Key Highlights:

• Lenovo’s profit dropped by 23% in its third fiscal quarter to $340 million
• The tech giant anticipates that its new AI PC models will ignite its future revenue growth

By Lau Chi Hang

Shares of Lenovo Group Ltd. LNVGF were under severe pressure recently following the release of its third fiscal quarter results up to December. The stock experienced a sharp decline of 9.3% initially but managed to recover slightly to end the day down by 3.3% at HK$8.55. Nevertheless, this performance left Lenovo trailing behind only local developer Wharf Real Estate (1997.HK) as the biggest laggard of the day.

So, why the investor fretting? Despite Lenovo reporting revenue of $15.7 billion for the three months ending in December, marking a third consecutive sequential increase, and a profit of $337 million, up by 35% from the prior quarter, the year-over-year comparison was less favorable. The revenue saw paltry growth of just 3% from the corresponding quarter of the prior year, with profits nosediving by 23%. Year-to-date, Lenovo’s revenue dropped by 13% while profit plummeted by 49%.

Falling Out of Favor with Investors

Though the recent positive trend in quarterly revenue might suggest some operational improvements, skepticism looms large among analysts concerning Lenovo’s long-term outlook. Several analysts slashed their price targets for the company by varying degrees, with Bank of America making a substantial cut from HK$11.20 to HK$9.10. Likewise, CLSA and UBS downgraded their ratings. The frosty sentiment primarily stems from concerns over Lenovo’s server business bleeding red ink due to hefty spending on new product development and lackluster guidance.

Despite the pervasive pessimism, HSBC stands out as a lone bull, increasing its target price on Lenovo while highlighting the company’s robust operating margins surpassing market expectations and foreseeing a break-even for its global server business by 2025.

Bright Prospects with AI PCs

While short-term market sentiment might be lukewarm towards Lenovo, longer-term hopes hinge on advancements in AI-powered PCs, or AI PCs. The rising enthusiasm for AI integration in PCs has propelled the stocks of many related companies, exemplified by Dell’s 32% surge following strong server sales driven by demand for AI-optimized models.

The emergence of hybrid AI PCs is expected to trigger a new wave of PC upgrades, revitalizing sales growth. Lenovo’s Chairman and CEO, Yang Yuanqing, anticipates that more than half of all PCs will sport AI functionalities by 2026. To stay competitive in this pivotal era, Lenovo and its rivals are ramping up investments in product innovation, with Lenovo aiming for a record-high R&D spending ratio this fiscal year.

In an investor conference, executive vice president and Lenovo China President Liu Jun divulged plans for unveiling two AI PCs in the $1,000 to $1,500 price range at the company’s Innovation Technology Conference in April, beckoning attention towards Lenovo’s strategic moves in this critical domain.

Skepticism around the PC Industry Evolution

However, skeptics cast doubts on whether the AI PC trend will foster a renaissance in PC sales for the mature industry. Despite the AI PCs’ potential, the global PC market continues to exhibit sluggish growth post-Covid, with IDC projecting modest average annual growth of 3.1% through 2027. Consequently, the transformative impact of AI PCs on overall sales appears limited.

Moreover, uncertainties linger over Lenovo’s ability to capitalize on the AI PC wave, with potential profit windfalls potentially eluding PC manufacturers in favor of players in the supply chain like chip manufacturers such as Nvidia and AMD. Geopolitical tensions add another layer of complexity, as restrictions on the sale of advanced chips to China could adversely impact Lenovo and its compatriots in the tech space.

Suggestions of U.S. scrutiny on Lenovo due to suspicions of data privacy breaches highlight the broader challenges facing Chinese tech firms in the international arena. With Washington’s cautious stance towards Chinese tech advancements, Lenovo faces a precarious position along with its peers in the industry.