for XIACF.

Moreover, it is natural to be worried if Xiaomi's other international businesses might be potentially affected by geopolitical issues in the future, since the company has a 1:1 split between domestic and foreign markets in terms of sales contribution.

Eyes On R&D Spending

Xiaomi's current sell-side consensus financial projections (source: S&P Capital IQ ) offer valuable insights about the company's prospects.

The analysts see XIACF's normalized net profit margin improving from 3.0% in FY 2022 to 4.0%, 4.1%, and 4.1% for FY 2023, FY 2024, and FY 2025, respectively. But Xiaomi used to achieve a much higher normalized net income margin in excess of 5% for every year between FY 2018 and FY 2021.

On the other hand, the market expects Xiaomi's revenue (in local currency or RMB terms) to decline by -1.5% in FY 2023, prior to growing by +11.9% and +12.4% for FY 2024 and FY 2025, respectively. However, XIACF's FY 2018-2021 top line CAGR was a much more impressive +23.4%.

One key line item to note is R&D costs. Xiaomi's R&D expenses grew by +17.7% YoY to RMB4.1 billion in the first quarter of 2023. Moving forward XIACF has guided for the company's R&D costs to go up by at least +25% from RMB16 billion in FY 2022 to RMB20 billion for FY 2023. Xiaomi noted at its first quarter earnings briefing that it had been incurring higher R&D costs relating to "smart EV (electric vehicle) business and other new initiatives."

In a nutshell, Xiaomi is increasing its investments in R&D, but the higher spend is unlikely to translate into accelerated revenue growth in the very near term based on the consensus numbers. I think the market might penalize Xiaomi's shares by assigning the stock a valuation discount due to its aggressive spending which isn't expected to pay off in a short period of time.

Concluding Thoughts

I still have a bearish view on Xiaomi. The company's troubles in India and its expectations of significantly higher R&D expenses justify my Sell rating for the stock.

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