Xiaomi Stock: Multiple Headwinds (OTCMKTS:XIACF)

Elevator Pitch

I have a Sell investment rating for Xiaomi Corporation’s (OTCPK:XIACF) [1810:HK] stock.

My previous article published on April 14, 2022 focused on the company’s business outlook and share buybacks. My latest update assesses Xiaomi’s future prospects in consideration of recent developments.

The latest smartphone shipment data indicate that the performance of Xiaomi’s core smartphone business in the second quarter of 2022 was poor, and this raises the probability of revenue and earnings misses for the company in the upcoming quarter. To add to Xiaomi’s woes, the geopolitical risks for the company and its Chinese peers are rising in India, due to growing tensions between India and China. At the same time, a recent Bloomberg news article has raised concerns about potential regulatory challenges for Xiaomi’s new Electric Vehicle or EV business. The above-mentioned explains my Bearish view for the name.

Xiaomi – 2Q 2022 EPS Miss Is Very Likely

Xiaomi is expected to announce the company’s financial results for the second quarter of this year in late-August 2022. Although the company hasn’t provided an official date for the Q2 2022 results announcement, Xiaomi usually releases its second-quarter financials towards the end of August as per history.

The sell-side’s consensus financial estimates sourced from S&P Capital IQ imply that Xiaomi’s revenue and normalized earnings per share or EPS will decrease by -13.0% YoY and -51.3% YoY, to RMB76.4 billion and RMB0.12, respectively in Q2 2022. In my opinion, the current consensus numbers for Xiaomi are still way too optimistic.

According to data on global smartphone shipments provided by IDC, Xiaomi’s smartphone shipment volumes dropped by -25.5% YoY from 53.1 million units in the second quarter of 2021 to 39.5 million units in Q2 2022.

While COVID-19 lockdowns in Mainland China were expected to hurt Xiaomi’s smartphone shipment volumes in the recent quarter, it is worrying that the company has ceded market share to its closest rivals. Xiaomi’s global smartphone market share contracted from 16.9% in Q2 2021 to 13.8% in Q2 2022, while the market shares of Apple (AAPL) and Samsung (OTCPK:SSNLF) (OTCPK:SSNNF) expanded by +1.4 percentage points and +2.9 percentage points, respectively, over the same period.

Apart from significantly lower smartphone sales volumes in Q2 2022, Xiaomi’s smartphone business should also see its profit margins compress due to an increase in logistics and component expenses, and stiffer price competition.

With the core smartphone business contributing close to two-thirds of Xiaomi’s revenue for fiscal 2021 and underperforming in Q2 2022, the company is very likely to see its second-quarter top line and bottom line come in below the market’s expectations.

Regulatory Uncertainty For New Electric Vehicle Venture

In my prior April 14, 2022 update for Xiaomi, I had cautioned that the company’s “R&D (Research & Development) expenses could rise sharply this year, with the increase in staff strength for its new electric vehicle business venture.” It looks like Xiaomi’s new EV business might possibly face other hurdles apart from those related to costs and investments.

Bloomberg published an article on July 29, 2022, claiming that “Xiaomi Corp. is facing difficulties getting regulatory approval for its electric vehicle project” after discussions with “officials at the National Development and Reform Commission about the licensing” had gone on “for months without success.”

The market didn’t respond well to this piece of news. The stock price of Xiaomi’s Hong Kong-listed shares declined by -5% from HK$13.00 as of July 28, 2022 to HK$12.34 as of July 29, 2022.

On the same day, a commentary published in Chinese state media China Daily appeared to have rebutted the points raised in the earlier Bloomberg article. In the China Daily piece, it was stated that Xiaomi’s EV venture is “progressing as per schedule, and a license is not needed at the moment” as “the project is still in research and development mode.” But this China Daily article also indirectly confirms that Xiaomi will require regulatory approval for its EV business at a later stage in the future.

It is uncertain whether Xiaomi’s new EV business will get the blessing of regulators, and this suggests that there is uncertainty over the ability of the company to meet its 2024 target of launching its first EV.

Geopolitical Risks In Key Foreign Market

In its FY 2021 financial results announcement, Xiaomi disclosed that it generated half of its sales from markets outside of Mainland China, and it revealed that India and Europe are its main international markets. Xiaomi also highlighted in its fiscal 2021 results presentation slides that it was the leading smartphone maker in India last year with a 24.9% market share.

The numbers above suggest that India is a key foreign market for Xiaomi.

A recent July 8, 2022 Nikkei Asia article mentioned that there has been “a string of raids on Chinese smartphone makers amid (various) government allegations.” The Indian authorities have previously accused Xiaomi of “tax evasion” and “illegal remittances” as per reports published in January 2022 and April 2022, respectively. A July 17, 2022 Financial Times commentary attributed these recent incidents to “frosty relations” between China and India, and India’s intention to support its “domestic tech sector.”

In the worst case scenario, it isn’t unthinkable that Xiaomi and its Chinese smartphone peers are restricted from selling their products and services in India in one way or another.

Bottom Line

Xiaomi is a Sell. The company is expected to report its Q2 2022 results in the later part of August 2022, and the smartphone industry’s shipments data points to Xiaomi missing market expectations with its second-quarter results. Regulatory risks for its EV business and geopolitical headwinds for its India market are also among the key investor concerns for Xiaomi.