$XIAOMI-W(01810)$ 2022 free cash flow (FCF) is likely to turn negative along with declining revenue and a narrowing EBITDA margin on weak consumer sentiment, especially in China and Europe, amid Covid-19 lockdowns in China and high inflation in Europe driven by the Russia-Ukraine conflict, as well as continual investment in the electric vehicle (EV) business, says Fitch Ratings. However, Xiaomi’s ratings headroom remains high and we expect revenue to rebound in 2023.
We forecast 2022 revenue to decline by 3% to 4% (2021: +34%), on weak demand for smartphones, slower growth in internet of things (IoT) and lifestyle products due to logistic bottlenecks overseas, and subdued internet services growth on shrinking advertisers’ budgets. We expect Xiaomi’s 2022 smartphone shipments to fall by a low teen-digit on weaker consumer demand in the core markets of China, India and in Europe. Shipments declined by 22% year-on-year in 1Q22, despite a 14% rise in average sales price due to sales of premium smartphones in overseas markets. We expect 2H22 revenue for smartphones, IoT and lifestyle products to rise against 1H22, as the likely easing of China’s lockdowns will unleash pent-up demand.
We expect the Fitch-defined EBIT margin on non-financial operations to narrow to 3.8%-5.3% in 2022-2023 (2021: 7.2%), as the gross margin on smartphones may decline to around 10% in 2022 (2021: 12%) on promotional events to drive sales and clear inventories. A Fitch-expected double-digit decline in Chinese smartphone shipments in 2022 will hamper pre-installed phone apps revenue, which has a higher gross margin than other advertising businesses, and squeeze the overall gross margin on internet services. Smartphones and internet services collectively contribute around 76%-80% of total gross profit.
We expect 2023 revenue growth to most likely rebound at a high single-digit percentage, led by market share gains, especially in Europe and Latin America, on further success in penetrating carrier channels. About 40%-50% of smartphone shipments go through carrier channels in these markets. Xiaomi’s market share of carrier channels rose to 17% in Europe and 18% in Latin America in 1Q22 (2020: 8% and 5%, respectively), according to Canalys. The increase in shipments to overseas markets will also boost high-margin pre-installation revenue. In China, we believe Xiaomi will continue to invest in R&D to drive premiumisation efforts and to further improve the efficiency of its offline channels. Xiaomi had more than 10,500 offline stores in China at end-1Q22. Offline channels account for about 70% of smartphone shipments in China.
We believe that Xiaomi will maintain a solid net cash position of CNY35 billion-40 billion in 2022-2023 and a conservative capital structure with total debt/EBITDA for the non-financial operations of 0.7x-1.1x, well below our negative sensitivity of 2.0x. FCF is likely to turn negative in 2022 (2021: positive FCF of CNY2 billion), on negative operating cash flow due to financial pressure on both suppliers and customers and investment in the EV business. We forecast that FCF will recover to over CNY10 billion from 2023 as the economic environment improves.
Xiaomi’s ratings are underpinned by its smartphone market positions in populous emerging markets and developed markets such as Western Europe, a broad smartphone portfolio of value-for-money and premium products, outstanding online distribution capability, highly efficient operations and a conservative capital structure. In addition, it has demonstrated solid execution in its premiumisation strategy and overseas market share expansion.
However, the ratings are affected by Xiaomi’s significant execution risk in the EV business. The company is pressing ahead with R&D investment in the EV business despite the gloomy 2022 economic outlook. Competition in China’s EV sector is extremely intense.
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