Lenovo Q1 16A – White knuckle ride.

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One to watch but its scary ride right now.  

• Lenovo reported disappointing Q1 16A results as the weak PC and aggressive smartphone competition market triggered weak sales and OPEX declines could not keep up.
• Q1 16A revenues / EBIT were $10.76bn / $96m compared to estimates of $11.85bn / $157m.
• Despite the revenue weakness gross margins were steady at 15.4% compared to 15.6% in Q4 15A which were also above consensus expectations of 14.8%.
• Despite the PC market related weakness, Lenovo managed to gain share without cutting prices moving into clear leadership with 20.6% market share ahead of HP on 18.9%.
• Lenovo also gained slightly in the tablet market to 5.6% share but struggled in smartphones where share fell to 4.4% from 5.5% in Q4 15A and 7.6% in Q1 15A.
• This was largely due to severe competition in the Chinese market as well as an increasingly difficult environment in Brazil and Latin America where Motorola has historically been quite strong.
• Mobile did most of the damage to EBIT as a $292m loss (-13.8%) was recorded compared to -7.7% in Q4 15A.
• The PC business remained healthy despite the weaker revenues posting margins of 5.5%.
• As a result, Lenovo is speeding up its reorganisation with another 3,200 positions to go, mostly at Motorola, which should be completed within the next three months.
• This should deliver savings of $650m in H2 16E ($325m per quarter) and return the overall group to low single digit profitability and positive cash generation.
• Once it has returned to this position it will then be better placed to consider its long term future.
• The PC business is looking good because if it can distance itself further from the No 2 player it will increasingly be able to earn better margins as a result of its scale advantage.
• Action is needed in mobile as Lenovo wants to become a strong number three in the market and is facing off against a resurgent Huawei which picked up 310bp of smartphone market in the last quarter alone.
• How much Huawei had to give up in terms of margins to gain that share is not clear but I suspect that profitability in Huawei’s consumer segment has taken a heavy hit.
• The key here is for Lenovo to make the most of Motorola.
• It has a good brand is some markets and its products are reasonably distinctive from those offered by its peers.
• If it can really streamline its operations and still maintain a distinctive look and feel, then it has a chance, but the market share losses need to stop now.
• I am predisposed to like Lenovo as it has a pretty solid management team that is well versed in selling commoditised products and dealing with the ravages of competition.
• Furthermore, I think that it has understood how the world of consumer electronics is evolving towards the ecosystem.
• The shares are down 48% since May even though its fundamental position remains reasonably steady.
• This is another one to watch carefully from the side-lines as at the moment it’s a white knuckle ride.