Lenovo’s December-Quarter Profitability and Progress on Inventory Correction Are Impressive

While Lenovo’s 00992 December-quarter revenue was down 24% year over year due to weak PC shipments, we are encouraged that the company maintained solid profitability. The operating margin of 4.9% in the December quarter was only slightly lower than 5.0% in the September quarter and up from 4.6% in the year-ago quarter, due to the solid margin expansion in the server business and the company’s cost-saving initiatives, which are impressive in a challenging environment. We expect the March quarter to be the bottom of Lenovo’s fundamentals due to the low seasonality and expected restructuring, but we believe that most risk factors are already priced in. We maintain our fair value estimate of HKD 10.50, which corresponds to 11 times price/earnings and 3.2 times price/book on a fiscal 2022 basis.

According to Gartner, global PC shipments declined 28.5% year over year in the December quarter, worsening from the 16.6% decline in the September quarter. However, we believe actual end demand did not deteriorate as much as this suggests—Lenovo’s management said the number of PC activations in the quarter was down only 5% year over year. Based on this, we ascertain that the inventory in the supply chain has been reduced over the past few quarters. Lenovo’s own inventory levels have also declined by more than 15% over the past two quarters, which leads us to conclude that the inventory adjustment is nearing its end. While demand for consumer PCs remains uncertain, we believe that replacement demand for commercial PCs will pick up in the second half of the year. Overall, while we forecast 2023 global PC shipments to decline 8%-9% from the previous year, we expect them to return to growth in the December quarter of 2023, which should be a catalyst for the stock.