2023-11-15 09:29:21 ET
Summary
- Baidu's Q3 earnings are expected to show revenue growth, strengthening the company's comeback story from the lows of 2022.
- A strong Q3 performance, however, may not result in an immediate change in investor sentiment.
- I am bullish on the long-term prospects for Baidu based on three main reasons.
- National Bureau of Statistics data released on November 15 shows China's industrial output grew 4.6% in October while retail sales increased by 7.6%. The recovery is progressing well.
- The weakness in the property sector in China has trickled down to the advertising market as well, which is a risk investors need to monitor closely.
It's not been easy being an investor with exposure to Chinese Internet companies. Ever since the fallout from the global pandemic, seemingly undervalued Chinese tech stocks have delivered disappointing investment returns. My stake in Alibaba Group Holding Limited (BABA), as I have claimed publicly, is deep in the red but I am continuing to add to my position at these prices. Although I never invested in Baidu, Inc. (BIDU), I found the company attractively valued back in 2021 when BIDU stock was still in a free fall. Last June, I rated Baidu stock a hold despite appreciating the company's AI efforts, and Baidu has lost almost 20% of its market value since then.
A couple of days ago, I published an article discussing two catalysts that could drive BABA stock higher. One catalyst is today's meeting between President Biden and Chinese President Xi Jinping. Baidu, as a Chinese tech company, will also benefit from a favorable outcome from this meeting. To repeat, I am not expecting this meeting to result in any breakthrough developments but I believe this will ease some of the tension between the two economic powerhouses. With Baidu scheduled to report third-quarter earnings on November 21, I feel now is a good time to revisit my thesis for the company.
Q3 Earnings Will Strengthen Baidu's Comeback Story
For the third quarter, analysts are expecting earnings per share of $2.34 on revenue of just over $4.7 billion. Although this projected EPS hints at a YoY decline, revenue is expected to increase compared to the previous year. If this expectation materializes, the third quarter will mark the third consecutive quarter of revenue growth. Back in 2022, Baidu's revenue declined as the company succumbed to macroeconomic pressures stemming from China's Zero-Covid policy. A strong performance in the third quarter will boost investor expectations for Baidu to end 2023 strongly, recovering swiftly from the lackluster financial performance in the previous year.
A strong Q3 performance, however, may not result in an immediate change in investor sentiment. Even when revenue surged 15% in the second quarter, the market reaction was muted as this was not enough to incentivize investors to turn bullish on Chinese tech stocks.
Exhibit 1: Earnings-related BIDU price changes
I am not betting on the market to react any differently to Q3 earnings, but I believe the upcoming earnings report will strengthen Baidu's comeback story from the lows of 2022.
3 Reasons To Be Bullish On Baidu
As a long-term-oriented investor with an extensive investment time horizon, I am not looking to make a quick buck in the market. I look for mispriced bets that can offer multibagger returns in the long run. When I say "long run", I'm thinking about 5+ years. In reality, I am willing to hold my investments for much longer as long as the investment thesis remains intact.
I am bullish on the long-term prospects for Baidu based on three main reasons.
First, Baidu's market leadership in the search engine space is unrivaled, and I believe the company will remain the leader in this space in the foreseeable future. In the U.S., we have already seen how Alphabet Inc. (GOOG), the parent company of the market-leading search engine, has capitalized on this advantage to open new doors to grow exponentially in the last couple of decades. Baidu's position in China is even stronger than Google's in the United States, as illustrated below.
Exhibit 2: Search engine market share in China
Exhibit 3: Search engine market share in the U.S.
As many of you know, the strength of the ad market plays a key role in determining Baidu's monetization of search engine traffic. The performance of the advertising industry, on the other hand, is correlated to the strength of the economy. The slowdown in economic growth last year proved to be a significant challenge for Baidu's advertising business. In 2023, the advertising industry in China has recovered along with the recovery of the economy. However, a full recovery may not be on the cards until the country's property sector comes out of its slump.
National Bureau of Statistics data released just a few hours ago shows China's industrial output grew 4.6% in October, ahead of analyst expectations for growth of 4.4% and the 4.5% increase registered in September. Retail sales increased 7.6% in October, compared to 5.5% in September and the 7% growth expected by analysts. This better-than-expected performance suggests the economy is getting back on the right track, which is good news for the advertising sector.
Exhibit 4: China's industrial output and retail sales growth in October
The only thing stopping the Chinese economy from booming today is the weakness in the property sector. This weakness is trickling down to the advertising sector as well. Despite policymakers' efforts to revive the real estate sector through fiscal and monetary policy support, a recovery seems a long way away. Many economists have called for policymakers to consider structural reforms to revive the property sector, which we are yet to see on a meaningful scale.
Looking ahead, in 2024, I expect some of the policy support to kick in and help the property sector stage a comeback, possibly helped by structural reforms. I am projecting the advertising sector to see an acceleration of growth by mid-2024, helping Baidu thrive.
Second, I believe Baidu is moving in the right direction with its AI investments and integrations, paving the way for the company to emerge as the clear leader in China's AI sector. ERNIE's integration into all of Baidu's products will lead to durable competitive advantages in the long run with many of its peers still scratching the surface on the AI front. I discussed Baidu's AI prospects in my previous article, so I will not dive deep into those details here.
Third, I expect Baidu to focus on returning capital to shareholders through share buybacks in the future, rewarding long-term investors. Last February, Baidu's board approved a new share repurchase program worth $5 billion, effective through 2025. Baidu has a net cash position, with the company ending the second quarter with cash and short-term investments of CNY190 billion compared to long-term debt of CNY61 billion and total liabilities of CNY152 billion. Baidu is a cash-rich business that is bringing in billions of dollars in free cash flows every year, the business is well-positioned to grow, and the company has a net cash position. All this points to Baidu's potential to return capital to shareholders while investing for growth. When possible, I think investors should invest in Hong Kong-listed equities.
Takeaway
Baidu is well-positioned to grow. Taking into account the attractive valuation of the company, the improving regulatory environment in China, and the prospects for better relations between China and the U.S., I am upgrading Baidu to a buy rating. However, the company's progress may not be rewarded in the market for some time, which is why investing in this Chinese tech giant may only suit long-term-oriented investors who are ready to stomach elevated levels of volatility in the short term.
For further details see:
Baidu: Upgrading To Buy