Xiaomi's EV Drive Burns Big Bucks As Smartphone Sales Slow

2022 wasn’t a vintage year for former smartphone highflyer Xiaomi Corp. (1810.HK) (OTCPK:XIACF, OTCPK:XIACY). With revenue from its core smartphone business dropping steadily and little relief on the horizon, the Chinese company is stepping on the accelerator for its recent drive into electric vehicles (EVs). But that decision, which will burn tens of billions of investment dollars, looks increasingly dubious as China’s once-vibrant EV sales show growing signs of braking sharply.

Xiaomi’s fourth quarter results released late last month show its revenue fell 23% year-on-year to 66 billion yuan ($9.6 billion) in last year’s fourth quarter, led by an even larger 27% drop in smartphone revenue to 36.7 billion yuan. Its adjusted net profit fell 67% to 1.46 billion yuan, marking the company’s weakest quarter last year. For the full year, Xiaomi’s adjusted profit plunged 61% to 8.5 billion yuan, while its revenue fell 15% to 280 billion yuan.

Xiaomi’s shares fell 3.5% the day after the announcement and hovered around HK$12, indicating the outlook for one of China’s best-known homegrown smartphone brands remain a mystery to many investors.

Xiaomi’s smartphone sales decreased by 20% to 167.2 billion yuan for all of last year, and its smartphone shipments dropped by a similar 21%, both sharply outpacing an 11.7% decline in the global smartphone market. As it underperformed against its peers, Xiaomi’s share of the global market slipped to 12.8% last year from 14.1% in 2021, enough to make it the world’s third biggest brand both years, according to data from Canalys.

Unsold phones

As overall sales sag, Xiaomi’s management is trying to explain to investors that it is moving its focus to the more profitable higher-end of the market, emphasizing “quality over quantity.”

Its latest results show that its high-end smartphone sales have indeed picked up. The company’s share of smartphones selling for above 3,000 yuan in the mainland China market jumped 6.8 percentage points last year from 2021. Xiaomi also ranked first in sales of smartphones costing 3,000 yuan to 4,000 yuan, or about $300 to $450, with the average selling price of one of the company’s smartphones up more than 14% last year.

As Xiaomi’s sales slow, the company’s impairment provision for inventory write-downs reached about 560 million yuan in last year’s fourth quarter, following a similar charge the previous quarter. That brought its full-year impairment provisions to a huge 3.47 billion yuan, up 160% from the previous year. That kind of inventory clearance brought down the company’s smartphone gross margin by 2.9 percentage points to a thin 9%.

Despite China’s scrapping of most Covid restrictions at the end of last year, largely bringing the global pandemic to an end, Xiaomi president Lu Weibing wasn’t optimistic that the smartphone market would improve much this year, saying shipments may continue to decline in the first half. “Seeing as the macro environment may gradually improve in the second half of the year, the company will deploy a more moderate operational strategy focusing on both scale and profit, and hopes that the market will give Xiaomi its patience and confidence,” said Lu.

Management’s guarded outlook may calm the nerves of existing Xiaomi stockholders, though potential new investors may take a more wait-and-see attitude until the smartphone business shows clearer signs of improvement, said Kenny Wen, KGI Asia’s head of investment strategy.

Huge EV investment

While the smartphone business remains weak, Xiaomi is holding out higher hopes for its recent expansion into EVs. The company said its goal of starting EV mass production in the first half of next year remains unchanged. But Wen stressed that Xiaomi is not currently on his EV investment list because there are many other better options in the segment.

“In terms of its potential EV plays, there are already a large number of other choices in the market,” Wen said. “When you consider that the overall EV industry is headed into a downturn, throwing big cash into building cars in the short term may bring greater uncertainty to the company.” Wen added he didn’t really understand Xiaomi’s big decision to enter EVs, and couldn’t help wondering why it is so confident about that initiative.

Xiaomi’s latest price-to-sales (P/S) ratio of about 4 times is lower than the 6.7 times for Apple Inc. (AAPL), which has also moved into EVs. But considering Apple’s far bigger success in the high-end smartphone market, making it the world’s most valuable tech company, such a valuation gap is hardly surprising.

Despite outside concerns about its EV initiative, Xiaomi had spent a sizable 3.1 billion yuan on the drive through last year. A big portion of that went to its fast-growing automotive R&D team, which expanded nearly five-fold from more than 500 people in the second quarter to 2,300 at the end of the year, accounting for about 14% of the company’s R&D staff.

Xiaomi is forecasting overall R&D spending over the next five years will exceed 100 billion yuan, meaning its cash burning will only accelerate. That could be problematic since the company had only 27.6 billion yuan in cash and cash equivalents at the end of last year. What’s more, it recorded 4.4 billion yuan and 7.9 billion yuan of cash outflow for its operating and financing activities, respectively, leading some to wonder where exactly all the money is coming from.

Big R&D spending is only the first step in a cash burning exercise for EV development. Still to come are construction of manufacturing facilities, construction of EV charging stations and other costs once models are actually being produced. That’s why many EV startups are still recording huge losses years after their establishment, and may explain why some analysts aren’t too bullish on Xiaomi’s prospects.

JPMorgan believes the outlook for Xiaomi’s smartphone and EV segments are both unclear, and thus is maintaining a “neutral” rating of the company with a target price of HK$12 – roughly its current level, implying little or no upside. Macquarie estimates that Xiaomi’s revenue won’t grow this year, even as the EV business drives up operating expenses and weighs on its profit margins. It rates the company an even lower “underperform,” with a target price of HK$9.77, representing potential 20% downside to its current levels.

Disclosure: None.

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