► Secular slow down in the property market is limiting new demand in home appliances. Meanwhile the expected surge in replacement demand in 2020 is weighed down by COVID, but great 618 sales indicate the drawback may be temporary.
► Haier’s oversea expansion brought it explosive top-line growth in 2016 and 2017, but lack of concentration in the domestic market has exposed Haier to weaker competitiveness in China and higher global supply chain risks in times of COVID.
► A premiumization strategy has provided Haier with short-term cushioning and catalysts to capitalize on sticky, high-spending consumers as well as growing demand from lower-tier cities.  
► Haier’s first-mover advantage in the smart home appliance market gives it a higher potential to tap into millennials and has attracted consumers to purchase appliances in bundles.

Business Overview

Haier Smart Home was formerly known as Qingdao Haier, having changed its name in 2019. It has a long history of designing, manufacturing, and selling white appliances in China. Its products and services include fridges & freezers, air conditioning, washing machines, kitchen & small appliances and integrated channel services, these accounting for 30.1%, 14.5%, 22.2%, 14.7%, and 14.0% respectively. In terms of profit, these appliances account for 36%, 17%, 28%, 17%, 5.5% respectively. Looking at both revenue and profit breakdown, we can see that fridges & freezers and washing machines are Haier’s core money-generating products.

Macro downturn and low margins have driven sales

According to Morgan Stanley, the inherent sources of demand for home appliances are new demand and replacement demand. We will examine how each category of appliances is impacted by new demand and replacement demand under current macro conditions. As for air conditioning, the demand has been trending lower in recent years as the Chinese government imposes stricter property policies to eliminate speculative activities. For refrigerators and washing machines, demand has been resilient due to an expected replacement cycle in 2020 and 2021. As appliance penetration increases in lower-tier Chinese cities, more households with fewer financial burdens such as mortgages are purchasing appliances, also driving up demand for small kitchen appliance and high end appliance. 

Sales of white appliances have gone through a rollercoaster so far this year. Quarter one of 2020 marked an industry-wide sales decline in light of COVID. ACs, refrigerators, washing machines, and kitchen appliances have seen sales decline by 61%, 28%, 35% and 52% respectively. We also saw a margin contraction in Q1, as sales volumes decreased on a smaller scale than sales revenue.

However, the skyrocketing sales record in 618 has proven that the effect of COVID on replacement demand might be short-lived. JD’s 618 sales have seen a 34% increase from the previous year, and home appliance sales have ranked the second most selling products. Since April, we can see a trend of recovery in home appliance sales, despite the ongoing COVID effect.

Global expansion strategy is a double-edged sword

Haier’s recent yearlong top-line growth is largely fueled by its overseas expansion strategy. After its acquisition of GE Appliance in 2016, Haier recorded impressive revenue growth of 32% and 33% in 2016 and 2017. While overseas expansion continues to generate revenue growth, it is bringing a few potential risks. In the short term, overseas presence is exposing Haier to both global macro and geopolitical risks. COVID-19 has put a stop to manufacturing activities in both Europe and the US, which has brought disruptions to its supply chain. The rising trade tension between the US and China might also bring an unfavorable image to GE Appliances, a Chinese-owned company in the US.

In the longer-term, the focus on overseas expansion is also weighing on Haier’s domestic competitiveness. In 2017, Midea surpassed Haier for the first time in washing machine sales volume, an area where Haier has traditionally dominated. This is just one snapshot of Haier’s ongoing problem with global expansion. Overall, on the one hand, Haier is slower to grow than competitors in sales in China; on the other hand, Haier’s overseas margin is eaten by high post-acquisition expenses, and it is experiencing slower sales growth due to more pessimistic consumer sentiments in the US and Europe compared to China. Overseas supply chain disruptions might also continually weigh on Haier as COVID-19 continues.

Premiumization provides cushioning and prospects

Haier’s premiumization strategy and smart home platform are bringing Haier an edge in the competition. With online sales channels becoming increasingly popular and competition growing stronger in the home appliances sector, Haier’s premium branding allows it to maintain a higher-than-industry-average margin and provides it with cushioning at times of economic uncertainty.

In Q1 2020, Casarte, Haier’s premium brand, recorded -6.7% growth, which outperformed its peers, and Haier’s overall sales decline was also better than peers. During the past three years, Casarte has recorded above 30% Year-over-Year growth rate, which is among the fastest-growing brands in the whole industry. Haier’s advantage from premiumization stems from: 1) the spending behavior of wealthier Chinese households being little affected by economic shocks; and 2) growing penetration in lower-tier cities where households are less exposed to financial burdens.

Being the first mover in the smart home market has so far proven effective

The preference for smart homes is on the rise as millennials are gaining more financial power. As the first entrant in the smart home appliance space, Haier is benefiting from a couple of catalysts: 1) Haier has established partnerships with both online and offline distributors to effectively deliver a variety of customized appliances to the emerging lower-tier cities. According to Goldman Sachs, Haier’s Smart Home Platform has reached 75% coverage of villages and towns in China and is expected to reach full coverage by August 2020. 2) Haier has a full suite of smart home product offerings, and sales are often executed in bundles. In the 618 sales this year, approximately 1/3 of Haier’s sales consist of more than one appliance, proving its effective product synergies. Going forward, Haier might be able to capitalize more on these two catalysts as the market for smart home appliances expands.

We should also note that betting on the expanding smart home market also runs the risk of heating competition and disruptive technology. For instance, the entry barrier for small appliances is low, and competition is heating in this space, with emerging players like Joyoung, Xiaomi, Bears Appliance, quickly capturing significant market share. Although Haier is a leading player in the smart home industry now, there is a risk of disruptive technology taking over territory as this market expands. Take Zoom and the video conferencing industry for example. After Zoom was released in 2013, it quickly snapped up significant market share from large established players such as Cisco and Microsoft. Now, Zoom is hosting almost 40% of users in the video conferencing space. So, we need to pay attention to how Haier is developing its smart home ecosystem and whether any emerging technology or product is better at meeting demand in a smart home.

Forward-looking

Overall, Haier’s expansion strategy has allowed it to capture growth in the overseas market while losing sales growth in the domestic market and exposing itself to higher global supply chain uncertainties. Haier’s transformation to smart home appliance provider and premium branding has given Haier upsides in long-term competition, but how much market Haier can capitalize on depends on consumer behaviors and competitive landscapes.

We used the P/E ratio comparable approach to arrive at a rough estimation for the share price of Haier Smart Home (600690:SZ). We selected the top 4 market cap companies in the white appliance sector for reference. We watch for two things in our analysis: 1) The 52 week P/E ratios for these companies; and 2) the P/E comparison between Haier and others.

We see that white appliance stocks are trading in line with 52 weeks P/E ratio. We see three components that can factor into the P/E ratios of white appliance stocks and Haier’s P/E in particular:
1.    This past year's consistent slow growth in the Chinese property market supports a P/E in line with the 52-week average.
2.    COVID brought a hit to the macroeconomy, and disruption in overseas sales in Q1 supports a P/E contraction.
3.    Better-than-expected sales during the 618 indicate the sales capability of white appliances companies and resilient consumer demand even during COVID, which suggests an increase in multiples.

In terms of individual P/E ratios, we see that Haier is trading at a discount compared to Midea and Gree and at a premium compared to Hisense. We think a significantly lower P/E ratio for Hisense is justified as it has little growth catalysts. Based on our analysis of Haier’s growth drivers, Haier is growing at a slower pace in domestic expansions. While Haier has a great ‘Smart Home’ story, there are currently too many uncertainties with its overseas growth. So, we do not see incorrect multiple valuations between Haier and its peers. We recommend a hold position under the current situation. However, a significant secular shift in high-end or tech-savvy white appliances in Haier’s favor could trigger a higher P/E multiple and justify a higher share price.