SMARTPHONES: Huawei Margins, Sales Show Smartphone Stress

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Bottom line: Huawei’s eroding profit margins and slowing smartphone sales growth reflect stresses being felt both at home and abroad in an overheated industry showing rapid signs of global saturation.

Huawei announces H1 results

The latest financial results from Huawei are showing how smartphones are at once becoming a growth engine but also a drag on the telecoms giant. The company’s fast-growing smartphone business was one of the main engines behind a 40 percent surge in sales during the first half of this year, as Huawei consolidated its position as the world’s third largest brand behind only Samsung (Seoul: 005930) and Apple (Nasdaq: AAPL). But at the same time, fierce competition in the sector also sharply eroded Huawei’s profit margins.

An interesting footnote to Huawei’s latest figures is that they diverge somewhat from data released last week by TrendForce, the first of several independent consultants that report quarterly global smartphone sales. Such discrepancies aren’t uncommon due to the way that different organizations log sales. But in this case, the discrepancy between Huawei’s numbers and TrendForce’s could hint at growing stockpiles of unsold phones starting to accumulate in the warehouses of Huawei’s vendor partners.

Let’s begin with some of the big picture numbers in the newly released first-half results from Huawei, China’s biggest high-tech exporter that is arguably the world’s strongest seller of equipment used in big telecoms networks. In a bid to diversify beyond that limited and maturing business, the company has placed growing emphasis on consumer products over the last 5 years, most notably on smartphones.

The company posted overall revenue of 245 billion yuan ($35.6 billion) in the first half of the year, up an impressive 40 percent from last year. (company announcement; Chinese article) Sales for its consumer unit, which relies heavily on smartphones, were up by a similar 41 percent to 77.4 billion yuan, meaning that part of the business now accounts for nearly a third of total sales. Huawei’s other fast-growing unit focuses on networking equipment sales to individual companies rather than big telecoms carriers.

But while revenue was up sharply in the first half of the year, the company’s operating margin fell by an equally big amount. Huawei said its overall operating margin dipped to 12 percent in the first half, down by a third from the year-ago figure of 18 percent. It didn’t give any margin figures for the smartphone business, but I expect that figure was probably down in the single digits due to fierce competition in China, its biggest market.

Growing Stockpiles?

Now that we’ve covered the big numbers, let’s look at some of the more detailed ones coming from Huawei and how they differ from TrendForce. Huawei says its first-half smartphone sales totaled 60.6 million units, representing a 25 percent increase over last year. (company announcement) TrendForce puts the figure at about 55.8 million, or about 8 percent less than Huawei’s figure.

That discrepancy could hint that 61 million smartphones were officially ordered and shipped to Huawei’s vendors, but that the vendors only managed to actually sell around 56 million of those or possibly even less. TrendForce’s year-on-year growth is roughly the same as the 25 percent cited by Huawei, though it’s notable that figure is quite a bit lower than Huawei’s breakneck growth from previous quarters.

Huawei spent much of its announcement focusing on its growth outside China, and also its focus on product development. Those have been two of its strongest areas over many of its Chinese smartphone rivals, since the company already boasts a global sales network and also has strong R&D capabilities accumulated from more than 2 decades as a major networking equipment maker.

I’m probably becoming a little biased in looking for negative signals coming from Huawei, following reports late last month that the company was revising down its aggressive smartphone sales targets. (previous post) But that said, I’ve seen too many examples of similar rapid rises and falls by former hot-shots in various Chinese sectors. In this case there’s quite a relevant parallel in Xiaomi, the former smartphone superstar that has tumbled over the past year due to stiff competition and various internal issues.

I doubt that Huawei will follow the same path as Xiaomi, since it has far deeper resources and a much longer operating history. But it does appear that Huawei could be set for a sharp slowdown, similar to ones being faced by even global leaders Apple and Samsung, as competition grows and the worldwide smartphone market shows growing signs of saturation.

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