2023-08-01 02:48:18 ET
Summary
- Analysts have low expectations for Baidu's Q2 2023 earnings, so I believe there is upside potential in both revenue and EPS growth.
- Specifically, I expect a strong performance from Baidu's advertising business, complemented by a better-than-expected demand for Baidu's AI-enabled Cloud solutions.
- Reflecting on a likely earnings beat, I see a catalyst for strong share price momentum through the 2H of 2023.
Baidu ( BIDU ) is expected to report earnings for the June quarter on August 15, and analysts' expectations are quite low for both topline and earnings. Some data points, however, suggest that Baidu's Core business, advertising, may have performed exceptionally well; and, the company's Cloud business could have seen stronger than expected demand from non-government entities.
Disagreeing with depressed consensus estimates, I anticipate Baidu to deliver a 12-15% YoY growth in topline and an EPS growth of 6-10%, versus ~8.5% and ~ 4.5%, respectively, estimated by consensus. In my view, this earnings beat could likely act as a catalyst for strong stock price appreciation momentum in the second half of 2023.
For reference, Baidu stock has outperformed the S&P 500 (SP500) benchmark YTD, but with significantly higher volatility. Since the start of the year, BIDU shares are up about 30%, as compared to a gain of approximately 20% for the S&P 500.
Seeking Alpha
Still-Depressed Q2 Expectations ...
Baidu is set to publish earnings for Q2 2023 on August 15th. And based on information collected by Seeking Alpha, 21 analysts have submitted their estimates, as of July 30th. These projections anticipate that the Chinese search giant will likely deliver revenues in the range between $4.53 billion and $4.73 billion, with the consensus at midpoint being anchored around $4.65 billion. Using the consensus estimate as a reference point, it is suggested that Baidu's Q2 sales may expand by approximately 8.5% YoY versus the same period in 2022.
Seeking Alpha
The EPS expectations for Baidu's Q2 2023 are as follows: Estimates vary from $2.02, with the average being $2.98, with $2.39 being the consensus, suggesting a YoY EPS growth of 'only' 4.5%.
Seeking Alpha
... Open Room For Upside
While some caution may be warranted going into the reporting period for Chinese tech giants, overall, I argue that expectations are overly pessimistic for Baidu -- where I view a topline expansion of 12-15% YoY and a EPS growth of 6-10% as reasonable.
Specifically, I expect Baidu's advertising business, which is the company's primary profit center, to shine and outperform against expectations. Although the macro rebound from China's COVID-reopening is somewhat slower than initially anticipated, a few key advertising verticals are on track to perform exceptionally well, specifically sectors such as healthcare, e-commerce, and travel, where pent-up demand continues to release. In that context, CEO Robin Li commented during the Q1 conference call with analysts (emphasis mine):
After the Chinese New Year, there was a quick recovery, which was especially beneficial for many of our advertisers in offline sectors such as travel, healthcare, bin services, and local services .
... So, travel is also improving, apparently, and we saw the Labor Day holiday was really, really hot.
Other consumer data points are also encouraging, such as the strong "618 shopping festival" in May and June, where Morgan Stanley pointed out surprisingly healthy demand in multiple advertising-centric product categories, specifically for smartphones, home appliances, and fashion.
With this frame of reference, I model a 6-8 point advertising topline acceleration vs. Q1, which would bring revenue from Baidu Core to about RMB 24.3 billion, increasing 12-15% YoY.
On the backdrop of supportive advertising topline, Baidu's profitability should benefit as well, as suggested by Robin Li (emphasis mine), likely bringing Baidu Core operating income to RMB 4.3-4.5 billion:
The growth in our online marketing revenue have also had a positive impact on the margins of our mobile ecosystem. So, the overall margin for Baidu Core got better. The success is due to our focused user and customer experience on our platform. And furthermore, we have observed a strong growth in user engagement and traffic.
With regards to cloud, recently published research reports by J.P. Morgan, Barclays and Tiger Securities suggest that Baidu's cloud business may be "weak", materializing only 2-4% YoY growth in the July quarter. However, investors should consider that the major anchor for this pessimistic outlook is related to "lack of government-related cloud projects". Barclays argues:
Cloud might have been weak as the lack of funding for many local governments has resulted in a sharp drop in intelligent transportation projects: We highlight that one key area of weakness in the broader Chinese economy is spending by local governments. Many local governments in China are financed by the funds they receive from land sales, which have been very weak over the last three years during the government crackdown on the real estate industry. As a result, some local governments could not even make payrolls let alone have excess capital for “nice to have but not entirely necessary” projects like intelligent transportation.
That said, the Chinese government is not the only buyer of Baidu's Cloud offering; and, demand from industry verticals such as manufacturing, energy, and healthcare may have performed quite well -- with drivers being similar to the advertising arguments.
Personally, I model BIDU’s Cloud growth to be around 4-7% YoY; and the operating profit growth to be around 10-15% YoY, as focus on profitability takes center stage:
Since Q2 of last year, we have phased out low margin businesses and projects for AI Cloud leading to a healthier business product portfolio and cost structure. At the same time, we continue to standardize AI solutions for key used cases for replication.
Risks
The thesis of this article argues that analysts' expectations for Baidu's Q2 results are overly pessimistic, and there is upside in taking a more bullish view. Betting on earnings, however, is high-risk trading and investors should note that even despite thorough research, there remains considerable uncertainty regarding both market's true expectations for Baidu's earnings, as well as the company's financial performance.
On a more structural risk basis, my primary concern for investing in Baidu is related to regulatory pressure that China's tech and internet giants have faced in recent months/ years. Needless to say, if this regulatory scrutiny continues, Baidu's valuation would need to be discounted with a respectively "material" risk discount. That said, however, it appears that the most intense phase of the "crackdown" is behind us.
In addition to regulatory challenges, Baidu's stock price volatility is heavily influenced by investor sentiment towards Chinese ADRs in general. This means that even if the company's business fundamentals remain steady, its stock price may experience significant fluctuations based on how investors perceive the risks associated with Chinese investments.
Conclusion
Reflecting on analysts' estimates for Baidu's Q2 results, I see upside in the spread of what is expected vs. what the company may actually deliver. Specifically, I expect a strong performance from Baidu's advertising business, complemented by a better than expected demand for Baidu's AI-enabled Cloud solutions -- supporting an earnings beat that may serve as a catalyst for strong share price momentum through the 2H of 2023.
With that frame of reference, it is worth noting that even without the Q2 earnings beat, Baidu shares seem to be undervalued. Presently, the stock is being traded at consensus Forward EV/EBIT of roughly x15, and an EV/Sales of approximately x2.3. As Baidu is often labeled the "Google of China", it is worth noting that Baidu's valuation metrics suggest a material 30-50% discount to GOOG, depending on the reference metric.
Finally, I continue to like Baidu as the key enabler of AI adoption across industries in China, and looking beyond Q2 earnings "short-termism", it is only a question of time until BIDU share price converges to fair value, which I see around $256.90. "Buy".
For further details see:
Baidu: Q2 Beat May Catalyze A Price Appreciation