Grain Factory Researcher Will | Let expectations run wild for Xiaomi

The "Grain Factory Review" channel is dedicated to reviewing Xiaomi's quarterly financial reports, product launches, market performance, or other major events. It does not pursue timeliness or efficiency but aims to provide readers with the perspectives of Xiaomi researchers.

$XIAOMI-W(1810.HK)

"Will, what kind of company do you think Xiaomi will be in 10 years?" A mutual fund manager threw this question at me during a dinner.

I quickly organized many answer clues in my mind, ready to talk about the success of the first car SU7, the future of consumer electronics, how "system + AI + chips" could provide differentiated advantages, and how globalization and efficiency could bring cost advantages.

But before I spoke, I paused for a moment. This seemed to be the first time institutional investors actively discussed Xiaomi's endgame with me. I subconsciously asked myself, "Has the stock price risen so much that it's making people question their lives?"

Over the past three years, institutional investors' concerns revolved around two main themes: whether Xiaomi's SU7 could succeed and the fluctuations in smartphone shipments, market share, and gross margins. Everyone seemed trapped in assumptions and parameters about Xiaomi's short-term performance, unable to look up and envision Xiaomi's mid-to-long-term potential.

This dinner was symbolic because afterward, institutional investors began discussing Xiaomi's future with me one after another. Through these conversations, I observed a shift in investors' attitudes.

I believe the underlying logic of this change lies in Xiaomi Group steadily meeting financial and operational expectations, thereby rebuilding credibility among investors. Beyond assigning higher valuation multiples to Xiaomi financially, investors gradually began buying into Xiaomi's macro narrative.

The current valuation of all financial assets is a discount of future expected returns. For stocks, the future return expectation is the process of institutional investors reaching a consensus on a company's revenue/profits over the next three years. For example, Xiaomi investors started estimating full-year adjusted profit levels during the mid-year report and were already predicting whether 2025 car sales would hit 300,000 or 400,000.

Thus, expectations for future revenue and profits largely determine Xiaomi Group's current valuation.

However, each expectation is like an exam. The market continuously adjusts expectations based on actual performance (beat or miss), forming new consensus and valuation ranges, which in turn cause stock price fluctuations.

Setting aside macro and external factors, Xiaomi's two major valuation pullbacks since its IPO are significantly linked to unmet expectations.

- 2018: Shortly after Xiaomi's IPO, it announced a strategy to cap hardware net profit at 5%, attempting to replicate internet-style success in the hardware ecosystem. At the time, Xiaomi's expectation management was to use the hardware flywheel (phones x IoT) to drive software and service revenue. Although skeptical, the capital market assigned a $55 billion valuation (HK$17 per share).

But from 2018 to 2019, Xiaomi failed to deliver exponential growth in internet-style services/software within its hardware ecosystem. Traditional pre-installations, gaming, and financial internet revenue grew linearly with phone shipments, while the IoT ecosystem, aside from TV subscriptions and accessory e-commerce, didn't spawn new monetization scenarios. Thus, amid "hardware not making money and software going nowhere," investors quickly voted Xiaomi's stock price down from HK$17 to HK$8.5.

- 2021: Xiaomi's stock hit an all-time high of HK$35.9 in early 2021 and remained strong at HK$25-30 despite the U.S. military list incident. This valuation was built on Huawei's exit from the smartphone market in 2020, which led Xiaomi to set ambitious flags for market share, shipments, and new retail. Institutional investors layered on expectations for Xiaomi's rise in premium segments, offline new retail expansion, and rapid shipment growth to boost market share.

However, 2021 saw the Xiaomi 11 series stumble, becoming the biggest obstacle to its premium strategy. Meanwhile, COVID-19 stalled the 10,000-store plan for offline new retail. Xiaomi's global market share briefly hit No. 2 in Q2 2021 but failed to hold, and full-year shipments fell far short of expectations, with ASP also not improving significantly. Combined with global macro pessimism toward Chinese assets, Xiaomi's unmet expectations drove its stock price back down from HK$35.9 to HK$8.3.

Against this rollercoaster backdrop, most institutional investors had a poor holding experience. It's no surprise that when Xiaomi announced new expectations—balancing scale/profits, NEVs, and premiumization—institutional investors were naturally skeptical.

One institution told me after Xiaomi announced its car plans: "Until I see results, I won't assign any valuation to these goals—nothing is true until proven otherwise." Indeed, before the SU7's success, many institutions assigned zero or even negative valuation to Xiaomi's auto segment.

Thus, rebuilding credibility among institutional investors is Xiaomi's most straightforward investor relations goal.

But rebuilding trust isn't easy. Like a plane, falling takes seconds, but taking off requires initial acceleration and a long runway. Restoring Xiaomi's image among institutional investors won't happen overnight.

After this week's Q3 earnings, a friend asked: "Was this report a big beat or a slight beat?" My answer: "Whether it's a big or slight beat doesn't matter. What matters is that Xiaomi is consistently meeting expectations—that's this quarter's biggest highlight."

First, Xiaomi has delivered excellent earnings for three consecutive quarters this year:

- Xiaomi beat revenue/profit expectations for three straight quarters: All three quarterly reports this year exceeded consensus. This quarter, revenue was expected at RMB 90.2B but came in at RMB 92.5B; adjusted profit was expected at RMB 5.9B but hit RMB 6.3B.

- Xiaomi achieved YoY revenue/profit growth for three straight quarters: After six consecutive quarters of YoY revenue decline starting in 2022, Xiaomi barely turned positive in 23Q3. But this year, all three quarters showed significant growth. With SU7 monthly deliveries now at 20,000 units, quarterly revenue contribution will easily exceed RMB 12B, solidifying it as Xiaomi's second growth curve.

- Xiaomi's core business gross margin exceeded 20% for three straight quarters: Starting Q2 this year, Xiaomi segmented its business into "phones + IoT + internet" (core, valued by PE) and auto (innovation, valued by PS). This helps investors avoid over-focusing on quarterly gross margin dips in phones or IoT, as Xiaomi can maintain a healthy >20% gross margin for the core business overall.

- Xiaomi's smartphone market share exceeded 10% in all core markets for three straight quarters: Since 24Q1, Xiaomi has held >10% share in all core markets for three quarters, cementing its position as a global smartphone leader. As Canalys SVP Nicole Peng noted, "10% share" is a key threshold for negotiating power with local partners/carriers—the industry calls it "The Magical 10%."

Second, Xiaomi Auto fully delivered on all capital market expectations for the SU7 launch:

- NEV license: After announcing car plans in 2021, the market first questioned how Xiaomi would secure an NEV license. Despite Bloomberg and others highlighting difficulties, Xiaomi briefly borrowed BAIC's license in 2023 before updating SU7's registrant to "Xiaomi Auto Technology Co.," fully resolving the issue.

- Orders and launch sales: Pre-launch, the market was bearish, with institutional forecasts at 3,000-5,000 units. But Xiaomi's "10,000 units in 4 minutes, 50,000 in 27 minutes" far exceeded expectations, with 88,000 orders in the first 24 hours—selling out the full-year 60,000-80,000 delivery guidance on day one.

- Premium and female user mix: SU7's positioning shattered stereotypes: 56% of owners are iPhone users, and >40% are female. Its success also opened doors for Xiaomi's premium strategy, with the female-focused Mix Flip foldable exceeding sales expectations and Q3 foldable share in China reaching 17.2%.

- Monthly and annual deliveries: With strong demand, scrutiny shifted to supply. Yet Xiaomi repeatedly defied expectations, achieving "deliver upon launch, scale upon delivery"—10,000 units in 3 months, 20,000/month by month 7, and 100,000 cumulative by month 8. The 2024 target is now 130,000, surpassing all domestic EV startups' debut models.

- Auto gross margin: Capital markets focused most on how Xiaomi Auto would make money. Given Xiaomi's low-margin phone history and initial 5-10% guidance, expectations were modest (8-9%). But Q2 revealed a 15.4% gross margin (vs. Tesla's 13.9%), and Q3 showed further improvement to 17.1% (+1.7% QoQ).

- Cash management and full ownership: Auto is capital-intensive, and Xiaomi insisted on 100% ownership, seemingly leaving only massive cash burn. Yet from RMB 108B at the car announcement, cash reserves have grown quarterly to RMB 151.6B this quarter. With no signs of an auto spin-off, the Nov 20 announcement of ~500M share incentives likely reflects auto team members converting EV shares to Xiaomi stock, easing market concerns.

Returning to the opening question: After reviewing all this, investors see Xiaomi stabilizing its turbulent core business while hitting every SU7 launch target. Thus, they're increasingly convinced that phones and IoT can grow steadily, reconsidering Lei Jun's "SU7's success is Xiaomi's methodology success," anticipating the next SUV's success, and even discussing Xiaomi's macro logic:

Can the "Human x Car x Home" ecosystem create synergies? Is consumer electronics' endgame truly "hardware-software-AI integration"? How will Surge chips differentiate Xiaomi phones in cost/performance? How will the 3rd/4th car disrupt the auto industry and become Xiaomi's flagship products…

As these answers clarify, capital markets will form new consensus on Xiaomi's future, truly unlocking its valuation ceiling.

That concludes this quarter's earnings review.

Grain Factory Researcher Will

November 21, 2024, Hong Kong