We upgrade Xiaomi to BUY (from Hold) as we are increasingly positive on its strong 5G product pipeline, share gain from Huawei, gradual recovery in India/ Europe and resilient internet service revenue. Despite significant COVID-19 impact on sales/ supply chain, Xiaomi’s 1Q20 adj. net profit grew 10% YoY to RMB2,301, 10%/20% above our/market estimates, driven by smartphone ASP hike, stronger internet revenue (ads/gaming +17%/81%) and better GPM in IoT/smartphone. We raised FY20-22E EPS by 16-24% and lifted TP to HK$16.3 with roll-over 20x FY21E P/E (from 20x FY20E P/E). We believe Xiaomi will outperform its peers and strengthen leadership with a solid roadmap in 5G era amid consolidation.
- 1Q20 better than feared; positive on smartphone/IoT margin recovery. Xiaomi posted 14% YoY revenue growth in 1Q20, driven by better-than-expected smartphone (Vol/ASP +5%/7%) and solid internet services (+39% YoY), offsetting weaker IoT (+8%) due to COVID-19 impact. GPM improved to 15.2% (vs 11.9%/13.9% in 1Q19/4Q19) with stronger smartphone/IoT GPM. By region, overseas revenue accelerated to 48% YoY (vs 41% in 4Q19) while China revenue declined 8% YoY given COVID-19 impact.
- Smartphone: China demand fully recovered; India/Europe lockdown easing. Mgmt. stated China production largely resumed and shipment has returned to pre-pandemic level. India started to lift restriction since early May and demand now reached 60% of pre-pandemic level, while smartphone activations in Europe returned to 90% of that in Jan. We expect smartphone sales to decline 5% YoY in 2Q20E but rebound rapidly with 20%/24% YoY in 3Q/4Q20E on China 5G demand and share gain from Huawei overseas.
- Internet: better advertising and online gaming. Despite weaker China ads budget in 1Q20, advertising revenue jumped 17% YoY, thanks to better monetization methods, advertiser base and recommendation algorithms. Online gaming was robust at 81% YoY growth and other internet /overseas sales jumped 72% YoY, which we believe will sustain into 2Q-4Q20E.
- Upgrade to BUY on 5G momentum and rapid share gain in 2H20E. Our new FY20-22E EPS are 7-10% above consensus as we are more positive on margins and share gain from Huawei overseas. We upgrade to BUY and rollover TP to HK$16.3 based on 20x FY21E P/E (vs prev. 20x FY20E P/E). Catalysts include 5G product launch, demand recovery and HSI inclusion.
