2023-08-30 05:09:45 ET
Summary
- Xiaomi achieved a significant earnings beat for Q2 2023, as expenses for the company's core businesses decreased by -11% YoY in the recent quarter.
- But the QoQ decrease in Xiaomi's smartphone ASP and the increase in costs relating to investments in EVs are key areas of concern.
- I raise my rating for Xiaomi stock to a Hold in view of its better than expected second quarter bottom line.
- But a Buy rating for Xiaomi is unwarranted, as the company's future financial performance might potentially be hurt by smartphone ASP contraction and higher than expected expenses associated with EVs.
Elevator Pitch
I rate Xiaomi Corporation ( OTCPK:XIACF ) [1810:HK] stock as a Hold.
My prior update for Xiaomi written on June 15, 2023 was focused on analyzing the company's business operations in India and its investments in Research & Development or R&D.
For the current write-up, I evaluate Xiaomi's financial performance for the second quarter of this year. On the positive side of things, Xiaomi's Q2 2023 bottom line exceeded expectations by a wide margin due to good cost management for its core businesses. On the negative side of things, it is a concern that Xiaomi suffered from a QoQ contraction in smartphone ASP (Average Selling Price) in Q2 2023, and expenses associated with the company's new Electric Vehicle or EV business are rising. As such, I upgrade Xiaomi's rating to a Hold (from a Sell previously), but I stop short of rating the stock as a Buy.
The Market Had Anticipated Narrower Revenue Contraction And Strong Earnings Recovery In Second Quarter
Before Xiaomi announced its Q2 2023 financial results on August 29 before trading hours, the sell-side predicted that the company's performance in the second quarter will be superior to what it achieved for Q1 2023.
As per S&P Capital IQ's consensus data, Xiaomi's YoY top line decline in local currency or RMB terms was projected to have improved from -22.8% for Q4 2022 and -18.9% for Q1 2023 to -6.6% in the most recent quarter.
With regards to expectations for the company's bottom line, the market was of the view that Xiaomi's normalized net profit would have expanded by +12.7% QoQ and +75.0% YoY for Q2 2023.
In the subsequent sections, I review Xiaomi's actual Q2 2023 performance.
Xiaomi Delivered A Massive Earnings Beat Thanks To Good Expense Control
The company did deliver a set of financial results in Q2 2023 that represented a significant improvement from its results for the first quarter of this year, as indicated in Xiaomi's second quarter earnings announcement . More importantly, both Xiaomi's most recent quarterly revenue and adjusted core earnings were higher than the analysts' consensus estimates.
Revenue for Xiaomi decreased by -4.0% from RMB70,171 million for Q2 2022 to RMB67,355 million in Q2 2023. The company's top line rose by +13.2% on a sequential or QoQ basis and surpassed the market's expectations by +2.8%. Xiaomi recorded a much more substantial +41.1% earnings beat, as its normalized net income jumped by +141.0% YoY to RMB5,140 million for the second quarter of 2023.
Given that Xiaomi's bottom line beat was way more significant than its top line beat, it is clear that the company's above-expectations normalized net profit was driven more by an improvement in profitability rather than the QoQ revenue growth.
In its Q2 2023 results announcement, Xiaomi specifically highlighted the company's "strategy of 'dual emphasis on scale and profitability'" and noted its "relentless efforts in cost savings and efficiency enhancements." Efforts focused on expense optimization and improving profitability are reflected in Xiaomi's key metrics.
As disclosed in its Q2 2023 results presentation slides , Xiaomi's adjusted operating costs (which don't include costs incurred for its new Electric Vehicle business) declined by -11% from RMB9.8 billion for Q2 2022 to RMB8.7 billion in Q2 2023. Also, Xiaomi shrunk its inventories by -33% YoY from RMB57.8 billion as of June 30, 2022 to RMB38.5 billion at the end of Q2 2023, which represented a ten-quarter low for the company.
However, there are other metrics revealed as part of the company's quarterly results which imply that Xiaomi's outlook might not be as rosy as what its headline numbers suggest, as detailed in the next section.
But There Are Certain Things To Watch For Xiaomi
In my view, there are two specific matters that investors with an interest in Xiaomi need to watch closely.
One key thing is the weakness associated with Xiaomi's core smartphones business.
Revenue for Xiaomi's smartphones segment fell by -17.8% YoY to RMB31.7 billion in the second quarter of the current year, and this was equivalent to a reasonably modest sales increase of +4.6%. In contrast, the company's internet services and IoT & Lifestyle products businesses both achieved revenue expansion in YoY terms and on a sequential basis in Q2.
Xiaomi noted in its Q2 2023 earnings release that the company's ASP decreased by -3.4% QoQ to RMB1,112.2 in the recent quarter as a result of "enhanced promotional efforts in the overseas market."
With my earlier mid-June article for Xiaomi, I warned that there is a risk that the company's "international businesses might be potentially affected by geopolitical issues (i.e. China's relationship with other countries) in the future." Separately, Xiaomi is likely to face stiffer competition in foreign markets going forward. An example of a tough rival is Honor (previously a sub-brand of Huawei) which has plans to distribute its phones in India in the near future.
The other key matter relates to Xiaomi's growing investments in new business areas such as Electric Vehicles or EVs.
Xiaomi's costs relating to "smart EV and other new initiatives" more than doubled YoY from RMB0.6 billion for Q2 2022 to RMB1.4 billion in Q2 2023, as disclosed in its second quarter earnings presentation. The company's R&D costs also rose by +21% YoY and +11% QoQ for the most recent quarter.
In other words, although Xiaomi has been successful at optimizing costs for its mature and core businesses, the company's total expenses might still go up as it allocates a greater amount of capital to new growth ventures like EVs.
Closing Thoughts
I am encouraged by Xiaomi's Q2 2023 earnings beat and I have revised my rating for the stock from a Sell earlier to a Hold now. But Xiaomi isn't deserving of a Buy rating, as there are concerns pertaining to the company's smartphone ASP and a significant increase in expenses for the new EV business.
For further details see:
Xiaomi: Earnings Beat Overshadowed By ASP Decline And EV Investments (Rating Upgrade)