Xiaomi Stock: Focus On 2022 Outlook And Share Repurchases

Elevator Pitch

My Hold investment rating for Xiaomi Corporation (OTCPK:XIACF) [1810:HK] stays unchanged as per my earlier update for the company written on January 11, 2022. In my prior article for Xiaomi, I touched on its loss of market share to Honor in the China smartphone market and the launch of new flagship smartphones.

I turn my attention to the outlook for Xiaomi’s core smartphone business and its electric vehicle venture in 2022 and the company’s new $10 billion share repurchase program in my latest article.

In a nutshell, my view of Xiaomi as a potential investment candidate is mixed. On one hand, the business outlook for Xiaomi this year is negative, taking into account potential price competition and weak consumer demand for the smartphone business and higher R&D expenses incurred for the new EV business. On the other hand, Xiaomi is trading towards the low end of its historical P/E multiple range, and the company has recently announced a new share repurchase program which could potentially help to support the company’s share price to some extent.

Core Smartphones Business Segment Is Expected To Be Under Pressure

Xiaomi’s smartphones segment is the company’s core business accounting for 64% and 43% of its fiscal 2021 revenue and gross profit, respectively according to its full-year 2021 results announcement.

In my previous January 11, 2022 article, I noted that “Honor (China smartphone competitor) continues to gain traction in China’s smartphone market” at the expense of Xiaomi.

The latest industry data suggests that Xiaomi is still facing intense competition from its rival, Honor. According to research published by Counterpoint, Honor’s China smartphone market share grew from 9% in the fourth quarter of 2020 to 15% in Q4 2021. During the same period, Xiaomi’s share of the Chinese smartphone market only increased slightly from 12% to 13%.

Xiaomi also highlighted at the company’s most recent Q4 2021 results briefing that the smartphone segment’s 2022 gross profit margin is dependent on “what’s going to happen to the competitor landscape when supply become more normalized.” In other words, there is a risk of greater price competition when current supply chain disruptions in the smartphone sector are eased going forward.

Another key headwind for Xiaomi is the weak demand for smartphones in China and foreign markets. An April 6, 2022 CNBC article cited comments from a number of analysts who highlighted that smartphone sales in the Chinese market are expected to drop in the second quarter of 2022 “as a resurgence of COVID cases could dampen consumer sentiment.”

In international markets, demand for smartphones are very likely to be lackluster, as inflation erodes the purchasing power of consumers. In the company’s FY 2021 results announcement, Xiaomi revealed that its “revenues outside mainland China are mainly from India and Europe”, and these two markets are experiencing high levels of inflation. Inflation in India recently surged to the highest in almost one year and a half; while Eurozone’s inflation rate was as high as 7.5% in March.

In summary, Xiaomi’s smartphone business faces pressures relating to intense competition and lackluster demand this year. In my prior January 11, 2022 update, I stressed that Xiaomi has “to grow its market share in smartphones and cross-sell more high-margin internet services to its users or customers” to improve its future profit margins. In other words, a potential slowdown in Xiaomi’s smartphone segment this year might also hurt the growth prospects of its internet services business segment to some extent as well.

New Electric Vehicle Venture Will Be Negative For Company’s 2022 Profitability

I mentioned in my October 25, 2021 article for Xiaomi that the company has a goal of having “its first electric vehicle model enter mass production in the first half of 2024.” In that article, I also warned that the new electric vehicle venture might “be a significant drag on its earnings & cash flow in time to come.”

Xiaomi revealed at its fourth-quarter earnings call that the company now has more than 1,000 employees working in the research & development team for the electric vehicle business. The company also added that the “new growth area like electric vehicles” is where it will “continue to put more R&D (Research & Development) dollars” in 2022.

The company declined to provide guidance for its R&D expenses expected to be incurred this year. But Xiaomi’s R&D expenses-to-revenue ratio rose from 4.2% in Q3 2021 to 4.5% in Q4 2021, and this is likely a good indicator of the future upwards trend in R&D spending for 2022 and beyond.

Share Repurchases And Valuation

On March 22, 2022, Xiaomi announced that its “formally resolved to utilize the share repurchase mandate to repurchase shares in the open market from time to time at a maximum aggregate price of HK$10 billion.”

Following the share buyback announcement, the company has spent approximately HK$947 million (almost 10% of its HK$10 billion buyback program) repurchasing close to 69 million of its own shares at an average price of HK$13.74 between March 24, 2022 and April 13, 2022. As a comparison, Xiaomi last traded at HK$12.36 as of April 13, 2022.

Xiaomi’s shares have fallen by -59% from its one-year stock price peak of HK$30.45 recorded during intra-day trading on June 4, 2021 to its last done price of HK$12.36. Xiaomi is also currently trading -27% below the company’s IPO price of HK$17. The company’s share price weakness in recent months might have prompted the share repurchases.

Share buybacks are one of the indicators of undervaluation, and let’s see if this is the case for Xiaomi.

Xiaomi’s valuations appear to be undemanding on a historical comparison. Since the company listed its shares on the Hong Kong Stock Exchange on July 9, 2018, Xiaomi has traded between 10.6 times and 47.9 times consensus forward next twelve months’ P/E according to historical valuation data sourced from S&P Capital IQ. The market currently values Xiaomi at 12.2 times consensus forward next twelve months’ P/E, which is at the lower end of its historical valuation range.

But Xiaomi seems more fairly valued, if one compares its forward P/E multiple with its key financial metrics. The sell-side analysts forecast that Xiaomi’s normalized earnings per share will grow by a CAGR of +12% for the FY 2022-2024 period as per S&P Capital IQ, which translates into a P/earnings-to-growth or PEG ratio of around 1.0 times.

From a qualitative perspective, Xiaomi is still very much a hardware company with its core smartphone business segment generating a substantial proportion of its overall revenue and earnings as highlighted earlier. This limits the valuation multiple expansion potential for the stock, as the market is typically only willingly to assign higher valuation multiples to listed companies which earn most of their top line from asset-light, recurring revenue streams.

Bottom Line

Xiaomi is a Hold. Its valuations are fair but not exactly cheap based on the PEG valuation metric, and there is a good chance that the company’s 2022 financial performance might not meet market expectations considering various headwinds (e.g., increase in R&D expenses, the smartphone business’ weakness, etc.).