Lenovo Group (00992): Welcoming the Year of Explosive Growth for AI PC, Driving Valuations to Soar

After several quarters of adjustments, the fundamentals of the PC industry are gradually improving. According to IDC data, the global PC shipments decline has slowed down on a quarterly basis, with a Q2 shipment growth rate of 11.9%. LENOVO GROUP (00992), as a leading player in the industry, maintains a 24% market share. On October 24th, LENOVO GROUP (00992) showcased AI PC to the market, leading the innovation wave of AI hardware and terminals. Market expectations are that this will stimulate consumer purchasing intentions and shorten the replacement cycle, potentially reversing the current industry demand situation. In fact, PC industry inventory continues to be consumed, and new products will receive more attention from the market. The powerful product offerings of AI PC will solidify Lenovo's dominant position in the PC market. According to LENOVO GROUP's Q2 and first-half performance report for the 2024 fiscal year, although its revenue was affected by the PC industry, its recovery was strong. Q2 revenue reached $14.41 billion, an 11.7% increase compared to the previous quarter. Additionally, the company maintained strong profitability, with a year-on-year gross profit margin increase of 0.7 percentage points. Its first-half revenue and gross profit reached $27.31 billion and $4.774 billion, respectively, with a gross profit margin of 17.5%, an increase of 0.6 percentage points year-on-year. The financial report of LENOVO GROUP highlighted the new application of artificial intelligence (AI). Yang Yuanqing, Chairman and CEO of the group, mentioned that the company has been steadfast in promoting the transformation strategy towards intelligence for many years. It has a comprehensive AI roadmap and the capability to establish the strongest partnerships to seize the enormous opportunities created by the AI revolution. With a solid foundation, AI PC stimulates industry demand According to LENOVO GROUP's financial report, the three major business segments IDG, ISG, and SSG are robust. IDG was slightly affected by the PC industry but showed gradual improvement on a quarterly basis, while SSG maintained double-digit year-on-year growth. Compared to Q1, the three major business segments performed strongly in Q2, achieving revenues of $11.515 billion, $2.002 billion, and $1.918 billion, respectively, with growth rates of 12.22%, 4.65%, and 11.97%. They contributed 74.6%, 12.97%, and 12.43% to the company's revenue, respectively. As the core revenue generator, the PC segment of IDG has significantly improved over the past two quarters. The profitability ratio has steadily increased, with a Q2 operating profit margin of 7.35%, an increase of 1.02 percentage points compared to the previous quarter. The operating profit contributed 72% to the company's overall profit. ISG and SSG, as the company's twin engines, support its performance robustness. Among them, SSG achieved year-on-year revenue growth of 11.45% and 14.29% in Q2 and the first half of the year, respectively. The operating profit margin for both quarters exceeded 20%, contributing 32.6% to the company's profits. In LENOVO GROUP's Q2 financial report, "AI" is the most important keyword. The core IDG business includes PCs, smartphones, and other smart devices, with PCs accounting for 80% of the total. With the industry reshuffling, the company's market share remains stable at 24%, firmly establishing its leadership position and widening the gap with its two major competitors. It particularly dominates the commercial PC segment with a market share of 26% in Q2. In fact, the development of artificial intelligence is accelerating the transformation of intelligent devices centered around PCs. The release of Intel's next-generation Meteor Lake processor heralds the era of AI PCs. Lenovo, with its long-standing partnership with Intel, has taken a leading position in the market during the development of AI PCs, driving industry transformation and being the first to transform into AI PC products that fully meet the demands of new generative AI workloads. Lenovo's AI PCs can create personalized local knowledge bases, run large-scale personal models through model compression technology, achieve AI natural interaction, and provide tailored intelligent productivity tools while protecting personal privacy data. The introduction of AI PCs has also reversed the pessimistic expectations of major investment banks and other institutions for the PC industry. For example, according to an IDC report, the popularity of generative AI and other technologies will be important factors driving the development of the PC industry. IDC predicts that with the launch of a large number of AI PCs next year, overall sales prices will increase significantly. It should be noted that PC industry inventory is being cleared, and the fundamentals are gradually improving, with new products expected to stimulate consumer demand for upgrades in the second half of the year. Two factors are expected to stimulate industry demand in 2024: first, the new Windows 11 system is expected to further drive end-user demand; second, the start of the AI PC explosion year will further stimulate user demand, and Lenovo, with its first-mover advantage, will be the first beneficiary. In addition, non-PC businesses within IDG have performed well, accounting for 20% of its revenue in Q2 of the 2024 fiscal year. Smartphone sales are growing rapidly, aided by a market focus on high-end strategies, innovative high-end product portfolios, and double-digit shipment growth exceeding the market. Lenovo leverages its advantages in AI and has also entered the field of AI smartphones and other AI smart devices. With the launch of new models, multiple-line growth is expected. AI empowers twin engines, unlocking market space Lenovo's AI technology is not only applied in the IDG business but also penetrating the ISG and SSG twin engine businesses. It has realized a comprehensive AI roadmap and its years of R&D investment have resulted in a leading advantage in AI, which is now bearing fruit. In the ISG segment, the company has established a comprehensive portfolio of infrastructure solutions and expanded further into the AI field. Investments and developments in new areas carry costs, which is the reason for the pressure on profitability in this business segment. The company has launched a new type of edge server with differentiated technology, reducing energy consumption by 32%. This server can enable companies to deploy AI applications with high reliability and efficiency. Additionally, the company is developing hardware, software, and service combinations to facilitate seamless delivery of artificial intelligence in data creation and storage. The company has responded to the current demand for AI computing power by releasing the Lenovo AI Computing Strategy, comprehensively integrating AI into its products. This strategy aims to provide a full stack of AI solutions, covering hardware, software, and services, and to contribute to customers' AI transformation by providing computing power, algorithms, and data. With AI empowering its twin engine businesses, Lenovo is unleashing the potential of the market space, catching up with the trend of AI development, and driving business growth.Build an AI-driven infrastructure. The company's AI server products have performed exceptionally well, maintaining high growth momentum and accounting for nearly 20% of the server business. According to IDC data, the market share is expected to reach 22.97% by 2022. Furthermore, the storage business continues to maintain its leading advantage. In March of this year, the company released two new storage products that received market recognition, resulting in an increase in global market share ranking to third place.The SSG business is the company's most potential growth business, achieving double-digit growth for ten consecutive quarters and having the strongest profitability with a profit margin of 21%. This business includes support services, operation and maintenance services, and project solutions services, all of which achieved positive growth in the first half of the year. Among them, the operation and maintenance services benefited from the strong demand for the TruScale as a service solution, with a year-on-year growth of 41%. AI has significantly empowered the SSG business, and Lenovo ZhenSuan service "TruScale" has become one of the main growth drivers of SSG. It fully utilizes its layout in AI to support three types of computing scenarios (general computing, intelligent computing, and supercomputing) through three delivery modes (hybrid cloud, ZhenSuan service 2.0 subscription-based, and one-stop), providing full-stack full-life cycle services. The ZhenSuan service 2.0 added domestic computing power and platform service capabilities, covering AI services, middleware services, database services, and metaverse services. Lenovo Group's core business and dual-engine business are creating AI+ products in all scenarios. On one hand, this improves the product quality, activates market purchasing desire, and expands the market space. On the other hand, it maintains the company's leading position in the industry under the first-mover advantage, driving steady performance growth. In the second half of the 2024 fiscal year, it is expected that the company's IDG business will continue to grow, new products (including AI PCs) will increase profitability, the achievements of the ISG business's AI layout will become apparent with AI servers continuing to lead the industry, and SSG will maintain its double-digit growth trend, with TruScale featuring AI as a growth highlight, and abundant cash flow under high-profit margins. Major investment banks have a positive outlook on the company, and its valuation is expected to continue to rise. The AI era has arrived, and observant investors will notice that every industry is now talking about intelligence, with the automotive industry being the most typical example. They seek to gain higher product quality and market share through intelligence, with companies like Xiaopeng proposing AI driving products. AI is everywhere, permeating into everyone's lives. As early as 2017, Lenovo had already foreseen the opportunities in the AI era and put forward the "All in AI" strategy, establishing a leading position in the industry with six years of technological accumulation. From "All in AI" to "AI for All", the company is now at a turning point in its AI-driven transformation. This is also the confidence behind the company's AI layout in all three businesses. After years of technological accumulation, the market application has gradually matured, providing a solid foundation for commercialization and gaining high recognition from peers and the market. The iteration of AI+ products enhances the performance and cost-effectiveness of existing products, especially AI PCs, which are expected to become the biggest growth highlight at a time of low inventory and replacement cycles. Major investment banks are optimistic about Lenovo Group. Goldman Sachs research report believes that Lenovo's quarterly net profit exceeds expectations of the industry and the market. The company is still benefiting from the recovery of the PC industry and the Gen A trend, with expectations of positive year-on-year growth in shipments by the end of December, up by 6%, and a "buy" rating. EB SECURITIES believes that in the short-term, AI PCs will boost the company's valuation driven by market sentiment, and in the medium and long term, the fundamentals will fully recover and AI PC data will be verified, maintaining a "buy" rating. The secondary market has also shown trust in Lenovo Group, with the company's market value surging by 55.5% this year, outperforming the Hang Seng Index by 67.31 percentage points. The first half of the year saw an increase mainly due to the advantage in computing power, attracting investors' attention with the company's outstanding performance in AI servers. The second half of the year saw an increase in AI advantages, with the introduction of AI PCs reversing expectations for the second half of the fiscal year. With the support of computing power and AI, the company's fundamentals continue to improve, and its market value will also maintain an upward channel. In summary, Lenovo Group's Q2 performance in the 2024 fiscal year shows resilience, with AI continuously empowering its three major businesses. The iteration of AI+ products stimulates market demand and opens up business market space, and its market value is still seen as high.