Morgan Stanley: PC market to experience rapid growth next year, these two stocks are preferred.

Recently, the internationally renowned bank Morgan Stanley released a research report stating that PC manufacturers have been lowering their order forecasts for the supply chain since last year, and now these forecasts seem to have bottomed out. Morgan Stanley believes that PC manufacturers' shipment forecasts have been revised upward for the first time in a long time, and it is expected to recover and reach 265 million units (+8% YoY) by 2024.

According to Morgan Stanley:

As seen since 2022, the PC market has gone through a difficult period, and PC manufacturers have revised their shipment forecasts for the supply chain.

In the past two years, PC manufacturers (such as Dell and HP) have revised their shipment forecasts for the supply chain for the first time in a long time. Of course, this is not an isolated case, and other PC OEMs also face similar situations.

In the PC market in the business and consumer sectors, revisions have always been very small. However, Morgan Stanley believes that positive signals have emerged, indicating that the PC market has bottomed out. This is the reason for our change in perspective.

Indeed, PC shipments reached a low point in the first quarter of 2023, with a YoY decline of 29%. After emerging from the COVID-19 pandemic, PC OEMs continue to have high hopes for the rapid recovery of the PC market. Therefore, PC OEMs have spent several months and multiple downward revisions to reach today's level. In fact, these upward revisions from PC OEMs (although slight) indicate that the expectations of PC OEMs have been significantly lowered.

Table: Morgan Stanley believes that the PC market bottomed out in the first quarter of 2023 and will recover by 2023-2024.

We estimate that the PC TAM will resume positive growth in 2024, with a YoY growth rate of 8%.

In terms of stock price impact, Morgan Stanley is optimistic about Dell (10x F25 P/E) and Lenovo (9x F25 P/E) among PC manufacturers. They are the preferred stocks for the PC upgrade cycle, and their valuations are highly attractive with a high exposure to commercial PCs. For NB ODM, Morgan Stanley believes that the preferred targets are Wistron (17x F24 P/E) and Quanta (21x F24 P/E), although there is currently more wait-and-see sentiment. They are more beneficiaries of artificial intelligence. In the short term, any slight increase in end demand is likely to lead to a surge in supply chain orders before the sustainability and visibility of demand recovery improve. However, the overall valuation of PC manufacturer stocks should be positive. Morgan Stanley predicts that due to the promotion of commercial substitutes, the terminal demand market will not recover until the second half of 2024. In addition to the demand for Windows 11, the upward revision of PC OEMs has given the market further confidence, and Morgan Stanley is optimistic about the PC market next year.

How does Morgan Stanley view the recovery of the PC market in 2024/2025?

Will the upgrade of Windows 11 contribute to PC growth in CY24/CY25? Microsoft will end active support for Windows 10 in October 2025, which means users can continue to use Windows 10, but they will not receive any more security updates. This will be a concern for enterprise users and may lead them to switch to Windows 11 features.

According to Microsoft, upgrading or installing Windows 11 has minimal hardware requirements. However, Morgan Stanley believes that these hardware specifications are very low. According to IDC data, out of the installed base of 1.475 billion computers, less than 10 million, or less than 1% of the total computer installed base, meet these requirements. This means that from a hardware perspective, Windows 10 may not completely decline.

In addition, during the quarterly earnings conference call in March, Microsoft pointed out that "over 90% of the Fortune 500 companies are currently testing or deploying Windows 11, indicating a high adoption rate among large enterprises."

Minimum hardware requirements for installing or upgrading to Windows 11:

Processor: 1 GHz or faster with two or more cores

Memory: 4 GB or more

Storage: 64 GB or larger available disk space

If the demand for Windows 11 refresh increases, Morgan Stanley believes that it is most likely to be close to the support date before Windows 10 in the second half of 2024 and beyond. However, not all companies will wait until the deadline, and some companies may replace their devices earlier based on their own replacement cycles or the age of the devices. According to the model's deduction, the installed base of commercial PCs that will exit in 2022 will reach 6.4 million units (4 years behind), an increase of 87 million units compared to 2019's 554 million units. This means that there may be a large number of device bases that will require a hardware update. In addition, statistical data shows that currently only 20% of devices are running Windows 11 (as shown in the figure below), indicating that there is still a significant opportunity for upgrades. Compared to the previous Windows upgrade, there should be a slight refresh and stronger replacement demand.

JPMorgan believes that artificial intelligence may unleash replacement demand.

Generative artificial intelligence has the potential to unleash demand for more powerful machines. The market will start paying attention to this from the second half of 2024. More and more PC companies are starting to discuss AI PCs and how they will thrive, as well as changes in consumer behavior and hardware upgrades.

What we are seeing now is a very active collaboration between PC brands, ODMs, and component manufacturers. Companies are brainstorming to come up with the best solutions for the future.

We have seen some potential changes, including new semiconductors added for artificial intelligence, some of which are referred to as neural semiconductor processing units (NPUs). We believe this may generate additional heat, so solutions may need to be modified or design changes may be seen. In addition, the battery capacity for artificial intelligence may also increase battery consumption, and future personal computers will always need to be connected, so having a powerful and long-lasting battery life will be very important. Furthermore, audio quality and input are also important for attending meetings on the go. Additionally, through artificial intelligence, we see the potential for more voice-activated prompts or verbal interactions, which may drive some hardware upgrades to ensure accurate capture of audio quality.