Xiaomi Earnings: Margin Improvement Drives Profit Upside Surprise; Valuation Increased

The highlight of Xiaomi’s 01810 second-quarter 2023 result was a record gross profit margin and large underlying operating cost reductions which more than offset continued revenue weakness in the smartphone market. Second-quarter gross profit margin of 21% was up 420 basis points year on year and 150 basis points sequentially.

The two hardware business lines, smartphones and Internet of Things and lifestyle products, which contribute nearly 90% of revenue each, produced record gross profit margins. Second-quarter research and development expenses were up 21% year on year to CNY 4.6 billion driven in part by spending CNY 1.4 billion on smart electric vehicles and other growth initiatives such as robotics. However ex-R&D operating costs declined 15.5% year on year due to a strong effort by management to reduce controllable costs. The net result was second-quarter revenue down 4% year on year with operating profit excluding investment revaluations up 170% from the very weak second-quarter 2022. Second-quarter underlying operating profit margin increased to 6.2% from 2.2% in second quarter 2022. Xiaomi produced operating margins at this level back in 2021, but that was when the smartphone market was much stronger.

We have increased our fair value estimate to HKD 14.30 from HKD 12.40 based on a 7% revenue downgrade, but a 45% profit upgrade in 2023 driven by increased gross margin assumptions for all product lines and reduced operating costs in line with the second-quarter result.