Underlying perception: Understand the core barriers of Xiaomi's front-end channel brand+back-end scale advantage from the perspective of product distribution. The pricing of any product consists of five parts: production costs, R&D costs, marketing and advertising costs, sales and channel costs, and profit. We have summarized marketing and advertising costs, sales and channel costs into circulation costs, and further divided into transaction matching information costs and subsequent execution costs. The “Xiaomi model” uses a cost-effective model to reduce the middle link in the commercial distribution field as much as possible, reduce distribution costs through explosives and internet marketing. At the same time, through years of cost-effective mobile phones and IoT hardware products, we have gradually accumulated user trust and reputation.” The “buy with closed eyes” channel brand, loyal users who have further accumulated brands, increased their voice in the industrial chain and further reduced production costs through economies of scale from the supply chain side. The success of the Xiaomi SU7 is a reflection of the results of this model.

Mobile phone business: Emerging markets have performed well, and SU7 is expected to push high-end mobile phones to break the game. Xiaomi phones have been in the top three in the global market. In particular, they have achieved significant growth in emerging markets, with a global market share of 14.6% in 24Q2. The company carried out omni-channel construction through a new retail strategy, gradually increased its offline market share, and saw initial results on the path of high-end development. There is no gap between Xiaomi's high-end models on the configuration side, and their share and market share have also increased, but there is still plenty of room for improvement on the ASP side. We believe that the Xiaomi SU7 has successfully grasped the minds of users and is expected to become an important driving force for high-end Xiaomi phones to break the game.

IoT and consumer goods: Ecological chain investment expands product categories. Short-term hardware revenue growth is highly deterministic, and the long-term focus is service empowerment. The company lays out the Internet of Things (IoT) using self-developed core intelligent hardware as an entry point to rapidly expand product categories through investment+incubation ecosystem enterprises. Ecological chain investment has covered the three major sectors of mobile phones, smart hardware, and household consumables. The rich product categories have driven IoT business revenue to 32% CAGR in 16-23, and the number of devices connected to the 24Q2 platform reached 0.82 billion units (YoY +25.6%); based on the number of connected devices up to 23M11, Xiaomi has become the world's largest consumer-grade IoT platform. We believe that the development path of the Consumer Internet of Things is “expanding connectivity - platform construction - traffic monetization”. At this stage of transition from stand-alone intelligence to connected intelligence, application-layer enterprises with hardware development and production capabilities and platform-layer enterprises with a large number of connected devices are expected to be the first to benefit. Xiaomi's short-term revenue growth contributed by hardware expansion is highly certain, and whether it can penetrate software charges after interconnection in the long term is a key inflection point.

Internet business: 11% revenue contributes 39% of gross profit, and high-end mobile phones are expected to drive a continuous increase in ARPU value.

After attracting users through cost-effective hardware products, Xiaomi commercializes it through the Internet and other businesses. We believe that the revenue space and valuation of Xiaomi's Internet business depends on the services that Xiaomi can provide to users and the value it generates. By dividing Internet platforms into two types of supply and contract fulfillment online and offline, and further segmenting users' different needs for information, content, products, services, etc., we believe that the distribution of information and content is relatively more in line with Xiaomi's operating logic. Currently, Xiaomi mainly focuses on advertising and games, accounting for 68% and 15% of revenue in '23, respectively. From the comparison between user ARPU value and game revenue, it can be seen that there is still a lot of room for improvement in commercialization efficiency. We believe that the core reason behind this is that Xiaomi currently has relatively low users. As Xiaomi's high-end mobile phone business continues to advance, it is driving the ARPU value to increase, thus driving the company's Internet business growth.

Automobiles: Product integrity and brand excellence, holding riders' internet traffic entrances. Smart cars are important traffic entrances to the Internet of Things. The connection between mobile phones and vehicles has entered the stage of operating systems being opened up, and mobile phone manufacturers have an advantage in unifying the driver ecosystem. Xiaomi entered the construction market across borders through three channels of investment, self-development, and cooperation, and released its first new energy sedan, the Su7, at 24M3. Compared with the parameters of the Su7, there are no obvious advantages or disadvantages of NEVs in the 0.2-0.3 million yuan range. With product ecology and cultural marketing to transform consumers, the sales volume for 4 months after launch was high at 7,000+ vehicles, and it entered the top five NEV sales rankings of 0.2 million or more in July. Looking ahead to the business space, based on a delivery target of 0.13 million units for the full year of '24, it is expected to bring in about 30.8 billion yuan in revenue; profit returns from the Internet business after waiting for autonomous driving and the rise of smart cockpits in the long term.

Profit forecast and valuation analysis: We expect net profit belonging to NON-IFRS parent companies to increase by 9.9%, 42.5%, and 26.4% in 2024-2026, respectively, to 21.2 billion yuan, 30.2 billion yuan, and 38.1 billion yuan, respectively. The current stock price is 28X/19X/15X for 2024 to 2026 PE, respectively. Considering the company's diversified business layout and the strong market potential brought by the “people and drivers” ecosystem, the first coverage gave it a “recommended” rating.

Risk warning: The smartphone market is fiercely competitive; overseas market policy regulations are tightened; core supply chain dependency; SU7 order delivery falls short of expectations; macroeconomic fluctuations.