Profit margins are under pressure in the first half of 2019
In the first half of 2019, Lenovo Holdings' revenue increased by 14.6% to 179.3 billion yuan compared with the same period last year, of which strategic investment income increased by 14.5% to 179 billion yuan, financial investment income increased by 6.9% to 330 million yuan, and net profit decreased by 5.8% to 2.67 billion yuan. Of this total, the net profit of strategic investment decreased by 34.1% compared with the same period last year, and the net profit of financial investment increased by 187%.
Trend of development
Strategic investment business was temporarily under pressure, with net profit falling sharply by 34% in the first half of the year, mainly due to one-off investment gains from capital operations in the same period last year. In the IT business sector, profit margins improved significantly (up 159% from the same period last year), mainly due to Lenovo Group Limited's year-on-year turnaround in mobile business, strategic contraction and cost control achieved obvious results, but we expect the server business to continue the cotton boll growth pressure, mainly affected by weak market demand and falling prices of storage components. In the financial services sector, the overall business development remained robust, mainly benefiting from the steady growth of Luxembourg's international banking business, but we noted that due to trade frictions and macroeconomic uncertainties, SME loan business development is temporarily facing greater pressure, small and micro loan balance has declined, we believe that business development still needs time to recover. Innovative consumer business continues to optimize its structure, focusing on health care, education and other emerging areas, and the decline in business revenue and profits is mainly due to the fact that the company no longer pays homage to Bokou. The agricultural and food sectors maintain a healthy growth momentum, and Jiawo continues to integrate the upstream and downstream industrial chains to consolidate its leading edge in high-end fruits, animal protein and other fields.
Financial investment improved significantly, with revenue up 6.9% and net profit up 187%, mainly due to a sharp increase in the fair value of invested financial assets. As of the first half of 2019, Lenovo Star's asset management scale was about 2 billion yuan, withdrew or partially withdrawn from about 20 projects in the first half of the year; Junlian Capital raised a total of about 8 billion yuan, and withdrew or partially withdrew about 22 projects in the first half of the year; Hony Investment also withdrew or partially withdrew about 14 projects in the first half of the year. Due to the increasing volatility of the capital market, Lenovo Group Limited adjusted the development strategy of financial investment, accelerated the return of funds, and is expected to enhance the stability of financial investment.
Profit forecast and valuation
We keep our revenue forecast for 2019-2020 unchanged; due to high market volatility, we expect strategic investment margins to come under pressure, reducing net profit forecasts for 2019-2020 by 10.3 per cent and 7.9 per cent. The company's current share price corresponds to 7.7 times forecast 2019 earnings. Maintain a neutral rating but lower the target price based on segment plus aggregate valuation by 17 per cent to HK $20 (14 per cent upside from the current share price).
Risk
Macroeconomic and regulatory uncertainty.