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3 Reasons Xiaomi Is Skyrocketing Despite Declining Earnings

By Billy Duberstein - Aug 28, 2020 at 8:25AM

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Investors are getting more enthusiastic about this Chinese 5G play.

Shares of Xiaomi (XIACY) are skyrocketing this week on the heels of the company's second-quarter earnings report. At first glance, this may be somewhat surprising, as Xiaomi's adjusted earnings actually declined during the quarter. Though revenue increased 3.1% and gross margins expanded slightly, adjusted (non-IFRS) net income declined 7.2% as Xiaomi stepped up aggressive marketing and promotions for its new 5G phones.

Yet despite the anemic overall growth and an earnings decline, Xiaomi's stock shot up after the report. It's now up a whopping 38% for the month as of this writing. So what has investors so enthusiastic?

XIACY Chart

XIACY data by YCharts

Aside from India, smartphone sales were solid

One of Xiaomi's biggest markets is in fast-growing India, where it has the No. 1 market share. However, during the second quarter, India imposed strict pandemic-related lockdowns, which affected demand for Xiaomi's phones. What's more, Xiaomi also serves the Indian market from in-country production facilities, and the company's local manufacturing capacity was also impacted by supply issues. Despite the shipment declines, Xiaomi still retained its market share lead in India, according to management.

However, in Europe, Xiaomi appears to be catching on. Smartphone shipments to Europe were up 64.9%, enabling Xiaomi to crack the top three in European market share. This includes the No. 1 ranking in Spain, Ukraine, and Poland, No. 2 in France, and No. 4 in Germany and Italy. Xiaomi is also penetrating emerging markets, with shipments up 99.4% in Latin America, 66.3% in the Middle East, and 113% in Africa.

Overall, smartphone shipments were down about 11.6%, but higher average selling prices (ASPs) enabled smartphone revenue to only decline by 1.2%. The pandemic obviously affected Xiaomi's main regions last quarter, but increasing penetration in new markets outside of China and India was a promising sign.

A young person carrying a backpack smiles as they use their cellphone.

Xiaomi has been on a tear recently. Image source: Getty Images.

Investors cheer sales of higher-end phones

In addition to international growth, investors were likely encouraged by increased sales of Xiaomi's higher-priced phones for the premium market. Xiaomi first gained popularity by offering quality phones at bargain-basement prices, and there were concerns that Xiaomi would struggle to make profits in that low-end segment. Xiaomi has pledged not to make any more than 5% net margins on its phones, and investors have likely worried that low-end phone users won't buy as many high-margin services, where Xiaomi aims to make most of its profits.

Yet during the quarter, there seemed to be evidence that Xiaomi's higher-priced flagship 5G phones are gaining momentum. As stated above, ASPs increased 11.8% and sales of premium smartphones increased 99.2% in overseas markets. The high-end Mi 10 phone ranked in the top two smartphones on JD.com's (JD 0.19%) 618 Shopping Festival. Post-quarter, Xiaomi also debuted its new flagship 5G phone, the Mi 10 Ultra.

Clearly, Xiaomi has been able to pack higher-end phones with loads of features and power, and investors are liking the company's move up to a more affluent customer base.

A big competitor may get kneecapped

Finally, it looks as if Xiaomi could actually benefit from the U.S.-China tech cold war. In August, the U.S. further restricted hardware and software suppliers from Huawei, which is the largest smartphone vendor in China.

If Huawei's phones become less competitive due to inferior components, it could open up a larger opportunity for Xiaomi, as well as fellow Chinese smartphone rivals Oppo and Vivo. Huawei accounted for 45% of China's smartphone shipments last quarter, so there could be a good opportunity for the other competitors going forward should the U.S. restrictions on Huawei stick long term.

Adding it up to 5G

Increasing popularity overseas, success with higher-end phones, and the opportunity to take market share from Huawei all seem to have propelled Xiaomi's shares this month. While the stock is much more expensive than it was a month ago, it still appears reasonably priced considering the company's growth prospects. As the world is on the cusp of 5G smartphone adoption, look for Xiaomi to keep climbing as it delivers high-value phones for its prices.

Billy Duberstein owns shares of JD.com and Xiaomi. ADR. His clients may own shares of the companies mentioned.  The Motley Fool owns shares of and recommends JD.com. The Motley Fool has a disclosure policy.

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