Morningstar | Lenovo’s 4Q Results Slightly Beat on the Back of Margin Expansion; Raising FVE to HKD 8 per Share
No-moat Lenovo’s fiscal 2019 fourth-quarter results (ended in March) were better than our expectations, with revenue and net profit up 10% and 260% year on year, respectively. Strong revenue growth was driven by solid PC and smart device business, and the resumption of growth in the mobile business. The gross margin, up 1.7 percentage points year on year to 16.2%, was better than we projected, bolstered by a better product mix and favorable key component prices. We are raising our fair value estimate to HKD 8.00 per share from HKD 7.10, as we revise up our gross margin assumptions, while maintaining our no-moat and negative trend ratings. We think the margin expansion will be sustainable after the mix shifting toward higher-margin commercial PCs, as well as stabilized prices for the key components, given the shortage issue is being solved.We think the shares are undervalued at current levels, trading in four-star territory. We think the recent stock weakness was because of the negative sentiment from the rising U.S.-China trade tensions. The market seemed to be worried about the risk that the U.S. government lengthens its list of companies it believes pose a risk to national security and could prevent Lenovo from trading with U.S. firms. Given the company is neither owned nor controlled by the Chinese government, we think this risk is low. If trade tensions increase further, however, such a possibility cannot be entirely ruled out. If Lenovo loses all the business in the U.S. market, we project the company’s revenue will be 20% lower than our current estimates, leading to an erosion of more than 20% to our fair value estimate.
The PC and smart device segment, Lenovo’s largest business, achieved robust revenue growth of 10% for the March quarter. The company also returned to the leading position in the global PC market, with shipments up 9% compared with negative 2.6% growth for the market. The pretax income margin expanded to 5.2% from 4.8% a year ago, boosted by a favorable product mix toward premium segments and higher services attach rate. Its $800 plus price segment in commercial notebook PCs has led the market for three consecutive quarters, according to the company.
After five quarters of declines, the mobile business resumed its sales growth at 15% and remained profitable for the second consecutive quarter, improving pre-tax income by $146 million from last year, thanks to its strategy to focus on the North and Latin American markets. The data center business achieved the fastest growth since the acquisition of the x86 server business, led by strong growth of the hyperscale and software defined infrastructure. Losses narrowed to $53 million from $64 million the year-ago quarter, with the pretax margin improving from negative 5.2% to negative 4.2%.
Lenovo Group is an investment holding company. Through its subsidiaries, Co. is engaged in: manufacturing and distribution of IT products and provision of IT services; manufacturing of computers and peripheral equipment; provision of business planning, management, global supply chain, finance, and administration support services; R&D of mobile software; and distribution of IT products as well as mobile phone, smart phone and tablet, server and storage. Co. also provides a full complement of ENERGY STAR® qualified notebooks, desktops, workstations, monitors, and servers. As of Mar. 31, 2015, Co. oeprated four geographical segments, China, Asia Pacific, Europe-Middle East-Africa and Americas.
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