Is there a market misunderstanding? Morgan Stanley: During previous memory price increase cycles, Xiaomi's profit margin "actually improved."

As the market worries that rising memory prices will put pressure on smartphone gross margins, Morgan Stanley’s latest research report overturns this commonly held belief.

According to Chasing Wind Trading Desk, Morgan Stanley pointed out in its newly released report that the sharp rise in upstream memory chip costs, through specific pass-through mechanisms, may actually present an opportunity for terminal manufacturers to improve their profit margins.

By analyzing the correlation of historical data, Morgan Stanley found: During the three price increase cycles in 2016-17, 2019-21, and 2022-23, Xiaomi’s smartphone gross margin actually improved.

This counterintuitive finding suggests that the market may be underestimating the cost pass-through ability of phone manufacturers and Xiaomi’s profit resilience. In its report, Morgan Stanley maintained an “Overweight” rating and a target price of HK$62 on Xiaomi Group, representing a 50% upside from last Friday’s closing price of HK$41.

Counterintuitive Historical Correlation

The market currently holds a generally linear worry: as memory costs rise, smartphone manufacturers’ gross margins are bound to come under pressure. This seemingly reasonable inference dominates current “consensus expectations.” However, after a deep analysis of the historical correlation between Xiaomi’s smartphone gross margin and DRAM price changes, Morgan Stanley reached a completely opposite conclusion.

The report pointed out, by looking back at the cycles of “2016-17, 2019-21, and 2022-23,” the data clearly revealed a non-consensus finding: “When DRAM prices follow an upward curve, Xiaomi’s smartphone gross margin actually improves.” This shows that historical experience does not support the simple formula of “rising costs = decreased profits.”

Cost Pass-Through, Timing Dividend, and High-End Moat

Why does this divergence occur? Morgan Stanley believes the core lies in the effectiveness of the cost transmission mechanism and Xiaomi’s own product structure optimization. There are three key reasons behind this phenomenon:

First, the cost pass-through mechanism is effective. Research shows that smartphone manufacturers can restore gross margin levels throughout the cycle. When prices of memory and other key components rise sharply, it pushes the entire industry to significantly raise product prices, thus passing cost pressure on to end consumers.

Second, there is a “timing dividend.” When cost inflation pushes up prices, once the inflation trend reverses, manufacturers will face a favorable situation of “high selling prices and low costs,” thereby triggering a rebound in gross margin.

Third, long-term drivers from product structure upgrades. Xiaomi’s ongoing high-end strategy is a long-term positive driver for gross margin improvement. By improving its product portfolio, Xiaomi is gradually moving away from the mode of relying solely on low-end models for volume, thereby strengthening its defensive ability during these cost fluctuation cycles.

Supercycle or Short Cycle Will Determine Different Outcomes

Although historical data currently supports the bullish side, Morgan Stanley does not ignore the risks. In its report, Morgan Stanley distinguishes and anticipates future scenarios:

If the rise in memory costs follows a supercycle pattern, with price increases lasting longer, smartphone gross margins are expected to face sustained downward pressure. In this scenario, cost pass-through may lag, and manufacturers will endure margin compression for a longer period.

However, if the cycle reverses quickly, smartphone gross margins may also recover rapidly. Based on historical experience, once DRAM prices peak and fall, the speed at which margins improve for Xiaomi and others may exceed market expectations.

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The above wonderful content comes from Chasing Wind Trading Desk.

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