If there were a ranking of Chinese entrepreneurs based on reputation and influence, Lei Jun would be at the top. Under his leadership, Xiaomi has become a global leader in the smartphone market and is making strides in the electric vehicle industry, drawing significant investor attention.

When Xiaomi went public, Lei Jun promised investors would see their money double. However, the stock's journey has been volatile.

It halved within a year, then doubled in the next, and now hovers around its initial price, reflecting both market conditions and company performance. With the recent recovery in China stocks and Xiaomi's performance bouncing back, the company's share price has experienced a strong upward trend.

Each earnings release may signal a potential investment opportunity, but before diving in, investors need to understand how to interpret their financial statements.

To analyze Xiaomi's financial reports, we may focus on three key aspects: the core business, growth drivers, and profitability.

1. Core businesses

A company's core business is typically its most critical segment. For Xiaomi, there are four main areas: smartphones, IoT, internet services, and the smart vehicle business, which will start generating revenue in Q2 2024.

Currently, the smartphone segment is undeniably Xiaomi's most important core business. It accounts for nearly 60% of the company's total revenue, making it the primary driver of their earnings.

Xiaomi's ecosystem heavily relies on its smartphone users. The IoT business enhances this ecosystem, while the automotive segment leverages the brand and integrates with smart applications from Xiaomi smartphones.

As Xiaomi's core revenue driver, the smartphone business has had ups and downs but is now back on a growth trajectory. In Q2 2024, smartphone revenue jumped 32% year-over-year, marking four consecutive quarters of growth.

What are the growth prospects for Xiaomi's smartphone business, and is its foundation stable? Three key factors matter:

First, industry growth. The smartphone market is cyclical, influenced by upgrade demands and economic cycles. If the market grows, Xiaomi benefits; if it declines, all manufacturers feel the pressure.

According to IDC, global smartphone shipments have stabilized after nearly two years of decline and started to rise over the past five quarters, boosting Xiaomi's revenue.

Second, market share trends: An increasing market share for Xiaomi's smartphones not only drives revenue growth but also enhances brand presence and user influence. Given the seasonal nature of new phone releases, we focus on year-over-year quarterly market share changes. According to Canalys and Xiaomi's financial reports, Xiaomi's market share has increased year-over-year for four consecutive quarters, reaching around 14.6% in Q3 2024, indicating strong, sustained historical growth.

Third is the Average Selling Price (ASP). If ASP rises alongside shipment increases, it significantly boosts revenue growth. However, Xiaomi's ASP has remained relatively stable, fluctuating between 1,000 and 1,200 yuan, without a clear upward trend.

The relatively stable ASP is mainly due to two factors:

1. High-End Strategy: Xiaomi is pushing high-end smartphones priced above 3,000 yuan, which now account for over 20% of shipments, potentially boosting ASP.

2. Emerging Markets: Increased shipments to Latin America and Africa, where purchasing power is lower, have pulled ASP down.

In Q2 2024, Xiaomi's ASP was around 1,102yuan, slightly down year-over-year but still above the 1,100 yuan median.

Overall, to assess Xiaomi's smartphone business revenue trends, we need to monitor the industry's growth trajectory, Xiaomi's market share expansion, and whether the ASP can steadily rise with the ongoing high-end strategy.

2. Growth drivers

For Xiaomi's growth drivers, we can focus on two key areas: the existing internet services business and the more crucial newly developed smart automobile business.

Regarding existing operations, Xiaomi's smartphone and IoT businesses exhibit some cyclicality. In the past two years, several quarters saw revenue decline by more than 10%, and quarterly revenue has yet to return to historical highs.

In contrast, the Internet services business has shown more stable growth. Quarterly revenue declines have never exceeded 5%, and in the last four quarters, it has continually grown at a high level.

This segment can be considered the cornerstone of Xiaomi's revenue growth and a significant profit source, contributing over one-third of the gross profit with just over 10% of total revenue.

Xiaomi's Internet services business, which includes advertising and gaming revenue, depends on monetizing the MIUI system's traffic. While short-term revenue can be affected by economic cycles, long-term growth hinges on the scale of MIUI users.

Typically, new shipments of Xiaomi smartphones and tablets surpass the number of users replacing their devices, leading to a steady increase in MIUI's monthly active users (MAU). This growth is the key reason for the stable increase in Xiaomi's internet services revenue. In Q2 2024, MIUI's MAU reached approximately 676 million, with a year-over-year growth rate of over 10%. We may continue to monitor whether this growth remains stable.

Regarding new ventures, Xiaomi's smart automobile business is viewed by Lei Jun as the company's second major entrepreneurial endeavor and is a key growth area of market interest. Early signs may be promising: within a month of launch, Xiaomi received nearly 100,000 orders, and delivered over 20,000 vehicles each month on average, and in its first year, the company aims to deliver 120,000 vehicles. This may result in over 30 billion yuan in revenue for 2024, accounting for more than 10% of Xiaomi's total revenue.

The rapid surge in orders and production capacity for Xiaomi's automobiles is largely due to the strong brand reputation, technical expertise, supply chain advantages, and cost-effective marketing channels that Xiaomi has built through its smartphone and smart product ventures.

To determine if Xiaomi's automobile business can sustain this momentum, we need to monitor the ongoing popularity of its current model, the SU7, in the short term. In the medium to long term, success will depend on whether its upcoming second pure electric SUV and third extended-range SUV can also become hit products, potentially elevating Xiaomi's automobile revenue to a new level.

3. Profitability

It's consensus that car manufacturing is a highly capital-intensive business. Almost all new car manufacturers have faced significant losses, with many still deeply in the red. Xiaomi announced its entry into the automobile market in Q1 2021 and began large-scale investments in Q3 2021. This has raised concerns in the market about the potential negative impact on Xiaomi's overall profitability.

These concerns were not unfounded. Xiaomi's adjusted net margin dropped from 7.2% in Q2 2021 to 2.2% in Q4 2022, nearly resulting in losses, and its stock price approached historical lows during that period.

However, Xiaomi's profitability saw a significant rebound, with the adjusted net margin reaching approximately 7% at present.

From Q2 2021 to Q2 2024, Xiaomi invested over 10 billion yuan in its automobile project, raising its R&D expense ratio from 3.5% to 6.2%. Despite this increased expenditure, Xiaomi's net margin improved, primarily due to an increase in its gross margin from 17.3% to approximately 20.7%, a rise of about three percentage points. This improvement in gross profit margin has been the key factor in enhancing Xiaomi's overall profitability.

Of course, the improvements in Xiaomi's gross and net margins may not be sustainable. It is anticipated that in the initial phase of mass deliveries for Xiaomi's automobiles, each vehicle sold will likely result in a loss, significantly dragging down gross and net margins. In fact, by Q2 2024, Xiaomi's gross margin and adjusted net margin have already declined compared to the previous quarter. Only with continued production increases, benefiting from economies of scale that spread out R&D and fixed costs, can unit costs decrease to reach a break-even point.

In upcoming financial quarters, we need to monitor when Xiaomi's profitability, after an expected period of decline, will start to turn upwards. If this turning point arrives as anticipated and rapidly translates into profits, it might mark the true success of Xiaomi's new venture.

Having read this far, you may now have a deeper understanding of how to interpret Xiaomi's financial reports. It's noteworthy that the release of earnings reports from prominent companies may present unique trading opportunities for different types of investors.

For instance, if an investor, after analyzing past reports and considering recent developments, believes a company's latest earnings will send positive signals and boost the short-term stock price, they might consider taking a long position. This could involve buying the underlying stock or purchasing call options.

Conversely, if the investor expects the earnings to be unfavorable and potentially pressure the stock price, they might consider taking a short position, either through short selling or buying put options.

If the report's outcome is unclear but volatility is expected, they might use a straddle strategy, buying both calls and puts.

However, investors should carefully assess their risk tolerance, particularly when considering high-risk trades like short selling or options, before making any trading decisions.

Summary

When analyzing Xiaomi's financial report, we should focus on three key areas:

1. Core Business: Smartphones

1. Industry Growth: Can the smartphone industry continue its growth?

2. Market Share: Can Xiaomi expand its market share?

3. ASP (Average Selling Price): Can Xiaomi maintain or gradually increase its ASP?

2. Growth drivers:

1. Internet Services: Historically, a steady growth driver, we need to monitor whether MIUI users continue to grow.

2. Smart Automobiles: The future core growth driver. We should observe if the SU7 model remains popular and if upcoming new models become hit products.

3. Profitability:

1. Current Performance: Xiaomi's profitability recently reached new highs.

2. Future Challenges: The profitability will inevitably be impacted by losses from the automobile business. We need to monitor when the automobile division will reach break-even and how long the overall profitability decline will last before it rebounds.