DBS Group Research is reinstating its coverage on Hong Kong listed hardware giant Lenovo Group with a “buy” and target price of HK$11.30, following the group’s latest transformation strategy, which analysts Jim Au and Tsz Wong Tam believe will bring about a promising outlook for the company.
“We re-instate coverage on Lenovo with a ‘buy’ rating due to the new services and solutions business driver not being priced in, its net margin gap with its peers narrowing, and an undemanding valuation of a 6.0x FY2022 PE,” say the analysts.
The tech hardware giant, with the largest share of 23.5% in the global PC market, is transforming into a service-led company by leveraging the world’s largest active PC user base of about 218 million and its strong reputation in hardware products, channelling growth into the services and solutions business.
Started in 2021, Lenovo’s solutions and services business is expected to facilitate its transformation from a leading global devices company into a global devices, solutions, services, and software technology company.
The new solutions & services business (SSG) is going to drive the company’s transformation by delivering incremental business across smart verticals, attached services, managed services, and “X as a service” offerings name “TruScale”. These offerings include “devices as a service “(DaaS).
With its large active PC user base, the analysts believe that there is ample room for expansion in the SSG business. “We expect the new service business segment’s operating profit to grow at a CAGR of 31.1% in FY2022-2025, on the back of rising penetration of DaaS, which is expected to grow at a CAGR of 37.8% in 2021-2028; leveraging on its large PC user base; and its high commercial user penetration (over 60%),” says Au and Tsz.
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With that, the analysts forecast for the group’s operating profit share to increase from 23.5% in 9MFY2021 to 33.8% in FY2025. The incremental contribution is going to boost the company’s operating margin from 3.6% in FY2021 to 5.3% in FY2025, as SSG has an operating margin of 21.3% compared with 3.6% of the group.
Meanwhile, China’s central government launched the “Eastern Data, Western Computing” initiative early this year and approved the construction of eight computing hubs across the country to effectively improve the nation’s computing power and minimise carbon emissions. Annual investment in the above-mentioned areas is expected to exceed RMB400 billion, while the NDRC expects China's computing power demand to surge by over 20% annually during the period of the 14th five-year plan.
Lenovo’s industry-leading server cooling technology can lower its power usage effectiveness (PUE) to 1.10 in order to meet the project’s solid green targets of less than 1.25 (compared to the 1.49 average for China’s data centres in 2021).
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Assuming five million standard racks in China and an expected annual growth in computing power of 15%, the analysts expect the server business revenue to grow by 11.2% in FY2022 and 65.0% in FY2023, which is 3.0% and 53.2% higher than the market consensus, respectively.
Lenovo is currently trading at a 6.0x FY2023 PE, about 1 standard deviation below its five-year historical average (8.5x) because of the slowed PC industrial growth.
“Its valuation is also below its peers’ average (8.5x) because of its lower net margin due to lower revenue contribution from the services and solutions business. We expect the discount to its peers to narrow due to a higher contribution from the services and solutions business after the transformation into a service-led business,” says the analysts.
Shares in Lenovo closed at HK$7.37 on May 24, giving it a FY2022 price-to-earnings ratio of 6.6x with a dividend yield of 4.4%.
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