Lenovo Earnings: While Sluggish Server Demand Disappoints the Market, PC Recovery Is In Line

Although the weaker-than-expected loss at the server business disappointed the market, we believe Lenovo’s 00992 fundamentals are not as bad as the numbers look, and the PC business is in the recovery phase from the inventory adjustment, as we had expected. While we lower our operating income forecasts for fiscal 2023 (ending March 2024) and fiscal 2024 due to sluggish server demand, slightly lower margin for PCs, and higher financing costs due to higher interest rates, we raise our PC shipment assumptions from late 2024 onward as we are more confident that replacement demand will pick up. As a result, we maintain no-moat Lenovo’s fair value estimate of HKD 10.50 and believe its shares are undervalued.

Lenovo’s operating income and net income for the June quarter were USD 390 million and USD 177 million, respectively, below our expectations of USD 420 million and USD 250 million. While the PC business was in line with our expectations, the server business posted an operating loss for the first time in seven quarters. It was disappointing that Lenovo did not benefit from the emerging artificial intelligence investment and was not able to offset the slower investment in general servers. While the company is trying to capture the AI opportunity in the longer term and is making investments, we expect it to suffer from the inventory correction for general servers in the near term, at least through the end of 2023.

On the other hand, we are encouraged that the inventory correction for PCs is largely complete. Lenovo’s inventory has declined for four consecutive quarters and is now 33% lower than a year ago. As a result, we expect the operating margin of the IDG segment—which is 80% PC—to have bottomed out at 6.3% in the June quarter, and to start recovering from the September quarter. However, we are trimming our fiscal 2023 operating margin assumption for the segment to 6.7% from 6.9%, given the lower average selling price trend due to the intensifying competition.