2023-12-31 08:30:00 ET
Summary
- Baidu stock has not met my expectations, as the market remains pessimistic over Chinese equities. However, it has continued to execute well.
- Baidu's double beat on revenue and adjusted EPS in Q3 underscored its prowess. It also has a best-in-class "A" profitability grade, underpinning its robust business model.
- Baidu's leadership in AI and its ability to navigate export restrictions on US chips position it well against its peers. As a result, Baidu could stretch that AI lead further.
- I argue why AI investors have missed the potential upside in BIDU, as they placed too much pessimism on Chinese equities.
- However, the market's misunderstanding converts into fantastic opportunities for patient investors ready to exploit that gap to gain an advantage before the rest of the market sees it.
Even China's AI King and search market leader, Baidu, Inc. ( BIDU ), couldn't find shelter from the continued negative market sentiments affecting Chinese equities since my last update in late August 2023.
I had anticipated BIDU to remain at the forefront of relative market outperformance against its peers. However, the market had other ideas, as BIDU has declined more than 13% since then. The decline reached a low in early November 2023 before dip-buyers returned.
As a result, I believe it's apt for investors to reassess whether the bullish thesis on BIDU remains relevant, or should investors brace for more pain in 2024? Accordingly, Baidu posted a robust third-quarter or FQ3 earnings release in late November. It was met with a post-earnings surge as buyers realized they could have been too pessimistic on BIDU. However, that optimism saw another wave of selling through its mid-December lows, suggesting that overall market sentiments on BIDU remain uncertain.
Despite that, I assessed that while the market's caution on BIDU and Chinese stocks is apt, the company has continued to execute very well, as it leverages its market leadership in AI to drive growth in its core business and pursue growth in nascent verticals.
Baidu delivered a double-beat (on revenue and adjusted EPS) on its Q3 release. As explained earlier, BIDU had headed into its recent earnings scorecard with significant pessimism. As a result, the pleasant surprise from the double beat underscores my confidence that management's execution remains sound. My thesis is also supported by the robust "B" earnings revisions grade assigned by Seeking Alpha Quant.
Management articulated that the company expects to continue improving its profitability as it embeds AI into its core search offerings. Baidu has integrated its proprietary Ernie Bot into Baidu search, "complementing traditional search methods." As a result, it should lead to "more precise and contextually relevant responses to queries." While such developments aren't new, they demonstrate Baidu's ability to capitalize on AI to improve its core offerings.
In addition, I believe AI investors might have overlooked the company's leadership in LLMs, particularly with the US chips export restrictions. While China's AI leader isn't immune to such challenges, its massive scale and highly profitable business model (with a best-in-class "A" profitability grade) should underpin its ability to outcompete its peers. Management alludes to its competitive advantages at its Q3 earnings conference. Baidu highlighted that the "GPU export restrictions are affecting customers who prefer to train their AI models." As a result, it has also impeded AI startups that don't have the scale and wherewithal of Baidu to develop highly competitive "LLMs from scratch." As a result, these competitors are expected to face significant challenges in trying to achieve breakthroughs "achieving emergent abilities."
A November 2023 report by Bloomberg corroborates management's commentary. Leading Chinese AI expert Kai-Fu Lee highlighted his startup "aggressively purchased Nvidia ( NVDA ) chips" as he correctly anticipated more intense US export restrictions. As a result, his company has achieved a stockpile that could last "for approximately 18 months."
Nvidia's recent RTX 4090 D launch aimed to overcome the restrictions imposed on its usual RTX 4090 series by offering " approximately 10% fewer processing cores than the version sold in other countries." However, we still need to address the challenges in data GPUs (H800, A800) used for AI model training that isn't resolved from this iteration for its more gaming-focused RTX series. As a result, I believe Baidu's competitive advantage and market leadership remain a formidable challenge against smaller competitors looking to upstage its efforts moving ahead. In other words, the export restrictions should be interpreted as structurally positive to maintain Baidu's AI leadership in China against its peers.
BIDU is still in a consolidation phase bounded by its critical resistance zone at the $160 level. Its long-term low achieved in October 2022 ($73 level) remains in play, suggesting BIDU hasn't declined toward those levels.
As a result, I have confidence that BIDU should continue to grind higher from its malaise, although we need to be more wary about adding closer to its $160 resistance zone.
However, with BIDU still far below that resistance level and coupled with an attractive valuation ("B-" valuation grade), I intend to remain bullish at the current levels.
Rating: Maintain Buy.
Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.
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For further details see:
Baidu: Big Year Ahead In 2024 For China's AI Leader