AI server strong demand boosts ISG business gross margin, Minsheng Securities: Optimistic outlook for Lenovo (00992)

Lenovo Tech World 2023 conference opened on October 24th, showcasing revolutionary AI PC products. In response, Minsheng Securities released a research report stating that LENOVO GROUP (00992), as a core partner of NVIDIA, is starting a new growth cycle for PC+ servers. Minsheng Securities' Competition Team believes: LENOVO GROUP has three core business groups: Intelligent Devices Group (IDG), Infrastructure Solutions Group (ISG), and Solution Services Group (SSG). The IDG consists of personal computers, tablets, smartphones, and other smart device businesses. ISG focuses on servers, storage, edge computing, and services. SSG mainly consists of operation and maintenance services, project and solution businesses, additional services, and support services. The company's FY2023 revenue was $61.947 billion, a YoY decrease of 13.5%. Due to the decline in PC demand, net profit attributable to shareholders was $1.608 billion, a YoY decrease of 20.79%. The gross profit margin was 16.95%, a YoY increase of 2.71 percentage points. In terms of business segments, the proportions of FY2023 revenue from the IDG/ISG/SSG were 79.70%/15.75%/10.76%, with the IDG achieving revenue of $49.371 billion; ISG revenue of $9.756 billion; and SSG revenue of $6.663 billion. Intersegment offset accounted for $3.844 billion. The company's IDG business consists of personal computers, tablets, smartphones, and other smart devices, currently holding a leading position in the global market with continuous sales topping the charts in recent years. In the fiscal year 2022, Lenovo's IDG business revenue and operating profit fell by 21% and 24% YoY, respectively, mainly due to the following reasons: 1) The sudden increase in demand for remote work and online learning in 2020 and 2021 stimulated PC consumption by businesses and individuals. PC manufacturers benefited from the market boom, achieving consecutive years of growth in shipments while overspending the demand for PCs, resulting in a decline in market demand in 2022. 2) In 2022, global macroeconomic downturn and excessive inventory in the global PC channel affected shipments due to destocking in the industry. Although the PC market was weak in the past few quarters due to channel inventory adjustments, the adjustments are coming to an end, and the trends in shipments and activations will become more consistent. The entire intelligent device market is expected to continue to rebound in the fourth quarter of 2023. In addition, the rapid development of AI technology has created new demand for PCs. The wide-ranging demand for AI applications requires more powerful processors, larger memory capacity, and faster storage devices. Lenovo's AI PC products have been publicly demonstrated. With the rise of the AI PC emerging market and improvements in the macroeconomic environment, Lenovo's IDG business is expected to show sequential improvement. The company's ISG business has a rich product matrix, including servers, storage, and other network hardware products, and provides cloud solutions. Lenovo is the world's third-largest server brand, trailing only DELL and HPE, with a market share of 7.1% in 1Q23, and overseas customers accounting for over 70%, including major internet cloud companies such as Microsoft, Amazon, Baidu, and Tencent. Lenovo's server business adopts a unique ODM+ model, enabling one-stop solutions for large-scale CSP's diverse, customized, and global server design, manufacturing, supply chain, delivery, and services. It has also launched the dual-brand strategy of ThinkSystem+Lenovo Xeno targeting overseas/domestic markets, providing global technology and local custom services. In the field of AI, Lenovo has made layouts around computer vision, speech recognition, knowledge graphs, intelligent data, and natural language processing, including various cutting-edge technologies such as 5G, AI, edge computing, and edge management. By 2022, Lenovo has applied for over 1,500 patents. The company is a strategic global partner of NVIDIA and the only NVIDIA data center/workstation/edge computing triple-certified partner in China (other certified partners include DELL and Supermicro). Lenovo's AI servers are in short supply, and AI servers now account for over 20% of the ISG business. The latest two AI server models have overwhelming order numbers, with some orders queued until 2024. Benefiting from its rich server designs and product portfolio, coupled with the increasing demand in the AI market, the company's ISG business revenue is expected to increase sequentially from 2022 to 2023. In the fiscal year 2022, Lenovo's ISG business achieved revenue growth of 37%, reaching $9.8 billion, setting a record for the third consecutive year. Meanwhile, operating profit reached $98 million. The company's SSG business provides end-to-end services from hardware to software, including a variety of hardware products, IT management services for terminals, data centers, clouds, and new edge computing scenarios, as well as project and solution services based on Lenovo's "Qingtian" technology architecture. In fiscal year 2022, this business achieved revenue and operating profit growth of 22% and 16%, respectively, reaching $6.7 billion and $140 million. The integrated and one-stop service of the SSG business can help customers achieve efficient procurement while considering the stability and flexibility of enterprise IT architecture. In recent years, Lenovo has provided intelligent services to nearly 200 large enterprises, including China Petroleum, State Power, Beiqi, Dongfeng, and Weichai. With the rapid increase in market demand for one-stop services, Lenovo's SSG business has a promising development outlook. Revenue forecasts by business segment: Intelligent Devices Group: The company's business consists of personal computers, tablets, smartphones, and other smart devices, with the personal computer business being a global leader, holding the top spot in global shipments for multiple years, and the smartphone business acquired Motorola, achieving top three shipments in overseas markets such as North and South America. Since 2022, products such as PCs have entered a destocking cycle, causing global...The shipment volume has declined for two consecutive years, dragging down the company's performance. The current PC destocking has already ended, and it is expected to enter a new upward cycle. Jiabang Consulting predicts that PC shipments in 24th year will recover by 2-5%, and after the destocking, product prices are expected to be repaired. In addition, AI PC is expected to drive a wave of upgrading, and it is estimated that the company's revenue from this business will reach 42.953/46.819/50.096 billion US dollars in FY24-FY26, with a YoY growth rate of -13%/9%/7%.Infrastructure Solution: The company's main business is composed of servers, AI servers, edge servers, storage servers, etc. The company is the third largest server brand globally and is a strategic partner of NVIDIA. It is also the only NVIDIA data center/workstation/edge computing triple-certified partner in mainland China. In FY23Q1/Q2/Q3/Q4, ISG infrastructure services achieved year-on-year growth rates of 14%/33%/48%/56%, showing a sequential acceleration trend. In the past 23 years, due to macroeconomic fluctuations and capital expenditure control by internet giants, the traditional server business has been weak. However, the strong market demand for AI servers has partially offset the decline in traditional servers. The value of AI servers can be more than 30 times that of traditional servers. With the significant increase in the volume of AI servers, it is expected to drive rapid revenue growth in this business from FY25 to FY26. Overall, it is expected that this business will achieve revenues of $9.468 billion / $11.362 billion / $13.066 billion in FY24/FY25/FY26, with year-on-year growth rates of -5% / 20% / 15%. Comprehensive Solution Services: This business combines software, hardware, and service businesses to provide customers with comprehensive solution services. This business has grown rapidly in recent years and has good profitability. Relying on Lenovo's comprehensive hardware layout advantages, it effectively improves production efficiency for customers. Currently, there is an urgent need for digital transformation in major enterprises, and there is a vast market space for this business. Based on historical growth rates, we expect this business to maintain a fast growth rate of approximately 20% from FY24 to FY26, achieving revenues of $7.996 billion / $9.435 billion / $11.133 billion, with year-on-year growth rates of 20% / 18% / 18%. In terms of gross profit margin, with the accelerated volume of the company's high-gross margin SSG business and the strong demand for AI servers driving up the gross profit margin of the ISG business, it is expected that the company's overall gross profit margin will be 17.47% / 17.67% / 17.92% in FY24-FY26.