Poor Smartphone Market Hits Xiaomi Sales and Margins; FVE Cut to HKD 17.30

Xiaomi’s second-quarter result was hurt by some factors largely outside of its control and which will likely normalize in the mid to long term, including increased logistics and transportation costs, COVID-19 lockdowns in China, and inflation, which all contributed to a weak smartphone market. Second-quarter revenue fell 20% year on year with operating profit (ex-investment gains and losses) down 72% year on year. Despite the weaker macroeconomic environment, Xiaomi continued to invest in research and development to drive future growth, maintaining its confidence in the long-term future. R&D expenses were up 23% to CNY 3.8 billion, driven in part by spending CNY 611 million on smart electric vehicles and other growth initiatives such as robotics. Xiaomi plans to invest CNY 3.3 billion in autonomous driving research and development in the first phase with a self-developed full stack approach to autonomous driving technology. We reduce our fair value estimate to HKD 17.30 from HKD 19.00 previously, based on heavily downgraded revenue and margin forecasts in 2022 with some flow on to 2023 and 2024 forecasts, and CNY weakness. With the pullback in share price over the past 18 months and sentiment hit by many short-term factors, we see Xiaomi as undervalued at current levels.