Incidents:

Lenovo Group announced on August 15, 2024: FY2024/25 Q1 (corresponding to the natural year 2024Q2), the company achieved operating income of 15.447 billion dollars (YoY +20%, QoQ +12%), gross profit of 2.56 billion dollars (YoY +14%, QoQ +5%), and net profit of 0.243 billion dollars (YoY +37%, QoQ -2%).

Investment highlights:

Overall performance was FY2024/25 Q1. The company's revenue, gross profit, and net profit to mother all achieved year-on-year growth driven by accelerated growth in computing, infrastructure and services, further confirming that the company's business is in the process of gradual recovery. In terms of profit margins, gross margin and net margin levels declined to varying degrees year-on-year and month-on-month during the quarter, but fluctuations remained within a normal range. In terms of cost ratios, compared to the previous quarter, all three expense rates declined. R&D expenses, sales and marketing expenses rates, and management expenses rates were 3.1%/5.4%/4.2%, respectively, reflecting the company's outstanding effectiveness in controlling expenses. During the first fiscal quarter, Lenovo Group announced a strategic partnership with Alat Enet, a company under the Saudi Arabian Public Investment Fund (PIF) focusing on transformative technology investments and sustainable manufacturing: Alat Enet provided the Lenovo Group with a $2 billion interest-free convertible bond investment. Overall, we believe the company can benefit from this strategic cooperation in the medium to long term. First, Alat Ennett can help the company grow in the Middle East. Since Middle Eastern sovereign wealth funds are shareholders of many large Saudi companies, they can help companies reach customers more quickly. Currently, the company's Middle East business is about 1.25 billion US dollars, accounting for about 2% of the company's overall business scale. The company aims to make the Middle East business reach 10% of total revenue through this strategic cooperation. Second, establishing a new production base in the Middle East can further expand Lenovo's global layout, enhance the resilience of the company's global supply chain, and enhance flexibility. An interest-free convertible bond investment form will save the company 0.1 billion dollars in interest expenses each year for the next three years, and will not be affected by the dilution of convertible bonds.

IDG (Smart Device Business Group) FY2024/25 Q1, IDG achieved revenue of 11.422 billion dollars (YoY +11%, QoQ +9%), accounting for 69% of total revenue and 7.3% operating margin. In terms of PC business, according to Canalys and 2024Q2, global PC shipments increased 3.4% year on year, and Lenovo PC shipments increased 3.5% year over year, maintaining the top position with 23.4% market share. The share of the company's non-PC business revenue increased by 5pct to 47% year over year, reaching a record high. The contribution of the non-PC business to the company's revenue is constantly increasing. At the beginning of FY2023/24, the PC market continued to bottom due to excessive channel inventory. It seriously affected IDG's overall performance in the last fiscal year. This quarter, Lenovo's AI On stage AI PCs with large models were officially launched on May 20, and the next-generation AI PC launched by the company, Copilot+PC, was also launched on June 18. The market feedback on the first batch of AI PCs was positive. According to the company's forecast, AI PCs will account for more than half of the total PC market in 2027. We believe that with the launch of AI PCs in the first year, the AI PC penetration rate is expected to continue to increase, bringing upward elasticity to the company's revenue and profits.

ISG (Infrastructure Solutions Business Group) FY2024/25 Q1, ISG achieved revenue of $3.16 billion (YoY +65%, QoQ +25%), accounting for 19% of total revenue and -1.2% operating margin. ISG's revenue reached a record high in the quarter. Due to the current increase in investment in developing new projects and the slower than expected upgrade progress of old projects, which continue to put pressure on its cost structure, it is still in a state of loss, but operating losses have narrowed month-on-month and year-over-year. By product, total sales of storage, software, and services increased 59% year over year, reaching a record high; thanks to the leading position in the industry and higher cooling requirements of more powerful GPU platforms, the revenue of Poseidon liquid cooling servers increased 55% year over year; AI server reserves increased by more than 20% month-on-month, and orders increased by more than 50% month-on-month. We believe ISG's “Profitability Recovery Plan” is expected to help the business line turn losses into profits and grow this fiscal year as investments gradually turn into revenue.

SSG (Solution Service Business Group) FY2024/25 Q1, SSG achieved revenue of 1.885 billion dollars (YoY +10%, QoQ +4%), accounting for 11% of total revenue and 21.0% operating margin, contributing one-third of the company's operating profit, and continued to maintain its position as the company's growth and profit engine. Among them, the turnover of operation and maintenance services, project and solution services businesses accounted for 55% of SSG, an increase of 3 pcts year over year. According to the company's forecast, the CAGR for the new IT services market will be 10.6% from 2024 to 2027, while the growth rate of artificial intelligence services is nearly double that of the overall market. We believe that with the AI infrastructure in place, hybrid artificial intelligence services may become the core driving force of this business line, and SSG's revenue is expected to grow further.

Profit forecast and investment rating In view of the PC market recovery, the continued iterative penetration of AI PCs, and the marginal improvement in ISG's profitability, we believe that FY2024/25's performance is expected to grow. Based on this, we adjust this profit forecast. Based on this, we expect the company's FY2025-2026 revenue to be US$627.32 and US$711.26 billion, respectively, and net profit to mother of US$12.36 and US$1,872 billion, respectively. The corresponding P/E multiples are 12.46X and 8.23X, maintaining a “buy” rating.

Risks suggest that competition in the industry is intensifying; the degree of recovery in PC and server businesses falls short of expectations; geopolitical conflicts have led to supply chain disruptions; technology leapfrogging and substitution, disrupting the company's existing technical advantages; and the progress of AI applications in terminals falls short of expectations.