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Lenovo (992.HK): Lots to Like in 2014; Raising Target to HK$10.80




Sun Hung Kai Financial


24 Nov 2013





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There is a lot to like about Lenovo in 2014: * Lenovo’s smart phone growth has up until now been China specific. According to IDC, the company is now #4 globally for smart phone shipments and #2 in China. With a firm sales base at home and good traction in some emerging markets, Lenovo looks to mirror its PC strategy with its smart phone business. Over the next few quarters Lenovo plans to expand into 20 new countries. We expect the company to gain more than 1ppt in global shipment share before the end of FY2015. * Sales of Lenovo tablets have been brisk. We argue that the firm’s recent product rollouts have delivered more competitive tablets than in the past but there remains runway for improvement. The newly released Yoga tablet has been met with mediocre tech reviews but we see it as more of a marketing push than product innovation. Lenovo’s tablet business has been able to leverage its PC distribution channels fairly well resulting in a more balanced geographic mix of sales when compared to smart phone sales. Last quarter, the company shipped 2.3m units with only 38% of those in APAC. We believe Lenovo could sell well over 5m units by the same time next year, outpacing expected market growth of 25%-30%. * This coming quarter the company will open its US$800m Wuhan mobile factory. At capacity, the facility will be able to ship 100m tablets and smart phones annually. In Q3 (fiscal Q2) the company shipped a combined 14.6m tablets and smart phones. The plan is to bring more device production in-house which should reduce manufacturing costs while shortening the time to market for newly designed products. * A corporate PC refresh on the back of expiring Microsoft support for Windows XP in 2014 is real. PC shipments are showing an inflection point in commercial PC growth in U.S. markets. This should translate into the rest of the world following. Management noted that China commercial PC demand is already improving. Lenovo’s strong exposure to enterprise PC sales positions them well to benefit from improvement in global commercial PC sales. Our investment thesis for Lenovo is based on company-specific opportunities that will allow it to continue to grow revenue at 11% CAGR for FY2014E-16E driven by 1) sales of tablets and smart phones, 2) continued PC penetration in emerging markets and market-share gains in developed markets, plus 3) growth from 2012 acquisitions and JVs. We expect operating margins to improve 40-50 bps over the next two years, driven by 1) increases in in-house product manufacturing, 2) benefits from economies of scale across Lenovo’s platform of products, and 3) gross-margin improvement due to a higher mix of non-PC devices and commercial PCs. Forecast: We are raising our EPS for FY2014E from US¢7.5 to US¢7.9 and our FY2015E from US¢8.6 to US¢9.7. Our new FY2016E estimate is US¢10.8. Our estimate changes are based on a strong set of Q2 earnings, better operating cost to revenue ratios, greater profitability on tablets and smart phones and an improving outlook for commercial PC sales. Valuation: We raise our target price from HK$9.00/share to HK$10.80/share. Our target price is based on 14.5X our FY2015 estimates previously 13.5X. We believe improved growth visibility and profitability for tablets and smart phones will result in multiple expansion. Our expected EPS CAGR is 22% for FY2014E-16E. We reiterate our BUY recommendation on the stock. Risks: (1) Faster than expected decline in PC revenues; (2) Increa...

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