Xiaomi Corp 01810 (XHKG)

Morningstar Equity Analyst Report | Report as of 27 Aug 2020 04:38, UTC | Page 1 of 14

Morningstar Pillars Analyst Quantitative Important Disclosure: Economic Moat None None The conduct of Morningstar’s analysts is governed by Code of Ethics/Code of Conduct Policy, Personal Security Trading Policy (or an equivalent of), Valuation QQ Overvalued and Investment Research Policy. For information regarding conflicts of interest, please visit http://global.morningstar.com/equitydisclosures Uncertainty Very High High Financial Health — Strong Xiaomi’s Q2 Below Estimates, but Fair Value Estimate Increased to HKD Source: Morningstar Equity Research 12.50 on Likely Huawei Gains Quantitative Valuation 01810 Business Strategy and Outlook decline of 40%. The profit decline was driven by cost aCYM Dan Baker, Analyst, 27 August 2020 increases across the board with selling & marketing Undervalued Fairly Valued Overvalued Investors in Xiaomi will be hoping the company can expenses up 40%, administrative expenses up 16%, and leverage its proven ability to manufacture and market research and development costs up 26%. The impact of Current 5-Yr Avg Sector Country the pandemic in key markets such as India was a driver of Price/Quant Fair Value 1.44 — 0.77 0.78 good value-for-money smartphone hardware into a sticky Price/Earnings 41.7 — 21.4 12.9 software ecosystem that will allow the company to the lower-than-expected results but heavy promotional Forward P/E 38.6 — 15.9 11.9 increase its margins and returns. It will also try to use its expense weighed on the profit. We downgraded our 2020 Price/Cash Flow 17.6 — 15.6 10.3 "Internet of Things" products to help build this ecosystem. operating profit forecasts by 17% following this result. Price/Free Cash Flow 20.5 — 23.0 15.5 Trailing Dividend Yield% — — 1.89 3.53 The company has committed to limit its margins on Despite this, we made large upgrades to our forecasts Source: Morningstar hardware products (smartphones and Internet of Things) to 5% so it will really need this software ecosystem. from 2022 onwards as we now assume that Huawei will Bulls Say However, the company is still generating around 90% of not produce smartphones from 2022 and Xiaomi will pick OWith U.S. rules preventing Huawei sourcing its revenue from this lower-margin hardware. up an extra 4% of the global smartphone market share on semiconductors with U.S. technology used in top of its current market share of around 10%. Despite production, Xiaomi could benefit from Huawei The Chinese consumer Internet of Things market is still in smartphones being Xiaomi’s lowest-margin product we ceasing smartphone production. its early stages. Other large companies such as Alibaba, would expect the increased smartphone share to flow OIf Xiaomi can successfully cross-sell enough of its Huawei, Haier, and Baidu are also targeting this market through to higher Internet and Internet of Things and consumer Internet of Things products it may be able with large customer bases from their core businesses and lifestyle product revenue. to generate an economic moat based on switching each has its own Internet of Things ecosystem. We believe costs. it is too early to say how this market will play out--which This changed assumption, along with the CNY 4.7 billion lift in the value of Xiaomi’s investment portfolio over the OXiaomi has adapted quickly to changing market standards will win out, whether multiple standards will quarter, lifts our fair value estimate to HKD 12.50 from conditions in the smartphone market. This should put exist and how they may interwork. Regarding Internet HKD 10.00 previously. Our no-moat rating is retained as it in good position for the Internet of Things market. services, we are also concerned about the competition from existing Chinese Internet companies in areas such we believe Xiaomi is predominantly an electronics hardware supplier with limited switching costs with its Bears Say as mobile advertising, game distribution, mobile payments, and cloud services. We expect Xiaomi will Internet services business not yet well developed enough OXiaomi faces strong competition from the biggest grow strongly in these areas but not enough to justify a to assign a moat to. On our estimates, Xiaomi currently Chinese Internet companies in the high margin large premium valuation compared with that paid for a trades on a 2021 price/earnings ratio of 36 times. Internet services business. typical smartphone manufacturer. OThe fates of Nokia and BlackBerry highlight the Xiaomi’s growing Internet of Things and lifestyle services fickle nature of the mobile phone market and how Given Xiaomi almost doubled its smartphone market share business and Internet services revenue give it some technology changes can drastically change the in 2017 from 2016, it grew its revenue and earnings well differentiation from other consumer electronics peers that fortunes of companies. above market levels in 2017 and 2018. However, since usually trade at cheaper multiples but this multiple also O Xiaomi faces competition from Alibaba, Haier, and then, its global smartphone market share has since looks pretty stretched to us after the stock has run over Baidu in forming consumer Internet of Things flattened in the 9%-11% range. With Huawei potentially 100% in the past eight months. ecosystems. being forced out of the smartphone market via U.S. rules on semiconductor access, we forecast Xiaomi's global Economic Moat smartphone share to increase to around 14%. Dan Baker, Analyst, 27 August 2020 We believe Xiaomi has no economic moat as potential Analyst Note moats in areas such as switching costs, network effect, Dan Baker, Analyst, 27 August 2020 and intangible assets are not developed enough yet. Xiaomi’s second-quarter 2020 was below our expectations with revenue growth of 3.1% year on year, The only smartphone supplier to which we give an and an operating profit (ex-investment valuation gains) economic moat is Apple, which has a narrow moat based

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Xiaomi Corp 01810 (XHKG)

Close Competitors Currency (Mil) Market Cap TTM Sales Operating Margin TTM/PE consumer-facing Internet of Things is performing better in

Apple Inc AAPL USD 2,163,856 273,857 24.52 38.17 China and shows more potential. This is helped by the strong adoption of mobile payment services by Chinese Apple Inc 0R2V USD 2,163,856 273,857 24.52 38.17 customers, who can use these services to make small Apple Inc AAPL USD 2,163,856 273,857 24.52 38.31 payments sometimes required by Internet of Things Kyocera Corp KYOCY USD 21,116 14,227 5.56 22.83 endpoints. on switching costs. While Samsung Electronics also has a narrow moat, this is based solely on its semi-conductor Apart from Xiaomi, a number of other large companies are business, not its smartphone business. Inherently, we see targeting the consumer Internet of Things market in China. minimal switching costs associated with smartphones, as These include Haier, Baidu, and Alibaba. All are at the all these devices can perform most necessary early stages in their development but have large existing functions--place calls, send texts, browse the web, run businesses to leverage off and the size to target this apps, and so on. While we can see some moaty elements market. A summary of their progress and ambitions in this in Xiaomi's MI User Interface, or MIUI, for switching costs market is provided below. We believe it is too early to tell and network effect, we think these are currently too weak if Xiaomi will be successful enough in this space to develop to provide a moat. a moat based on switching costs.

Switching costs is one area where Xiaomi could Alibaba, with USD 500 billion market capitalization, is the potentially earn a moat, given we believe Apple has a world's largest online and mobile commerce company, narrow economic moat based on the cost of customers measured by GMV (CNY 4.8 trillion/USD 736 billion for switching from Apple IOS, particularly those with multiple the fiscal year ended March 2018). At the Cloud Computing Apple devices. However, while Xiaomi smartphones have Conference in March 2018, Alibaba announced it aims to pre-installed MIUI, the company allows users with other build an Internet of Things network with 10 billion Android smartphones to download MIUI. We have also connected devices over the next five years. Alibaba Cloud seen reports that Xiaomi released a phone in India with established its Internet of Things business unit in April plain Android. Besides, MIUI is only a user interface, not 2017. So far it has partnered with over 200 industry players a completely different operating system such as IOS. on its Internet of Things Connectivity Alliance to create Numerous other Android phone manufacturers have AliOS Things, an open-source operating system for developed similar adjustments to Android software Internet of Things, involving more than 14,000 developers. including Samsung with its TouchWiz, HTC with Sence, They will also develop edge computing using Alibaba and Oppo with Oxygen. However, while they change the Cloud's advantages in security, storage, cloud computing, look and feel of the software, they do not generate the and artificial intelligence. same switching costs as Apple's IOS does, in our view. Haier is the biggest home appliance original equipment By embedding MIUI in a home ecosystem, Xioami is trying manufacturer in China and also has TV, smartphones, and to increase switching costs across all of its devices. While many other businesses. It established the U-Home Xiaomi had 331 million monthly active MIUI users by platform to focus on four major areas: connected-home March 2020, Apple has over 1.3 billion active IOS devices. design, home automation, home security, and experience/entertainment. Supported by its huge The Internet of Things consumer market in China, and shipment volumes and leading position in the home globally, is in its early stages, which makes forecasting appliance market, Haier adds the connectivity module in market size and market shares more problematic than for its broad product lineup, especially in premium segments, the more mature mobile phone market. According to the to encourage consumers to experience the benefit from "White Paper on the Development of China's 5G Industry Internet of Things devices. Haier's U-Home is proprietary and Applications" published by CCID, it is estimated that to Haier products. It is expanding the coverage to include by 2025, the number of Internet of Things connections in more products and provide a customized service to China will reach 5.4 billion, with 3.9 billion of those on 5G consumers. Internet of Things. While enterprise-facing Internet of Things is grabbing the limelight in many other markets, Baidu is one of the biggest Internet companies in China

Xiaomi Corp 01810 (XHKG)

and is focused on search engine, digital map, and online phones to reduce reliance on external parties such as video businesses. After several attempts in the Internet Qualcomm and Mediatek, rather than sell them externally. of Things market, Baidu announced DuerOS as the operating system for various types of connected Looking at other sources of a potential economic moat, embedded systems. Coverage ranges from wearables to Xiaomi holds intangible assets associated with patents home automation to automotive. Baidu is trying to build for its hardware and software designs. The company a broad developer community for DuerOS by providing boasted 7,000 issued patents and had 16,000 pending different scale development kits and reference designs. patent applications. However, both the value of such Its core value is an AI engine supported in Baidu's cloud. assets and the sustainable competitive advantage DuerOS can link the Internet of Things endpoints with stemming from these assets remain cloudy. Regarding Baidu's AI service with shorter development investment. Xiaomi's potential brand equity, we look for brands that Baidu promotes DuerOS as the solution for consumer can allow premium pricing and Xiaomi's brand generally Internet of Things endpoint makers when they encounter does not allow that yet, although in late 2019 and 2020 it language barriers and localization requirements for AI is introducing higher priced smartphones and televisions. features. In the automotive market, Baidu announced the However, we think Xioami benefits from intangible assets, Apollo platform targeting the autonomous driving market. or a brand, in terms of the (mostly) positive user It announced its plan to share Baidu's experience in experiences that customers get from the firm's integrated self-driving car development and to cooperate with hardware, software and services. This brand equity may traditional automakers to develop vehicles that offer encourage customers to choose Xiaomi for their first autonomous driving. wearable device, instead of similar offerings from a host of other competitors. However, we still think tech brands Another way for Xiaomi to develop switching costs is are fleeting, as technological inferiority can supersede through its Internet services such as cloud and payment years of brand equity at any given time. As an example, services. A customer's photos may be stored on Mi Cloud, Nokia was long considered a top-10 brand, but brand they may subscribe to music on the Mi Music app and recognition failed to make up for its lack of technological they may be used to make payments via Xiaomi Wallet. innovation in the smartphone space. In other words, new However, Xiaomi will be competing against large Internet customers might give Xiaomi's products the benefit of the firms such as Tencent and Alibaba, who also offer many doubt and try it based on brand, but such an advantage of these services and also take a large portion of Xiaomi's might not be sustainable. customers usage time. Fair Value & Profit Drivers Xiaomi has developed its own System on a chip or SOC Dan Baker, Analyst, 27 August 2020 microprocessor for its smartphones. The Pinecone Surge Our fair value estimate for Xiaomi is HKD 12.50 per share. S1 SoC, released in 2017, was incorporated into the Mi This would put Xiaomi on a 2021 price/earnings ratio of 5C series smartphones. This was a mid-range SoC that 21 times. Our weighted average cost of capital is 9.8% was produced using a 28nm process. The industry expects the Pinecone Surge S2 to be released soon with better Our forecasts assume an average five-year revenue specifications and a 16nm production process. Xiaomi growth of 16%. The operating profit margin is forecast to was the fourth smartphone manufacturer in the world to increase from 4.3% in 2019 to 6.4% in 2024 as the profit develop its own SoC after Samsung, Apple and Huawei. contribution from higher-margin Internet increases. We This was likely to have followed a huge investment in forecast 14% per year smartphone revenue increase as it resources for R&D, production and infrastructure. Given gains market share due to the likelihood of U.S. rules the intellectual property involved in this exercise we forcing Huawei from the smartphone market freeing up would normally consider this a moaty activity but we do around 20% of the smartphone market for Xiaomi to not expect it to form a big enough part of the company's attack. We assume it adds around 4% to its existing 10% earnings to contribute a moat for the whole company. global market share. We forecast higher average growth While we expect Xiaomi to gradually catch up to the SoC of 15% per year in Internet of Things and lifestyle products specifications of its more experienced competitors, we revenue, given the lower base and higher expected system think it is likely to continue only using them in its own growth in this new market, although 2020 performance

Xiaomi Corp 01810 (XHKG)

will likely be more impacted by COVID-19 especially for growth, we remain cautious because of the high larger home electronics items. We forecast an average of concentration of voting power. Founder, chairman, and 27% per year revenue growth in Internet services, which CEO Lei Jun has nearly 55% voting power, despite holding should also benefit from increased smartphone market about 29% of the listed share capital, as he holds more share. We also add the book value of Xiaomi’s Class A shares (which exercise 10 votes) than Class B investments. shares (which exercise one vote). In addition, cofounder and president Lin Bin will own class A shares representing Risk & Uncertainty about 29% of the voting rights in the company. Lei Jun Dan Baker, Analyst, 27 August 2020 and Lin Bin will therefore have control over the We have a very high uncertainty rating on Xiaomi. We management and affairs of the company, and they may believe the biggest risk for Xiaomi is a potential loss of take actions that are not in the interests of minority market share in its smartphone business, which is the glue shareholders, such as blocking a potential value-enhancing behind its Internet of Things ecosystem ambitions. Nokia takeover. Additionally, in April 2018, Xiaomi issued 640 and Ericsson used to rule the mobile phone space, and million shares valued at CNY 9.8 billion (equating to about many workplaces provided their employees with USD 1.5 billion) to Smart Mobile Holdings, a company BlackBerry phones. Even looking at Xiaomi's own short controlled by CEO Lei Jun. There were no performance history we see its smartphone revenue actually declined hurdles associated with this share issue and no public 9% in 2016. In 2014 Samsung's global market share also release of the reasoning for such a generous issue, except fell from the low 30s to low 20s in about nine months to reward the CEO for services rendered to the company. (partly because of firms such as Xiaomi). The mobile phone The valuation of each of the shares implied in the industry can change quite unpredictably, especially when accounting for this transaction is about CNY 15.40. The there’s a step change in technology. seven-person board includes three independent directors, all of whom have joined the board since April 2018, but Another risk for Xiaomi is how the Internet of Things Lei Jun's control of the company makes the board structure market and standards develop. Alibaba, Haier, Huawei less relevant. and Baidu have their own standard interfaces for their devices as each strives to develop the coveted position of ecosystem monopoly or quasi-monopoly. As yet, we believe it is too early to tell if Xiaomi can achieve the critical mass level of penetration required to claim such status.

Stewardship Dan Baker, Analyst, 03 May 2020 We believe Xiaomi has Standard stewardship. The board and management expanded the company strongly and have taken key strategic decisions, including: 1) developing the company's own interface software, MIUI, which could potentially provide some switching costs for customers; 2) expanding the sales focus offshore to countries such as India, as the Chinese smartphone market has become competitive; and 3) expanding into household consumer items using MIUI, which could further strengthen switching costs. This has enabled the company to expand and generate CNY 206 billion in sales and CNY 9 billion in operating profit within 10 years of inception.

Although management's decisions have generated high

Xiaomi Corp 01810 (XHKG)

(ex-investment valuation gains) growth of 105%. The Analyst Notes Archive operating profit growth was mainly due to a particularly unprofitable first quarter in 2019, given the launch of many Xiaomi’s Revenue Growth Accelerates in Fourth new phones that quarter. Xiaomi’s online focused Quarter Along With R&D and Promotion Costs distribution model has allowed it to take market share Dan Baker, Analyst, 01 April 2020 across its business lines during the offline retail Xiaomi’s fourth quarter 2019 was ahead of our disruptions of COVID-19. This was particularly evident in expectations on revenue but below on operating profit the smartphone business, with Xiaomi increasing global with revenue growth of 27%, and operating profit shipments by 4.7% compared with an 11.7% decline in (ex-investment valuation gains) of CNY 879 million down the global market. Gross profit was up 45%, with gross 23% on the previous corresponding period. Gross profit profit margin increasing to 15.2% from 11.9% in the first was up 39% with gross profit margin increasing to 13.9% quarter 2019. Management indicated that the smartphone from 12.9% in the fourth quarter 2018. The reduced business in China had rebounded quickly in March from operating profit was mainly attributed to a 59% increase the coronavirus lows in February, and was now back to in selling and marketing expenses, a 27% increase in normal. However, with 50% of its revenue generated research and development expenses and a 52% increase outside of China, much of it in markets with severe in administrative expenses. Selling and marketing pandemic living restrictions, the outlook for the second expense was increased to boost brand awareness in quarter is less certain. April was particularly bad in its key overseas markets ahead of the launch of premium 5G Indian and European markets, but management indicated smartphones in early 2020. Adverse foreign exchange that smartphone activations were now back to 90% of movements also contributed to a swing in other gains and pre-COVID-19 levels in Europe and 60% in India. losses. Management indicated that that the smartphone business in China had rebounded quickly in March from We made minor upgrades to our forecasts in 2020, lifting the virus lows in February to around 90% of that recorded our fair value to HKD 10.00 from HKD 9.80 previously. Our in January (pre-virus). However, with 44% of its revenue no-moat rating is also retained as we believe Xiaomi is generated outside of China, much of it in markets with predominantly an electronics hardware supplier with severe virus-related living restrictions, the outlook for the limited switching costs, with its Internet services business second quarter is uncertain. not yet well enough developed to assign a moat to. On our estimates Xiaomi trades on a 2020 price/earnings ratio of We rolled out model forward, lowering our revenue and 27 times. profit forecasts for 2020 but making only minor adjustments to profit forecasts further out with our fair Xiaomi’s Share Price Rise Looks Overdone in Our value retained at HKD 9.80 per share. Our no-moat rating View is also retained as we believe Xiaomi is predominantly an Dan Baker, Analyst, 14 July 2020 electronics hardware supplier with limited switching No-moat Xiaomi’s stock price has nearly doubled since its costs with its Internet services business not yet well lows in mid-November 2019 and now trades at around a enough developed to assign a moat to. On our estimates 60% premium to our fair value estimate of HKD 10. Given Xiaomi trades on a 2020 price/earnings ratio of 22 times. our very high uncertainty rating, the stock is currently rated Xiaomi’s growing IoT & Lifestyle services business and at 2-stars and we would advise investors to look Internet services revenue give it some differentiation from elsewhere for technology investments. Potential positive other consumer electronics peers that usually trade at impacts from Huawei’s struggles against U.S. sanctions cheaper multiples. and positive market sentiment toward 5G may be partly behind the share price rally. Xiaomi’s online focused Xiaomi Reports Solid First Quarter Despite the distribution model has likely also allowed it to take market Coronavirus; FVE Increased to HKD 10 share across its business lines during the offline retail Dan Baker, Analyst, 20 May 2020 disruptions of COVID-19, so it may be seen as a beneficiary Xiaomi’s first quarter 2020 was ahead of our expectations of the difficulties that many countries have had in returning on revenue but broadly in line on operating profit with to “normal” life without triggering further coronavirus revenue growth of 13.6%, and operating profit outbreaks. The stock also benefited from rule changes

Xiaomi Corp 01810 (XHKG)

made to allow dual class share companies such as Xiaomi business and Internet services revenue give it some to be included in the Hang Seng indexes. At current prices differentiation from other consumer electronics peers that Xiaomi trades at a 2021 price/earnings ratio of 29 times usually trade at cheaper multiples but this multiple also compared with other electronics manufacturers in the low looks pretty stretched to us after the stock has run over teens. Apple, which trades at 26 times, is also trading at 100% in the past eight months. around a 60% premium to our fair value estimate. We believe Xiaomi’s valuation is too high, particularly for a company that we rate no moat, given the difficulties in differentiating its primary smartphone product, which uses the same Android operating system as most of its competitors.

Xiaomi’s Q2 Below Estimates, but Fair Value Estimate Increased to HKD 12.50 on Likely Huawei Gains Dan Baker, Analyst, 27 August 2020 Xiaomi’s second-quarter 2020 was below our expectations with revenue growth of 3.1% year on year, and an operating profit (ex-investment valuation gains) decline of 40%. The profit decline was driven by cost increases across the board with selling & marketing expenses up 40%, administrative expenses up 16%, and research and development costs up 26%. The impact of the pandemic in key markets such as India was a driver of the lower-than-expected results but heavy promotional expense weighed on the profit. We downgraded our 2020 operating profit forecasts by 17% following this result.

Despite this, we made large upgrades to our forecasts from 2022 onwards as we now assume that Huawei will not produce smartphones from 2022 and Xiaomi will pick up an extra 4% of the global smartphone market share on top of its current market share of around 10%. Despite smartphones being Xiaomi’s lowest-margin product we would expect the increased smartphone share to flow through to higher Internet and Internet of Things and lifestyle product revenue.

This changed assumption, along with the CNY 4.7 billion lift in the value of Xiaomi’s investment portfolio over the quarter, lifts our fair value estimate to HKD 12.50 from HKD 10.00 previously. Our no-moat rating is retained as we believe Xiaomi is predominantly an electronics hardware supplier with limited switching costs with its Internet services business not yet well developed enough to assign a moat to. On our estimates, Xiaomi currently trades on a 2021 price/earnings ratio of 36 times.

Xiaomi’s growing Internet of Things and lifestyle services

Last Close Fair ValueQ Market Cap Sector Industry Country of Domicile 27 Aug 2020 27 Aug 2020 02:00 UTC 27 Aug 2020 21.35 13.34 461.3 Bil a Technology Consumer Electronics CYM Cayman Islands

There is no one analyst in which a Quantitative Fair Value Estimate and Quantitative Star Rating are attributed to; however, Mr. Lee Davidson, Head of Quantitative Price vs. Quantitative Fair Value Research for Morningstar, Inc., is responsible for overseeing the methodology that 2016 2017 2018 2019 2020 2021 Quantitative Fair Value Estimate supports the quantitative fair value. As an employee of Morningstar, Inc., Mr. Total Return Davidson is guided by Morningstar, Inc.’s Code of Ethics and Personal Securities Sales/Share Trading Policy in carrying out his responsibilities. For information regarding Conflicts 30 of Interests, visit http://global.morningstar.com/equitydisclosures Forecast Range Forcasted Price 24 Dividend Company Profile Split Xiaomi is a technology product and services company founded 18 Momentum: — in early 2010, focusing mainly on smartphones and Internet of Standard Deviation: — Things products and related Internet services. An early Liquidity: High 12 adopter of online smartphone sales, Xiaomi used Android as its operating system but has its own customized user interface 8.28 52-Wk 21.75 called MIUI. As competition in its home Chinese smartphone 6 market intensified and growth has slowed, it has expanded into other markets and has become the smartphone market — — — -16.6 98.1 Total Return % leader in India. In 2019, from a country perspective, 56% of its — — — -39.1 100.2 +/– Market (Morningstar World Index) Quantitative Scores Scores — — — — — Trailing Dividend Yield % All Rel Sector Rel Country — — — — — Forward Dividend Yield % Quantitative Moat None 8 6 12 — — -4.1 29.9 41.7 Price/Earnings Valuation Overvalued 1 1 1 — — 0.8 1.2 2.0 Price/Revenue Quantitative Uncertainty High 87 80 86 Morningstar RatingQ Financial Health Strong 95 79 80 QQQQQ QQQQ QQQ 01810 QQ CYMa Q 2015 2016 2017 2018 2019 TTM Financials (Fiscal Year in Mil) Undervalued Fairly Valued Overvalued 66,811 68,434 114,625 174,915 205,839 205,839 Revenue Source: Morningstar Equity Research — 2.4 67.5 52.6 17.7 0.0 % Change -1,365 1,535 5,680 -3,320 7,885 7,885 Operating Income — — 270.0 -158.4 — 0.0 % Change Valuation Sector Country Current 5-Yr Avg Median Median -7,581 553 -43,826 13,554 10,044 10,044 Net Income Price/Quant Fair Value 1.44 — 0.77 0.78 -2,601 4,531 -996 -1,415 23,810 23,810 Operating Cash Flow Price/Earnings 41.7 — 21.4 12.9 -2,524 -1,826 -1,218 -3,785 -3,405 -3,405 Capital Spending Forward P/E 38.6 — 15.9 11.9 -5,126 2,705 -2,213 -5,200 20,405 20,405 Free Cash Flow Price/Cash Flow 17.6 — 15.6 10.3 -7.7 4.0 -1.9 -3.0 9.9 9.9 % Sales Price/Free Cash Flow 20.5 — 23.0 15.5 -0.34 0.02 -1.96 0.04 0.41 0.41 EPS Trailing Dividend Yield % — — 1.89 3.53 — — -8,023.2 — 831.8 0.0 % Change Price/Book 5.1 — 2.3 1.3 — — — 0.15 -0.04 0.92 Free Cash Flow/Share Price/Sales 2.0 — 1.7 1.3 — — — — — — Dividends/Share — — — -5.32 3.56 3.73 Book Value/Share Profitability Sector Country — — — 23,626 23,977 24,075 Shares Outstanding (Mil) Current 5-Yr Avg Median Median Return on Equity % 13.2 — 12.5 12.6 Profitability — — — — 13.2 13.2 Return on Equity % Return on Assets % 6.1 -12.6 6.4 5.6 -19.4 1.2 -62.3 11.5 6.1 6.1 Return on Assets % Revenue/Employee (Mil) 11.3 — 0.4 1.0 -11.4 0.8 -38.2 7.8 4.9 4.9 Net Margin % 1.71 1.52 1.63 1.49 1.25 1.25 Asset Turnover Financial Health Sector Country Current 5-Yr Avg Median Median — — — 2.0 2.3 2.1 Financial Leverage Distance to Default 0.8 — 0.6 0.6 4.0 10.6 13.2 12.7 13.9 13.9 Gross Margin % Solvency Score 366.5 — 449.9 498.4 -2.0 2.2 5.0 -1.9 3.8 3.8 Operating Margin % Assets/Equity 2.3 0.5 1.6 1.7 3,247 390 7,251 7,856 4,787 7,100 Long-Term Debt Long-Term Debt/Equity 0.1 0.0 0.1 0.2 -86,714 -92,192 -127,272 71,323 81,331 76,692 Total Equity 23.1 18.9 24.2 25.7 21.3 21.3 Fixed Asset Turns Growth Per Share Annual Revenue & EPS Revenue Growth Year On Year % 1-Year 3-Year 5-Year 10-Year Revenue (Bil) Mar Jun Sep Dec Total Revenue % 17.7 44.4 — — 2019 — 52.0 — — 205.8 67.5 Operating Income % — 72.6 — — 2018 34.4 45.2 — — 174.9 52.6 Earnings % 831.8 155.0 — — 2017 18.5 26.9 — — 114.6 Dividends % — — — — 2016 — — — — 68.4 Book Value % 12.4 — — — Earnings Per Share () 17.7 Stock Total Return % 142.9 — — — 2019 — 0.08 — — 0.41 2018 -0.31 -0.76 — — 0.04 2.4 2017 -0.35 -0.53 — — -1.96 2011 2012 2013 2014 2015 2016 2017 2018 2019 2016 — — — — 0.02

Research Methodology for Valuing Companies

Qualitative Equity Research Overview intangible assets, switching costs, network effect, cost Our model is divided into three distinct stages: At the heart of our valuation system is a detailed projection advantage, and efficient scale. of a company's future cash flows, resulting from our Stage I: Explicit Forecast analysts' research. Analysts create custom industry and Companies with a narrow moat are those we believe In this stage, which can last five to 10 years, analysts company assumptions to feed income statement, balance are more likely than not to achieve normalized excess make full financial statement forecasts, including items sheet, and capital investment assumptions into our globally returns for at least the next 10 years. Wide-moat such as revenue, profit margins, tax rates, changes in standardized, proprietary discounted cash flow, or DCF, companies are those in which we have very high working-capital accounts, and capital spending. Based modeling templates. We use scenario analysis, in-depth confidence that excess returns will remain for 10 years, on these projections, we calculate earnings before competitive advantage analysis, and a variety of other with excess returns more likely than not to remain for at interest, after taxes, or EBI, and the net new analytical tools to augment this process. We believe this least 20 years. The longer a firm generates economic investment, or NNI, to derive our annual free cash flow bottom-up, long-term, fundamentally based approach profits, the higher its intrinsic value. We believe low- forecast. allows our analysts to focus on long-term business drivers, quality no-moat companies will see their normalized which have the greatest valuation impact, rather than short- returns gravitate toward the firm's cost of capital more Stage II: Fade term market noise. quickly than companies with moats. The second stage of our model is the period it will take the company's return on new invested capital—the Morningstar's equity research group (“we," "our") believes To assess the direction of the underlying competitive return on capital of the next dollar invested ("RONIC")— that a company's intrinsic worth results from the future advantages, analysts perform ongoing assessments of to decline (or rise) to its cost of capital. During the Stage cash flows it can generate. The Morningstar Rating for the moat trend. A firm's moat trend is positive in cases II period, we use a formula to approximate cash flows in stocks identifies stocks trading at an uncertainty-adjusted where we think its sources of competitive advantage lieu of explicitly modeling the income statement, discount or premium to their intrinsic worth—or fair value are growing stronger; stable where we don't anticipate balance sheet, and cash flow statement as we do in estimate, in Morningstar terminology. Five-star stocks sell changes to competitive advantages over the next Stage I. The length of the second stage depends on the for the biggest risk-adjusted discount to their fair values several years; or negative when we see signs of strength of the company's economic moat. We forecast whereas 1-star stocks trade at premiums to their intrinsic deterioration. this period to last anywhere from one year (for worth. companies with no economic moat) to 10–15 years or All the moat and moat trend ratings undergo periodic more (for wide-moat companies). During this period, Four key components drive the Morningstar rating: (1) our review and any changes must be approved by the cash flows are forecast using four assumptions: an assessment of the firm's economic moat, (2) our estimate of Morningstar Economic Moat Committee, comprised of average growth rate for EBI over the period, a the stock's fair value, (3) our uncertainty around that fair senior members of Morningstar's equity research normalized investment rate, average return on new value estimate and (4) the current market price. This department. invested capital, or RONIC, and the number of years process ultimately culminates in our single-point star rating. until perpetuity, when excess returns cease. The 2. Estimated Fair Value investment rate and return on new invested capital 1. Economic Moat Combining our analysts' financial forecasts with the decline until the perpetuity stage is reached. In the case The concept of an economic moat plays a vital role not firm's economic moat helps us assess how long returns of firms that do not earn their cost of capital, we only in our qualitative assessment of a firm's long-term on invested capital are likely to exceed the firm's cost of assume marginal ROICs rise to the firm's cost of capital investment potential, but also in the actual calculation capital. Returns of firms with a wide economic moat (usually attributable to less reinvestment), and we may of our fair value estimates. An economic moat is a rating are assumed to fade to the perpetuity period over truncate the second stage. structural feature that allows a firm to sustain excess a longer period of time than the returns of narrow-moat profits over a long period of time. We define excess firms, and both will fade slower than no-moat firms, Stage III: Perpetuity economic profits as returns on invested capital (or ROIC) increasing our estimate of their intrinsic value. Once a company's marginal ROIC hits its cost of capital, over and above our estimate of a firm's cost of capital, we calculate a continuing value, using a standard or weighted average cost of capital (or WACC). Without perpetuity formula. At perpetuity, we assume that any a moat, profits are more susceptible to competition. We growth or decline or investment in the business neither have identified five sources of economic moats: creates nor destroys value and that any new investment provides a return in line with estimated WACC.

Morningstar Research Methodology for Valuing Companies Because a dollar earned today is worth more than a dollar earned tomorrow, we discount our projections of cash flows in stages I, II, and III to arrive at a total present value of expected future cash flows. Because we are modeling free cash flow to the firm—representing cash available to provide a return to all capital providers—we discount future cash flows using the WACC, which is a weighted average of the costs of equity, debt, and preferred stock (and any other funding sources), using expected future proportionate long-term market-value weights.

Research Methodology for Valuing Companies

3. Uncertainty Around That Fair Value Estimate Morningstar Equity Research Star Rating Methodology Morningstar's Uncertainty Rating captures a range of likely potential intrinsic values for a company and uses it to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating represents the analysts' ability to bound the estimated value of the shares in a company around the fair value estimate, based on the characteristics of the business underlying the stock, including operating and financial leverage, sales sensitivity to the overall economy, product concentration, pricing power, and other company-specific factors.

Analysts consider at least two scenarios in addition to their base case: a bull case and a bear case. Assumptions are chosen such that the analyst believes there is a 25% probability that the company will perform better than the bull case, and a 25% probability that the company will perform worse than the bear case. The distance between the bull and bear cases is an important indicator of the uncertainty underlying the fair value estimate.

Our recommended margin of safety widens as our uncertainty of the estimated value of the equity increases. The more uncertain we are about the estimated value of the equity, the greater the discount we require relative to our estimate of the value of the firm before we would recommend the purchase of the Morningstar Star Rating for Stocks The Morningstar Star Ratings for stocks are defined below: shares. In addition, the uncertainty rating provides Once we determine the fair value estimate of a stock, we guidance in portfolio construction based on risk compare it with the stock's current market price on a daily QQQQQ We believe appreciation beyond a fair risk- tolerance. basis, and the star rating is automatically re-calculated at adjusted return is highly likely over a multiyear time frame. the market close on every day the market on which the The current market price represents an excessively Our uncertainty ratings for our qualitative analysis are stock is listed is open. pessimistic outlook, limiting downside risk and maximizing low, medium, high, very high, and extreme. Please note, there is no predefined distribution of stars. upside potential. That is, the percentage of stocks that earn 5 stars can × Low–margin of safety for 5-star rating is a 20% discount fluctuate daily, so the star ratings, in the aggregate, can QQQQ We believe appreciation beyond a fair risk- and for 1-star rating is 25% premium. serve as a gauge of the broader market's valuation. When adjusted return is likely. × Medium–margin of safety for 5-star rating is a 30% there are many 5-star stocks, the stock market as a whole is discount and for 1-star rating is 35% premium. more undervalued, in our opinion, than when very few QQQ Indicates our belief that investors are likely to × High–margin of safety for 5-star rating is a 40% discount companies garner our highest rating. receive a fair risk-adjusted return (approximately cost of and for 1-star rating is 55% premium. equity). × Very High–margin of safety for 5-star rating is a 50% We expect that if our base-case assumptions are true the discount and for 1-star rating is 75% premium. market price will converge on our fair value estimate over QQ We believe investors are likely to receive a less than × Extreme–margin of safety for 5-star rating is a 75% time, generally within three years (although it is impossible fair risk-adjusted return. discount and for 1-star rating is 300% premium. to predict the exact time frame in which market prices may adjust). Q Indicates a high probability of undesirable risk-adjusted 4. Market Price returns from the current market price over a multiyear time The market prices used in this analysis and noted in the Our star ratings are guideposts to a broad audience and frame, based on our analysis. The market is pricing in an report come from exchange on which the stock is listed, individuals must consider their own specific investment excessively optimistic outlook, limiting upside potential and which we believe is a reliable source. goals, risk tolerance, tax situation, time horizon, income leaving the investor exposed to Capital loss. needs, and complete investment portfolio, among other For more details about our methodology, please go to factors. https://shareholders.morningstar.com.

Research Methodology for Valuing Companies

Other Definitions quantitative report and the quantitative ratings, there is no Value Estimate, current market price, and the Quantitative one analyst in which a given report is attributed to; Uncertainty Rating. The rating is expressed as 1-Star, 2-Star, Last Price: Price of the stock as of the close of the market however, Mr. Lee Davidson, Head of Quantitative Research 3-Star, 4-Star, and 5-Star. of the last trading day before date of the report. for Morningstar, Inc., is responsible for overseeing the methodology that supports the quantitative equity ratings Q: the stock is overvalued with a reasonable margin of Stewardship Rating: Represents our assessment of used in this report. As an employee of Morningstar, Inc., safety. management's stewardship of shareholder capital, with Mr. Davidson is guided by Morningstar, Inc.'s Code of Ethics Log (Quant FVE/Price)<–1*Quantitative Uncertainty particular emphasis on capital allocation decisions. Analysts and Personal Securities Trading Policy in carrying out his consider companies' investment strategy and valuation, responsibilities. QQ: the stock is somewhat overvalued. financial leverage, dividend and share buyback policies, Log (Quant FVE/Price) between (–1*Quantitative execution, compensation, related party transactions, and Quantitative Equity Ratings Uncertainty, –0.5*Quantitative Uncertainty) accounting practices. Corporate governance practices are Morningstar's quantitative equity ratings consist of: only considered if they've had a demonstrated impact on (i) Quantitative Fair Value Estimate QQQ: the stock is approximately fairly valued. shareholder value. Analysts assign one of three ratings: (ii) Quantitative Star Rating Log (Quant FVE/Price) between (–0.5*Quantitative "Exemplary," "Standard," and "Poor." Analysts judge (iii) Quantitative Uncertainty Uncertainty, 0.5*Quantitative Uncertainty) stewardship from an equity holder's perspective. Ratings (iv) Quantitative Economic Moat are determined on an absolute basis. Most companies will (v) Quantitative Financial Health QQQQ: the stock is somewhat undervalued. receive a Standard rating, and this is the default rating in (collectively the "Quantitative Ratings"). Log (Quant FVE/Price) between (0.5*Quantitative the absence of evidence that managers have made Uncertainty, 1*Quantitative Uncertainty) exceptionally strong or poor capital allocation decisions. The Quantitative Ratings are calculated daily and derived from the analyst-driven ratings of a company's peers as QQQQQ: the stock is undervalued with a reasonable Quantitative Valuation: Using the below terms, intended to determined by statistical algorithms. Morningstar, Inc. margin of safety. Log (Quant FVE/Price) >1*Quantitative denote the relationship between the security's Last Price ("“Morningstar," "we," "our") calculates Quantitative Uncertainty and Morningstar's quantitative fair value estimate for that Ratings for companies whether it already provides analyst security. ratings and qualitative coverage. In some cases, the Quantitative Uncertainty: Intended to represent Quantitative Ratings may differ from the analyst ratings Morningstar's level of uncertainty about the accuracy of the × Undervalued: Last Price is below Morningstar's because a company's analyst-driven ratings can quantitative fair value estimate. Generally, the lower the quantitative fair value estimate. significantly differ from other companies in its peer group. quantitative Uncertainty, the narrower the potential range × Fairly Valued: Last Price is in line with Morningstar's of outcomes for that particular company. The rating is quantitative fair value estimate. Quantitative Fair Value Estimate: Intended to represent expressed as Low, Medium, High, Very High, and Extreme. × Overvalued: Last Price is above Morningstar's Morningstar's estimate of the per share dollar amount that quantitative fair value estimate. a company's equity is worth today. Morningstar calculates × Low: the interquartile range for possible fair values is less the quantitative fair value estimate using a statistical model than 10%. Risk Warning derived from the fair value estimate Morningstar's equity × Medium: the interquartile range for possible fair values is Please note that investments in securities are subject to analysts assign to companies. Please go to less than 15% but greater than 10%. market and other risks and there is no assurance or https://shareholders.morningstar.com for information about × High: the interquartile range for possible fair values is guarantee that the intended investment objectives will be fair value estimates Morningstar's equity analysts assign to less than 35% but greater than 15%. achieved. Past performance of a security may or may not be companies. × Very High: the interquartile range for possible fair values sustained in future and is no indication of future is less than 80% but greater than 35%. performance. A security investment return and an investor's Quantitative Economic Moat: Intended to describe the × Extreme: the interquartile range for possible fair values is principal value will fluctuate so that, when redeemed, an strength of a firm's competitive position. It is calculated greater than 80%. investor's shares may be worth more or less than their using an algorithm designed to predict the Economic Moat original cost. A security's current investment performance rating a Morningstar analyst would assign to the stock. The Quantitative Financial Health: Intended to reflect the may be lower or higher than the investment performance rating is expressed as Narrow, Wide, or None. probability that a firm will face financial distress in the near noted within the report. Morningstar's Uncertainty Rating future. The calculation uses a predictive model designed to serves as a useful data point with respect to sensitivity × Narrow: assigned when the probability of a stock anticipate when a company may default on its financial analysis of the assumptions used in our determining a fair receiving a "Wide Moat" rating by an analyst is greater obligations. The rating is expressed as Weak, Moderate, value price. than 70% but less than 99%. and Strong. × Wide: assigned when the probability of a stock receiving Quantitative Equity Reports Overview a "Wide Moat" rating by an analyst is greater than 99%. × Weak: assigned when Quantitative Financial Health <0.2 The quantitative report on equities consists of data, × None: assigned when the probability of an analyst × Moderate: assigned when Quantitative Financial Health statistics and quantitative equity ratings on equity receiving a "Wide Moat" rating by an analyst is less than is between 0.2 and 0.7 securities. Morningstar, Inc.'s quantitative equity ratings are 70%. × Strong: assigned when Quantitative Financial Health >0.7 forward looking and are generated by a statistical model that is based on Morningstar Inc.'s analyst-driven equity Quantitative Star Rating: Intended to be the summary ratings and quantitative statistics. Given the nature of the rating based on the combination of our Quantitative Fair

Research Methodology for Valuing Companies

Other Definitions

Last Close: Price of the stock as of the close of the market of the last trading day before date of the report.

Quantitative Valuation: Using the below terms, intended to denote the relationship between the security's Last Price and Morningstar's quantitative fair value estimate for that security.

× Undervalued: Last Price is below Morningstar's quantitative fair value estimate. × Fairly Valued: Last Price is in line with Morningstar's quantitative fair value estimate. × Overvalued: Last Price is above Morningstar's quantitative fair value estimate.

This Report has not been made available to the issuer of the security prior to publication.

Risk Warning Please note that investments in securities are subject to market and other risks and there is no assurance or guarantee that the intended investment objectives will be achieved. Past performance of a security may or may not be sustained in future and is no indication of future performance. A security investment return and an investor's principal value will fluctuate so that, when redeemed, an investor's shares may be worth more or less than their original cost. A security's current investment performance may be lower or higher than the investment performance noted within the report.

The quantitative equity ratings are not statements of fact. Morningstar does not guarantee the completeness or accuracy of the assumptions or models used in determining the quantitative equity ratings. In addition, there is the risk that the price target will not be met due to such things as unforeseen changes in demand for the company's products, changes in management, technology, economic development, interest rate development, operating and/or material costs, competitive pressure, supervisory law, exchange rate, and tax rate. For investments in foreign markets there are further risks, generally based on exchange rate changes or changes in political and social conditions.

A change in the fundamental factors underlying the quantitative equity ratings can mean that the valuation is subsequently no longer accurate.

For more information about Morningstar's quantitative methodology, please visit http://global.morningstar.com/equitydisclosures.

Xiaomi Corp 01810 (XHKG)

General Disclosure The analysis within this report is prepared by the person (s) noted in their capacity as an analyst for Morningstar’s equity research group. The equity research group consists of various Morningstar, Inc. subsidiaries (“Equity Research Group)”. In the United States, that subsidiary is Morningstar Research Services LLC, which is registered with and governed by the U.S. Securities and Exchange Commission.

The opinions expressed within the report are given in good faith, are as of the date of the report and are subject to change without notice. Neither the analyst nor Equity Research Group commits themselves in advance to whether and in which intervals updates to the report are expected to be made. The written analysis and Morningstar Star Rating for stocks are statements the Report and are subject to change. While financial situation or particular needs of any specific of opinions; they are not statements of fact. Morningstar has obtained data, statistics and recipient. This publication is intended to provide information from sources it believes to be reliable, information to assist institutional investors in making The Equity Research Group believes its analysts make Morningstar does not perform an audit or seeks their own investment decisions, not to provide a reasonable effort to carefully research information independent verification of any of the data, statistics, investment advice to any specific investor. Therefore, contained in the analysis. The information on which the and information it receives. investments discussed and recommendations made analysis is based has been obtained from sources herein may not be suitable for all investors: recipients believed to be reliable such as, for example, the The quantitative equity ratings are not a market call, must exercise their own independent judgment as to company’s financial statements filed with a regulator, and do not replace the User or User’s clients from the suitability of such investments and recommendations company website, Bloomberg and any other the conducting their own due-diligence on the security. The in the light of their own investment objectives, relevant press sources. Only the information obtained quantitative equity rating is not a suitability experience, taxation status and financial position. from such sources is made available to the issuer who assessment; such assessments take into account may is the subject of the analysis, which is necessary to factors including a person’s investment objective, The information, data, analyses and opinions presented properly reconcile with the facts. Should this sharing of personal and financial situation, and risk tolerance all herein are not warranted to be accurate, correct, information result in considerable changes, a statement of which are factors the quantitative equity rating complete or timely. Unless otherwise provided in a of that fact will be noted within the report. While the statistical model does not and did not consider. separate agreement, neither Morningstar, Inc. or the Equity Research Group has obtained data, statistics and Equity Research Group represents that the report information from sources it believes to be reliable, Prices noted with the Report are the closing prices on contents meet all of the presentation and/or disclosure neither the Equity Research Group nor Morningstar, Inc. the last stock-market trading day before the publication standards applicable in the jurisdiction the recipient is performs an audit or seeks independent verification of date stated, unless another point in time is explicitly located. any of the data, statistics, and information it receives. stated. Except as otherwise required by law or provided for in General Quantitative Disclosure General Disclosure (applicable to both Quantitative a separate agreement, the analyst, Morningstar, Inc. The Quantitative Equity Report (“Report”) is derived and Qualitative Research) and the Equity Research Group and their officers, from data, statistics and information within Unless otherwise provided in a separate agreement, directors and employees shall not be responsible or Morningstar, Inc.’s database as of the date of the Report recipients accessing this report may only use it in the liable for any trading decisions, damages or other and is subject to change without notice. The Report is country in which the Morningstar distributor is based. losses resulting from, or related to, the information, for informational purposes only, intended for financial Unless stated otherwise, the original distributor of the data, analyses or opinions within the report. The Equity professionals and/or sophisticated investors (“Users”) report is Morningstar Research Services LLC, a U.S.A. Research Group encourages recipients of this report to and should not be the sole piece of information used by domiciled financial institution. read all relevant issue documents (e.g., prospectus) such Users or their clients in making an investment pertaining to the security concerned, including without decision. The quantitative equity ratings noted the This report is for informational purposes only and has limitation, information relevant to its investment Report are provided in good faith, are as of the date of no regard to the specific investment objectives, objectives, risks, and costs before making an

Xiaomi Corp 01810 (XHKG)

Morningstar Rating Last Price Fair Value Estimate Price/Fair Value Trailing Dividend Yield % Forward Dividend Yield % Market Cap (Bil) Industry Stewardship QQ 21.35 HKD 12.50 HKD 1.71 — 0.00 514.01 Consumer Electronics Standard 27 Aug 2020 27 Aug 2020 27 Aug 2020 27 Aug 2020 27 Aug 2020 27 Aug 2020 16:22, UTC 06:04, UTC investment decision and when deemed necessary, to currently covers and provides written analysis on seek the advice of a legal, tax, and/or accounting • Neither Morningstar, Inc. or the Equity Research please contact your local Morningstar office. In professional. 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Xiaomi Corp 01810 (XHKG)

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