Interactive Investor

Stockwatch: a great company you might never have heard of

14th May 2021 10:55

Edmond Jackson from interactive investor

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Stars are aligning for this global consumer electronics giant based in the world’s fastest-growing region. 

It is timely to consider the progress of the Hong Kong-listed electronics group Xiaomi (SEHK:1810). When investors think of technology, typically it is names most familiar in Western product markets. But helped by strong sales in China and India, Beijing-based Xiaomi Corporation is now the world’s fastest-growing smartphone company – with a 12% share, ahead of Apple (NASDAQ:AAPL) and vying with Huawei for number two position behind Samsung (LSE:SMSN)

Key aspects are coming together nicely 

I was initially impressed when researching the company’s growth since foundation in 2010, before buying one of its phones. Last year, about 62% of revenue derived from smartphones, otherwise mainly lifestyle products and internet services. Interestingly, it plans to invest some £7 billion equivalent in electric vehicle development over the next 10 years.  

Such a move is potentially very significant given the cost of electric cars and battery duration are key hurdles for mass market acceptance. In smartphones, Xiaomi has quite dominated entry-level phones at a fraction of rival’s prices, and is taking over the top-end, for example with the Mi 11 ultra-rated “world’s best for camera” and “10x longevity” – charging in half an hour and making a 10% battery charge last for 55 hours. 

Then last Wednesday came news that the Biden administration has taken Xiaomi off a US trading black list, instigated by President Trump. The Xiaomi brand has not become tainted as Huawei was when the UK government prohibited the 5G roll-out. 

It comes in a financial context of bumper 2020 results where the table of summary income statements shows profit doubling in the last year to £2.2 billion equivalent, as if affirming an inflection point for financial growth.

Xiaomi   Corporation: summary income statements
Year to 31 Dec (Billion Chinese   renminbi)   2016 2017 2018 2019 2020
Total revenue   68.4 114.6 174.9 205.8 245.9
Cost of revenue   61.2 99.5 152.7 177.3 209.1
Gross profit   7.2 15.1 22.2 28.6 36.8
Operating expenses R&D   3.2 5.8 7.5 9.3
  general   4.2 20.1 13.5 18.3
  Total incl. other   9.5 25.5 20.7 27.0
Operating profit   3.8 12.2 1.2 11.8 24.0
Interest expense       0.4 0.5 3.4
Pre-tax profit   1.2 -41.8 13.9 12.2 21.6
Taxation     2.2 0.5 2.1 1.3
Net income   0.6 -43.8 13.6 10.1 20.3
Source: Xiaomi Corporation   2020 annual report        

Better risk/reward than US technology stocks? 

Over the last five to 10 years, I have covered Apple and Microsoft Corp (NASDAQ:MSFT), soaring from price/earnings (PE) multiples in the low teens to over 30x. While re-ratings were justified by innovation and higher quality of earnings, you have to question if such ratings will hold for the next 10 years. Over the last year, monetary stimulus has also stretched valuations in momentum stocks.  

They are also more exposed should emerging inflation be hard to contain without interest rate rises. High-profile growth stocks have enjoyed a tremendous run in an era of ultra-low rates, with future earnings hopes valued higher today. 

If interest rates are broadly at a turning point and the 21st century belongs more to Asia Pacific, with China wresting control from the US as the dominant global power, there is a case for selective exposure to the best of what China offers. 

Tesla (NASDAQ:TSLA) has enjoyed first-mover advantage of high margins on premium cars, but I suspect Far Eastern designers will bring down costs to capitalise for a mass market. 

At 25.85 Hong Kong dollars (closed this morning), Xiaomi’s trailing PE multiple is in the mid-20’s – offering fair value, I believe, considering the group’s underlying financial dynamics and marketing prowess. Admittedly, it has re-rated with much else in global technology, up from about $10 a year ago to $33 last January, closing at $25.65 this morning. Nor has it been immune to inflationary jitters this last week. 

But in terms of buying any drop ahead in global technology stocks, I would look beyond the west to where dynamism in the Far East looks to have better potential to capture mass markets with “something new”. 

South Korea’s LG Electronics could shake up electric vehicles 

The obvious initial thought to a Western consumer/investor would be Samsung, which seeks aggressive marketing via its “SDI” battery unit, having acquired US auto parts supplier Harman International in 2016 for $8 billion (£5.7 billion). Yet it is criticised for not making the most of this deal. 

Batteries appear to be the crux for marketing, given they represent about 40% of electric vehicle costs – still out-of-reach for many consumers – and make them impractical for driving longer distances. 

A new partnership set to launch this July, between South Korea’s LG Electronics (LSE:LGLD) and Magna International, the world’s largest auto parts maker, aims to further re-rate LG’s vehicle components solutions side. This business has grown from under £2 billion equivalent in 2014 over £10 billion last year, hence is very well positioned. 

Therefore, LG and Samsung represent potentially the most serious competition from the Far East, for mass market electric vehicles, and merit watching. Yet Xiaomi has proven itself canny at both marketing and technological development. I would not under-estimate its abilities from a standing start. 

How I came to favour Xiaomi phones over Samsung 

Having launched its first smartphone in August 2011, incredibly by 2014 Xiaomi had the largest market share in China - becoming the world’s fourth-largest smartphone maker by the second quarter of 2018.  

Last October, it passed Apple to become third-largest, with 42% year-on-year growth; then for 2020 as a whole its shipments within China soared 52% and 24 million phones shipped globally made it the fastest grower.  
Canny marketing hooks customers with cheap albeit well-performing “entry” models, but Xiaomi is also now beating global leaders at the top-end. 

Having found Samsung phones too small or big, early last year I was intrigued to order a £69 Xiaomi phone online from its Paris warehouse. At 5.5” it has proved most comfortable, gives me about three days regular use before charging, and has a decent 13 megapixels camera. 16GB storage is easily expanded up to 256GB with an SD card. Frankly, it is all I need. 

Low prices are partly a function of a longer product cycle - 24 to 36 months – where Xiaomi buys in bulk, instead of chasing parts to higher specifications annually, as rivals do. Given the 2020 operating margin was just below 10%, it still looks as if an element of “subsidising” new customers is involved. 

This has not compromised high-spec new offerings: the Mi 11 proved very popular at launch, and its “ultra” version is rated for the world’s best phone camera. The battery also offers 10x greater longevity and full charging in half an hour. There is a remarkable 55 hours in power-saving mode on a 10% charge. Can Xiaomi achieve superiority like this for vehicles? 

A quality pick, especially if tech stocks fall 

Cautious investors may prefer to see if Xiaomi can first genuinely enter the vehicle market and establish sales traction. Required investment may take the shine off profits it is achieving from phones, internet services and other products. There is no dividend policy. 

Yet the company has shown prowess at both ends of the marketing scale, based in the world’s fastest-growing region. If you lack conviction currently to invest, Xiaomi should still be on your radar. For the next decade versus Apple: Buy.  

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