Lenovo's Exposure To A Weak PC Market Masks Progress Elsewhere

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Despite stock growth, separator improvement, free rate travel conversion improvement, and diversification into different profitable business lines, Lenovo (OTCPK:LNVGF) (OTCPK:LNVGY) has typically traded arsenic a telephone connected PC demand, and that would look to beryllium the lawsuit again now. While PC request is so weak, and Lenovo guidance whitethorn beryllium overestimating nan gait of an eventual betterment (creating inventory guidance risks), Lenovo's stock value would look to disregard nan advancement made elsewhere successful nan business.

I do deliberation that Lenovo banal is undervalued connected its merits (likely semipermanent free rate flows), but I besides deliberation that sentiment changes slow and Lenovo could good stay a proxy for nan PC marketplace for a agelong clip to come. I've done good for myself trading nan shares, and I proceed to judge that they're undervalued, but it's difficult to urge them beyond investors pinch a batch of patience to hold for nan diversification efforts to carnivore moreover much fruit.

PCs Drive A Top-Line Miss, But Core Margins Outperform

Lenovo was deed difficult by a anemic PC marketplace successful nan fiscal 3rd 4th (December almanac quarter), but different businesses grew good and guidance erstwhile again exceeded sell-side targets for operating efficiency.

Revenue fell 24% arsenic reported (or 18% successful changeless currency) from nan anterior twelvemonth and 11% from nan anterior quarter, missing by 6%. The weakness was driven by nan Intelligent Devices Group (or IDG), wherever gross fell 34% yoy (and 16% qoq) connected a 29% year-over-year diminution successful PC shipments. Infrastructure Solutions Group (or ISG) gross roseate 48% connected 35% maturation successful server revenue, 52% maturation successful package revenue, and 345% maturation successful retention revenue, while Solutions & Service Group (or SSG) gross roseate 23% yoy connected 12% maturation successful Support, 7% maturation successful Project & Solution, and 97% maturation successful Managed Services.

Gross separator improved 40bp yoy and 30bp qoq to 17.1%, beating by 50bp. Operating income declined 20% yoy and 12% qoq, beating by 10% connected amended disbursal control, while separator roseate 30bp yoy and fell 10bp qoq to 4.9%.

By segment, IDG profits fell 37% (margin down 40bp to 7.3%), ISG profits roseate 156% (margin up 60bp to 1.5%), and SSG profits roseate 12% (margin down 2 points to 20.2%).

PCs Aren't Out Of The Woods Yet

While astir manufacture participants person been guiding for nan PC marketplace to bottommost successful nan March 4th of 2023, location are still risks present to nan outlook for Lenovo. While guidance claimed that sell-out ran 20% up of sell-in for nan 4th (meaning that transmission inventories declined), it looks for illustration transmission inventories are still astatine 10 weeks aliases more, which is historically precocious and a threat for further destocking.

Moreover, guidance has consistently been much optimistic than others pinch respect to nan pace/depth of this downturn. Management has revised their guidance from level to down 10%, but that conscionable now puts them successful statement pinch nan position of spot suppliers for illustration AMD (AMD) and Intel (INTC), and nan telephone for a double-digit rebound successful nan 2nd half of almanac 2023 seems optimistic.

Given really quickly nan worth of vanished PC inventories tin erode, I'd for illustration to spot a small much conservatism here. Lenovo has maintained a starring stock successful nan marketplace up of HP (HPQ), Dell (DELL), Apple (AAPL), and truthful on, and gaming PCs proceed to turn for nan company, but excess inventory held excessively agelong successful nan transmission could yet thrust sharper clearance actions.

On a much affirmative note, contempt important weakness successful nan smartphone market, Lenovo has kept this business profitable for 11 consecutive quarters.

Diversification Starting To Pay Off, But More Work Is Needed

Lenovo has managed to move its ISG business into a affirmative contributor to nan bottommost line, arsenic good arsenic summation stock successful nan server and retention market. A large portion of this has been a disciplined attack to nan business that favors separator complete measurement and tie-ups pinch ample customers that tin thrust comparatively predictable business volumes (like Microsoft (MSFT) successful storage). Management has besides been doing good expanding nan business, including a caller triumph pinch nan Kroger (KR) concatenation to support its self-check-out efforts pinch Lenovo's Edge AI servers.

The SSG has besides been proving retired arsenic a worthwhile finance for nan company. The halfway of this business remains successful fundamentally elevated tech support, but it's a worthwhile offering arsenic it allows clients to run pinch smaller IT staffs that walk little of their clip connected regular hardware support issues. Other offerings see project-oriented guidance services, wherever Lenovo fundamentally helps clients creation and run IT infrastructures, whether for circumstantial tasks aliases enterprise/campus-wide needs.

That Lenovo sewage ISG into nan achromatic is surely positive, but it's still margin-dilutive. I deliberation nan institution is connected nan correct way arsenic acold arsenic focusing much connected value-added offerings, but I don't spot this ever really being a awesome profit driver.

On nan different hand, nan SSG operations person a longer imaginable runway of maturation and maturation astatine charismatic margins, but I deliberation it will return a while longer for nan Street to lukewarm up to this business. Infrastructure-as-a-Service makes sense, peculiarly arsenic IT needs go much complex, and I expect much opportunities successful areas for illustration Smart Retail and Smart Manufacturing (basically designing end-to-end hardware and package packages to digitalize operations), but it will return clip to build.

The Outlook

The PC business still generates much than half of Lenovo's revenue, and it still drives sentiment for nan stock. That's not going to beryllium a affirmative for astatine slightest a fewer much quarters. Likewise, nan PC business will proceed to beryllium nan driver of profits and rate travel for Lenovo for years to come, moreover pinch above-average maturation successful nan SSG businesses.

I'm expecting this fiscal twelvemonth to adjacent pinch a double-digit gross decline, pinch different humble diminution pursuing adjacent year. Even pinch those headwinds, I expect semipermanent halfway gross maturation successful nan vicinity of 3%, pinch ISG and SSG offsetting weaker PC/smartphone growth.

Lenovo has done an exceptional occupation of maintaining/improving profitability successful its halfway PC business complete nan years, and I expect that will travel successful infrastructure arsenic well, though I don't ever expect ISG to drawback up to IDG successful position of profitability. The ongoing maturation and profitability of SSG is simply a cardinal driver, arsenic I judge maturation present complete clip tin push nan wide operating separator toward 5%, though I'm modeling a much humble semipermanent operating separator adjacent 4%.

I expect semipermanent FCF margins successful nan vicinity of 3%, though present excessively an expanded work offering could thrust a higher semipermanent ceiling fixed little capex reinvestment needs. As is, though, I expect a small spot of FCF separator betterment to thrust astir 4% FCF maturation disconnected of that 3% gross growth.

The Bottom Line

Discounted rate flow, arsenic good arsenic multiples-based approaches (EV/EBITDA, et al.), propose meaningful undervaluation astatine this point. This is wherever nan truth that Lenovo truthful often trades arsenic a proxy for PC demand/sales comes into nan image - it doesn't really matter what nan valuation looks for illustration if nan Street only thinks of it arsenic a PC play.

That could alteration complete time, and I do deliberation nan shares are undervalued now, but I've learned complete nan years that there's much money to beryllium made expanding and lightening my holdings successful consequence to nan rhythm of sentiment than waiting for nan Street to alteration its views. With that, investors should attack nan sanction knowing that worth will return clip to triumph retired complete sentiment.

Editor's Note: This article discusses 1 aliases much securities that do not waste and acquisition connected a awesome U.S. exchange. Please beryllium alert of nan risks associated pinch these stocks.

This article was written by

Stephen Simpson floor plan picture

Stephen Simpson is simply a freelance financial writer and investor. Spent adjacent to 15 years connected nan Street (sell-side, buy-side, equities, bonds); now a semi-retired raccoon rancher. That past portion isn't wholly true. Probably.

Disclosure: I/we person a beneficial agelong position successful nan shares of LNVGY, DELL either done banal ownership, options, aliases different derivatives. I wrote this article myself, and it expresses my ain opinions. I americium not receiving compensation for it (other than from Seeking Alpha). I person nary business narration pinch immoderate institution whose banal is mentioned successful this article.

Editor: Naga

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