Artificial intelligence is reshaping the memory market landscape, transforming Lenovo Group (HKG: 0992) from a victim of cyclical pressures into a beneficiary with pricing power, prompting Morgan Stanley to significantly upgrade its rating and price target for the company.

On July 9, Morgan Stanley's Howard Kao-led team raised its rating on Lenovo from Equal-weight to Overweight, lifting its target price substantially from HK$14.20 to HK$30.00, implying an approximate 34% upside from the closing price of HK$22.32 on July 8.

The report states that AI-driven demand has fundamentally altered the supply-demand dynamics of the memory market, enabling Lenovo to pass on higher component costs to customers while maintaining its profit margins. The bank expects this trend to persist at least through the second half of 2026.

Morgan Stanley's upgrade carries significant valuation implications. Its earnings per share forecasts for fiscal years 2027 to 2029 are roughly 20% above the market consensus, primarily due to stronger assumptions regarding profit margins.

Over the past two months, Lenovo's share price has surged by 82%, while the Hang Seng Index has declined by 9% over the same period.

Semiconductor Price Increases Redefine OEM Pricing Dynamics

The current memory price upcycle is fundamentally different from previous ones.

Morgan Stanley notes that in past memory upswings, customers often delayed purchases anticipating price declines, which directly limited the pricing power of OEMs and ultimately pressured their margins.

However, AI-driven demand is simultaneously tightening supply for HBM, DRAM, and enterprise SSDs, while new capacity additions require several years, not quarters, for construction, certification, and production ramp-up.

Morgan Stanley therefore views the current environment as a structural shift in industry supply-demand relationships, rather than a traditional semiconductor cycle fluctuation.

This shift has profoundly changed customer behavior. At the 2026 International Supercomputing Conference, Lenovo's management indicated that memory prices "may never return" to early 2025 levels, a view reiterated at an investor day in New York on June 25.

Morgan Stanley argues that with customers adjusting expectations and no longer anticipating near-term price declines—potentially even accelerating purchases to hedge against future price increases—Lenovo now has ample pricing power to fully pass through higher component costs without sacrificing profitability.

The bank also highlights that in the current environment, securing memory supply is at least as critical as price.

Lenovo holds structural advantages here, including procurement scale as the world's largest PC maker, long-term supplier relationships, and access to China's domestic memory supply chain.

These factors enable Lenovo to secure component supplies more effectively than most peers while maintaining a lower cost structure, allowing it to prioritize profitability without necessarily engaging in price wars.

Rapid Rise of ISG Accelerates Profit Structure Transformation

Lenovo's profit structure is undergoing a deep transformation, with the rapid rise of the Infrastructure Solutions Group (ISG) as the core driver.

Morgan Stanley projects that ISG revenue will surge 74% from approximately $19.2 billion in FY2026 to about $33.3 billion in FY2027, and further grow by 29% and 26% in FY2028 and FY2029 to $43.0 billion and $54.3 billion, respectively.

This growth is supported by robust enterprise server demand, continued investment in hyperscale data centers, accelerated AI server deployment, and higher system average selling prices underpinned by elevated component costs.

The shift in profit contribution will be even more pronounced than on the revenue side.

Morgan Stanley forecasts that ISG will grow from near breakeven in FY2026 to contributing about 35% of the group's profit by FY2029, with its operating margin expanding from 0.4% in FY2026 to approximately 6.9% by then.

In contrast, the share of revenue from the Intelligent Devices Group (IDG, encompassing PCs and tablets) is expected to decline from 67% in FY2026 to 50% in FY2029.

Lenovo's AI server order backlog has reached approximately $21 billion, providing high visibility into future demand.

Morgan Stanley notes that demand from key hyperscale customers like Microsoft and Oracle is expected to continue, while Lenovo is also expanding its exposure to cloud services and sovereign AI projects. Management has indicated there is no significant near-term risk of customers shifting orders directly to ODMs.

PC Division: Prioritising Profitability Over Volume

For its core PC business, Morgan Stanley expects Lenovo's PC shipments (including desktops and notebooks) to decline by about 9% year-on-year in FY2027 to 63.4 million units, primarily due to memory supply constraints rather than weak end-user demand.

Despite the shipment decline, PC revenue is projected to grow by about 8% year-on-year to $55.0 billion in FY2027, driven by higher average selling prices and an improved product mix, with the operating margin maintained at around 7.7%, translating to an operating profit of roughly $4.3 billion.

Morgan Stanley believes Lenovo's market share could actually increase from 24.1% in FY2026 to about 26.0% in FY2027, leveraging its procurement scale and supplier relationships in a supply-constrained environment.

Against an expected backdrop of a 3-4% year-on-year decline in global PC shipments in FY2028, Lenovo's PC shipments are projected to remain largely flat, demonstrating sustained market share gains.

Lenovo's smartphone business faces greater pressure.

Unlike the PC segment, Morgan Stanley believes Lenovo cannot fully pass on higher component costs to end consumers due to more intense competition in the smartphone market.

Smartphone shipments are forecast to decline by about 13% year-on-year in FY2027, with the operating margin falling from 3.6% in FY2026 to 1.7%, leading to an approximate 55% year-on-year drop in operating profit to around $127 million.

Forecasts Substantially Above Consensus Signal Valuation Upside

Morgan Stanley's earnings forecasts are notably more optimistic than the market consensus.

While its revenue forecasts for FY2027-FY2029 are only about 5% above consensus, its net profit forecasts are roughly 20% higher, with the core difference stemming from more robust margin assumptions.

Specifically, Morgan Stanley forecasts net profit margins of 3.0%, 3.4%, and 3.8% for FY2027-FY2029, compared to consensus expectations of 2.6%, 3.0%, and 3.3% respectively; its operating margin forecasts are 50 to 60 basis points above consensus throughout this period.

For the upcoming first quarter of FY2027 (F1Q27), Morgan Stanley's analysis projects revenue of $23.7 billion, 6% above consensus; net profit of $681 million, 26% above consensus; and a gross margin of 16.6%, up 190 basis points year-on-year, with a "very high" probability of an upside surprise.

On valuation, the HK$30 target price implies a 13.5x forward P/E based on FY2028 earnings, above Lenovo's historical average of around 9.5x over the past three years but still below the approximately 20x P/E implied by Dell Technologies' infrastructure business.

In a sum-of-the-parts valuation check, applying multiples of 10x, 16x, and 15x FY2028 P/E to the IDG (PC), ISG, and SSG (services) businesses respectively yields a blended valuation of around 13x, highly consistent with conclusions from a residual income model.

The report suggests that as ISG's profit contribution continues to rise, investors may increasingly re-evaluate Lenovo through the lens of an infrastructure and AI solutions provider, potentially driving its valuation closer to that of Dell.

Management's medium-to-long-term targets announced at the June 25 investor day support this thesis: a 1-2 year target of $100 billion revenue with a net profit margin above 3%; a 3-5 year target of $130 billion revenue with a 5%+ net profit margin; and a target beyond 5 years of $150 billion revenue with an 8%+ net profit margin.

Morgan Stanley views the 1-2 year target as conservative, with current forecasts indicating Lenovo is on track to essentially achieve these metrics in FY2027.