The smartphone maker has posted lower revenue and adjusted profit in the third quarter, hit by falling product sales and prices. But its spending on a move into EV production keeps rising

Key Takeaways:

  • Xiaomi’s revenue fell nearly 10% in the third quarter and its adjusted net profit tumbled 59% to 2.1 billion yuan
  • Market analysts think profits from the smartphone business could have peaked and may not be enough to sustain a concerted push into electric vehicles 

By Ken Lo

China’s Xiaomi Corporation (1810.HK) is branching out from handsets to electric cars, but its latest quarterly earnings report has left investors wondering if the smartphone maker could be taking a wrong turn.

Last Wednesday, Xiaomi announced that its net earnings veered into negative territory in the third quarter, with a loss of 1.47 billion yuan ($205 million). President Wang Xiang assured investors on an earnings call that the pace of the big push into electric vehicles (EVs) would not greatly affect overall performance. But the market fears the new venture could put the brakes on the company, and its stock price tumbled 3.6% the next day to HK$9.45.

Xiaomi’s revenue dropped 9.7% to 70.47 billion yuan in the third quarter from the same period a year earlier. Its non-IFRS adjusted net profit plummeted 59% to 2.12 billion yuan, eroded by 830 million yuan in expenses for new ventures including EV production.

Smartphone manufacturing is the company’s core business, contributing more than 60% of revenue, according to the earnings report. So, when the founder and chairman of the company, Lei Jun, vowed to invest $10 billion in making electric cars, it was naturally assumed that smartphone revenues would finance the change of direction.

The earnings report also showed that Xiaomi sold 42.5 billion yuan worth of smartphones during the third quarter, a year-on-year drop of around 11%. The company blamed weakness in the Chinese economy and renewed outbreaks of Covid-19 for the declining sales. In addition, the average selling price (ASP) fell as the company ramped up promotions in overseas markets to cut inventories and increased its provisions for inventory depreciation. The latest ASP was 1,058.2 yuan, a year-on-year decline of 3%.

As a result, the gross margin for the smartphone business fell to 8.9% at the end of the quarter, down 4 percentage points from a year earlier. The margin was much lower than the 13.5% for its Internet of Things (IoT) and lifestyle products, and 72.1% for its internet service business.

Falling smartphone demand

The overall market for smartphones has contracted as the global economic downturn deters consumers from buying new handsets. A report from the market analysis firm Canalys found that third-quarter smartphone shipments fell 9% year on year, making it the worst third quarter since 2014.

As things stand, Xiaomi ranks third in the global smartphone market with a 13.6% market share,  trailing Apple Inc. (AAPL.US) with 18% and market leader Samsung Electronics (005930.KS) with its 22% slice of the market. Analysts at Canalys are downbeat about smartphone demand in the near term and are not expecting any upturn in the next three quarters.

Xiaomi said it shipped 40.20 million handsets in the third quarter, a year-on-year decline of 8.4%, despite efforts to scale back inventories through increased overseas promotions. During the earnings call Wang said the company would try to capitalize on Black Friday demand and Christmas sales to achieve further falls in inventories.

Moreover, the company has not managed to fill the high-end smartphone space left by Huawei’s retreat from overseas markets. With its more profitable businesses contributing a small share of revenues, investors could have cause for concern that Xiaomi’s smartphone operation alone cannot generate the large sums needed to fund its EV ambitions.

The company’s R&D spending on the EV operation is climbing, from 425 million yuan in the first quarter to 829 million yuan in the third quarter, swelling its overall development costs. Total R&D expenses rose nearly 26% to 4.1 billion yuan in the third quarter from the year-earlier period. At the same time, Xiaomi’s R&D team for electric vehicles is expanding, from more than 500 people in the second quarter to over 1,800 by the end of the third quarter. The EV business is expected to burn through cash at an even faster rate in the future.

One thing is clear: R&D spending is just a small part of the total cost of running an EV operation. Going on to develop and produce the EVS and their battery materials is the really expensive part. Many established EV businesses are still groaning under huge losses, making it hardly surprising that some equity experts are bearish about Xiaomi right now.

Sell signals

GEO Securities, for one, has raised the red flag. Its CEO Francis Lun advised investors to sell the stock, citing Xiaomi’s rising R&D spending on the EV business, the sinking smartphone sales weighed down by global economic woes and the company’s setbacks in India, its biggest overseas market.

Lun noted that the EV sector was fiercely competitive and that 90% of the companies still in the market could be forced out at some point in the future. Even the biggest stock in the sector, BYD Co. Ltd. (1211.HK), had been sold off by star investor Warren Buffett. “Others would only fare worse,” he said.

KGI Asia’s head of investment strategy, Kenny Wen, has already taken the company off his investment list. He said the profit contribution from Xiaomi’s smartphone business was likely to have plateaued, while inventory continued to be a problem. As a result, he was pessimistic about whether the company could sustain its huge investment in the EV business.

Apple, like Xiaomi, has been actively expanding into the EV sector in recent years. Its cash reserves have shrunk by nearly half from $90.9 billion in September 2020 to $48.3 billion as of this September. Xiaomi does not have such a big stash of cash to fall back on. The company had 28.07 billion yuan in cash and cash equivalents left by the end of September, while its debt reached 25.8 billion yuan. So securities firms may have reason to fret about how it will fare in the EV sector. In terms of valuations, Xiaomi’s latest forward price-to-earnings (P/E) ratio is 16 times, much lower than Apple’s 24 times, reflecting investors’ concerns about its prospects.

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