20160817-美银美林-联想集团-00992.HK-June_Q_core_OP_a_big_miss__re-it_U_P_on_exacerbating_margin_pressure_13页_787kb

Lenovo Q2 2017 Financial and Strategic Summary

Core Business Performance

Lenovo's Q2 2017 results exceeded BAML estimates by 22%, but this was largely due to a one-time disposal gain of $120 million from the sale of a Beijing office building. Excluding this gain, the company's operating profit margin (OPM) was significantly lower at 1.3%, indicating a 38% miss compared to BAML's expectations on the operating level.

Mobile and Server Businesses

• Mobile: The pre-tax margin dropped to -12% in Q2, compared to -8% in March, despite a 6% quarter-over-quarter shipment increase and a shift to higher average selling price (ASP) segments. The challenges include intense competition in a slowing growth market and a lack of control over core components and channel networks compared to competitors like Huawei, OPPO, and Vivo.
• Server: Although Lenovo reported 14% year-over-year revenue growth in China, the pre-tax margin declined to -5.9% from -1.6% in March. The server business also faced operating losses, highlighting ongoing pricing competition from companies like Huawei, Inspur, and Dawnning.

PC Business

The PC segment was the only bright spot, with a pre-tax margin rising to 5.3% from 4.7% in March, driven by tight operational expenditure (opex) control and peers' model transitions. However, the margin premium might narrow in the second half of the year due to increased competition with new models from ASUS and Apple. Lenovo's PC business is strong in China and the US, but faces tough market conditions and strong price wars in EMEA.

Financial Estimates and Valuation

Investment Rationale and Rating

Lenovo is rated as Underperform due to its rushed M&A strategy, which has led to earnings uncertainty, a tighter cash position, and execution risks. The company's net debt reached $1.2 billion, and the earnings outlook has declined over the past two years, leading to a valuation correction.

Strategic Initiatives

• Product Focus: Lenovo is focusing on detachable PCs, gaming PCs, Chromebooks, and workstations. It plans to launch Moto Z and Moto Mods in China in September, aiming to strengthen its high-end portfolio.
• Channel Expansion: The company is expanding its channel presence in key markets, including China (Suning, JD.com), the US (BestBuy, Costco), and Germany. It aims to cover all three major channels in China.
• Cost Optimization: Lenovo has achieved a $1.35 billion opex reduction in the last four quarters.

Regional Performance

• China: Revenue declined 10% YoY, with a pre-tax margin of 4.8%. Despite this, the company saw a significant improvement in ASP.
• APAC: Revenue increased by 4% YoY, with a pre-tax margin of 1.0%. Lenovo gained 0.4% market share in the PC market.
• EMEA: Revenue fell 7% YoY, with a pre-tax margin of -2.0%. The server business remained challenging in this region.
• AG (Americas): Revenue declined 3% YoY, with a pre-tax margin of 1.3%. Lenovo's PC share increased to 14.4% in this region.

Earnings Revisions

Comparison with BofAML and Street Estimates

Preferred Brands

The report prefers industrial brands such as Hikvision, Advantech, and Delta over consumer brands like Lenovo, ASUS, and HTC, due to better profitability and margin performance.

Analyst Information

• Robert Cheng: Research Analyst at Merrill Lynch (Taiwan), contact: +886223763731, robert.cheng@baml.com
• James Wang: Research Analyst at Merrill Lynch (Taiwan), contact: +886223763816, james.p.wang@baml.com

Stock Data

• Price (Common / ADR): 5.47 HKD / 13.75 USD
• Price Objective: 4.50 HKD / 11.90 USD
• Investment Opinion: C-3-8 / C-3-8
• 52-Week Range: 4.49 HKD - 8.82 HKD
• Market Value (mn): 7,880 USD / 61,106 HKD
• Shares Outstanding (mn): 11,171.1 / 558.6
• Average Daily Value (mn): 57.72 USD
• Free Float: 55.0%
• BofAML Ticker / Exchange: LNVGF / HKG, LNVGY / OTU
• Bloomberg / Reuters: 992 HK / 0992.HK
• ROE (2016E): -4.1%
• Net Debt to Equity (Mar-2015A): 51.5%

Key Metrics

• Return On Capital Employed: 6.6% (FY17E)
• Return On Equity: 17.5% (FY17E)
• Operating Margin: 2.0% (FY17E)
• Pretax Margin: 1.7% (FY17E)
• Net Margin: 1.5% (FY17E)

Disclaimer

This research report provides general information only. No part of this report may be used or reproduced without the express written consent of BofA Merrill Lynch. Investors should consider this report as only a single factor in making their investment decisions.