Smartphone Margin Inflection Could Arrive Early; Xiaomi Price Target Raised to HK$33.00

Overview

The report focuses on Xiaomi's smartphone margins, product premiumization, EV sales revisions, and segment valuation following its 2Q26 results. Morgan Stanley believes the smartphone gross margin inflection could arrive one to two quarters earlier than previously expected, sufficient to offset part of the impact from lower EV and AIoT forecasts and provide a catalyst for valuation rerating.

Core views

Smartphone margins are the report's most important source of upward revisions. Xiaomi's smartphone gross margin reached 8.5% in 2Q26, better than the market feared despite a significant increase in memory costs. The 1H26 average gross margin was 9.3%, showing that the business maintained relatively healthy profitability even at the peak of the memory cost cycle. The company offset cost pressure by proactively adjusting its product mix, raising prices, and streamlining its product portfolio. Management's characterization of costs also shifted from “pressure will persist” in 1Q26 to “at an appropriate and manageable level” in 2Q26. It expects memory costs to continue rising in 3Q26 but for the pace of increase to slow in 4Q26. Morgan Stanley therefore believes the worst of the cost impact may have passed. Premiumization and pricing power provide structural support for margin recovery. Smartphone ASP reached a record RMB1,351 in 2Q26, up 25.9% YoY and 3.1% QoQ, mainly due to proactive reductions in low- and mid-end shipments and price increases. Premium smartphones priced at no less than RMB3,000 accounted for a record 32.1% of total unit sales in China, up 4.5 percentage points YoY. Within this category, market share in the RMB3,000–4,000 price segment rose 3.3 percentage points YoY to 16.2%. The report notes that premium models generate higher profit per device and are relatively better able to absorb rising memory costs. Management said it would continue stabilizing the smartphone business over the coming quarters through price increases, shipment controls, and product-mix improvements. Combined with an earlier flagship launch cycle, these measures underpin a gross margin recovery in 2H26. Based on slower growth in memory costs, higher ASPs, premiumization, and new flagship launches, Morgan Stanley substantially raised its 3Q26 smartphone gross margin assumption from 5.0% to 8.0% and its 4Q26 assumption from 5.0% to 9.0%. The 3Q forecast still incorporates memory cost pressure but assumes pricing and product-mix optimization will offset most of the impact. The 4Q forecast reflects slower cost growth, the full realization of premiumization benefits, and new product launches. The report expects the margin inflection point to arrive one to two quarters earlier than previously projected. As this is not yet reflected in consensus estimates, it could catalyze earnings estimate upgrades and a valuation rerating. For EVs, the report lowered its 2026 sales forecast from 500,000 units to 450,000 units and its 2027 forecast from 700,000 units to 600,000 units due to weaker-than-expected market growth in 2026 and 1H26 deliveries. It maintained its 2028 forecast at 900,000 units because it expects overseas expansion to support sales growth beginning in 2H27. The 2026 automotive gross margin assumption was lowered from 20.0% to 19.6%, while the 2027 assumption remained at 20.0%, reducing the forecast for cumulative automotive gross profit in 2025–2027 from RMB85.3 billion to RMB76.9 billion. However, the EV business's loss narrowed in 2Q26 from 1Q26, leading Morgan Stanley to conclude that the lower sales forecasts would not have a material adverse impact on overall earnings and would not undermine the long-term EV opportunity. The earnings forecasts balance smartphone improvements against slower growth in IoT, internet services, and EVs. The report lowered its total revenue forecasts for 2026 and 2027 by 2% and 6%, respectively, mainly due to slower growth in IoT and internet services and lower EV shipments. However, it raised its 2026 smartphone revenue forecast by 7% because smartphone shipments were stronger than expected. Driven by better-than-expected smartphone margins in 2Q26, the overall gross margin assumptions for 2026 and 2027 were raised by 0.1 and 0.2 percentage points, respectively. Combined with higher-than-expected non-operating income in 2026, the 2026 non-IFRS adjusted net profit forecast was raised by 6%, while the 2027 forecast was lowered by 1% due to slower EV growth. The latest model forecasts net sales of RMB431.789 billion, RMB503.483 billion, and RMB642.871 billion for 2026–2028, respectively, and non-IFRS net profit of RMB24.835 billion, RMB33.462 billion, and RMB47.418 billion, respectively. The valuation continues to use a sum-of-the-parts approach to reflect the differing growth and risk characteristics of each business. The intrinsic value of the smartphone business was raised from RMB21.0 billion to RMB45.0 billion. The intrinsic value of the EV business was lowered by only 2% due to lower 2026–2027 sales forecasts. The intrinsic value of the internet business was lowered from RMB176.0 billion to RMB165.0 billion to reflect slower growth. The smartphone, IoT, and internet services businesses are valued using residual income models, with costs of equity of 11%, 11%, and 11.4%, respectively, and perpetual growth rates of 3%, 3%, and 6%, respectively. The EV business is valued using a DCF with probability-weighted bull, base, and bear scenarios assigned weights of 20%, 60%, and 20%, respectively. Using a WACC of 12.2% and a perpetual growth rate of 5%, the probability-weighted intrinsic value is RMB119.0 billion, equivalent to approximately 21% of Xiaomi's current market capitalization. These segment-level changes raised the price target from HK$32.00 to HK$33.00, corresponding to 23 times expected 2027 P/E and 16 times expected 2028 P/E. Against the reference share price of HK$27.44, the price target implies 20% upside. The bull- and bear-case valuations remain at HK$50.00 and HK$15.00. The report maintains its Overweight rating and identifies Xiaomi as a top pick, citing an attractive risk-reward profile created by improving smartphone margins and narrowing EV losses. Its “Human × Car × Home” smart ecosystem and diversified revenue structure are also expected to enhance its relative competitiveness.

Analysis framework

Morgan Stanley first validates the smartphone margin recovery thesis using the actual 2Q26 gross margin, management's comments on memory costs, smartphone ASP, and the premium-model sales mix, and then revises its quarterly gross margin and company earnings forecasts accordingly. It subsequently lowers its EV sales and automotive gross margin assumptions based on 1H26 EV deliveries and industry growth, assessing the impact on cumulative gross profit and overall earnings. Finally, it separately values the smartphone, IoT, internet services, and EV businesses and applies a sum-of-the-parts approach to derive the price target and bull-, base-, and bear-case scenarios.

Methodology notes

• Valuation MethodSOTP Valuation

  Sum-of-the-Parts Valuation

  The report separately estimates the values of the smartphone, IoT, internet services, EV, and investment assets and then adds them together to derive Xiaomi's base-case value and price target, reflecting the differing growth and risk characteristics of each business.

• Valuation MethodRIM Residual Income Model

  Residual Income Model

  The report values the smartphone, IoT, and internet services businesses using residual income models, applying costs of equity of 11%, 11%, and 11.4%, respectively, and perpetual growth rates of 3%, 3%, and 6%, respectively.

• Valuation MethodDCF Discounted Cash Flow

  EV Business DCF Valuation

  The report estimates the present value of the EV business's future cash flows using a WACC of 12.2% and a perpetual growth rate of 5%, incorporating the lowered sales and gross margin forecasts into the model.

• Valuation Method

  Probability-Weighted Bull–Base–Bear Valuation

  The report separately estimates bull-, base-, and bear-case valuations for the EV business and applies probability weights of 20%, 60%, and 20%, respectively, resulting in an EV intrinsic value of RMB119.0 billion.

• Industry/Sector Analysis FrameworkVolume-price decomposition

  Smartphone Shipment, ASP, and Product-Mix Decomposition

  The report decomposes changes in smartphone revenue and margins into factors including shipment volume, ASP, and the premium-model mix to explain how proactive reductions in low- and mid-end shipments, price increases, and premiumization offset memory cost pressure.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Xiaomi Corporation (1810.HK)

  An earlier improvement in smartphone margins is the main positive driver, partially offset by lower EV sales forecasts and slower internet services growth.

  Strengths

  Smartphone ASP and the premium-model sales mix reached record highs, while product mix and pricing power improved; EV losses are narrowing; the report views the “Human × Car × Home” smart ecosystem and diversified business structure as competitive advantages.

  Weaknesses

  EV sales forecasts for 2026–2027 were lowered, growth in IoT and internet services is slowing, and the company continues to face rising memory costs in 2026.

  Comparison

  The report believes Xiaomi's “Human × Car × Home” smart ecosystem and diversified revenue exposure make it more competitive than peers, while the company is gaining share in the more profitable RMB3,000–4,000 smartphone segment.

  Risks

  Persistent memory cost inflation, intense EV competition, weak performance of new models, and geopolitical issues affecting component supplies or overseas sales.

Key data

• 2Q26 Smartphone Gross Margin8.5%Still better than feared during a period of significantly rising memory costs
• 1H26 Average Smartphone Gross Margin9.3%Shows that the business maintained healthy margins even at the peak of the memory cost cycle
• 2Q26 Smartphone ASPRMB1,351A record high, up 25.9% YoY and 3.1% QoQ
• Premium Smartphone Share of Unit Sales in China32.1%Refers to models priced at RMB3,000 or above; a record high, up 4.5 percentage points YoY
• Market Share in the RMB3,000–4,000 Smartphone Segment16.2%Up 3.3 percentage points YoY
• 3Q26 Smartphone Gross Margin Assumption8.0%Previously 5.0%
• 4Q26 Smartphone Gross Margin Assumption9.0%Previously 5.0%
• 2026 EV Sales Forecast450,000 unitsLowered from 500,000 units
• 2027 EV Sales Forecast600,000 unitsLowered from 700,000 units
• 2028 EV Sales Forecast900,000 unitsUnchanged; the report expects overseas expansion to support growth beginning in 2H27
• 2026 Automotive Gross Margin Assumption19.6%Lowered from 20.0%; the 2027 assumption remains 20.0%
• 2025–2027 Cumulative Automotive Gross Profit ForecastRMB76.9 billionPreviously RMB85.3 billion
• Probability-Weighted EV Intrinsic ValueRMB119.0 billionApproximately 21% of Xiaomi's current market capitalization
• Price TargetHK$33.00Raised from HK$32.00 and 20% above the reference share price of HK$27.44
• Valuation Multiples23 times expected 2027 P/E; 16 times expected 2028 P/EValuation levels implied by the price target
• Scenario ValuationsBull case HK$50.00; base case HK$33.00; bear case HK$15.00Bull- and bear-case values remain unchanged

Impact & implications

The report believes Xiaomi's smartphone business can offset memory cost pressure through price increases, premiumization, and product-mix adjustments. An earlier margin inflection could drive modest earnings estimate upgrades over the next 12 months and lead to a valuation rerating. Although near-term EV sales expectations were lowered, narrowing losses limit the impact on overall earnings. As a result, the increase in the smartphone business's value more than offsets the lower valuations of the EV and internet businesses, supporting the higher price target.

Risks

• If memory prices rise more than expected or cost inflation persists for longer, the recovery in smartphone gross margin could fall short of the report's forecast.
• Persistently intense EV competition could pressure sales, margins, and business valuation.
• If the new EV models launched in 2H26 receive weaker-than-expected market acceptance, earnings, valuation, and share-price performance could be adversely affected.
• Geopolitical tensions could disrupt supplies of key components or affect overseas market sales.
• Market concerns about increased investment in smart EVs could pressure the valuation.

What to watch

• Track smartphone gross margins in 3Q26 and 4Q26 and whether growth in memory costs slows in line with management guidance.
• Monitor mid- to high-end smartphone penetration, ASP, and market share in the RMB3,000–4,000 price segment.
• Monitor improvements in average revenue per MIUI user.
• Track EV deliveries, customer satisfaction, and orders and user feedback for new models.
• Monitor whether EV business losses continue to narrow and whether the 2026 automotive gross margin assumption of 19.6% can be achieved.
• Track overseas AIoT growth and changes in overseas market share.
• Monitor whether overseas EV expansion beginning in 2H27 can support the 2028 sales forecast of 900,000 units.
• Track whether consensus estimates raise 2H26 smartphone gross margins and earnings per share over the next 12 months.