A More Bullish Sentiment Could Push Baidu Much Higher

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The most recent sentiment change in China pushed Baidu's stock higher - along with other technology companies like Tencent or Alibaba.Revenue from online advertising is still struggling, but AI Cloud ...

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V2images My last article about Baidu, Inc. (NASDAQ:BIDU) was published about seven months ago on February 29, 2024, and similar to my other articles about Baidu I have written in the last few years, I was bullish once again. And since my last article was published, the stock actually gained 4% in value, but when looking at the numbers in more detail we can see that Baidu was rather in a downtrend most of the time and only in the last two weeks the picture turned, and Baidu jumped – similar to many other Chinese technology stocks. Data by YCharts In the following article, I will look at the business and stock once again and answer the question if Baidu is still a good investment at this point. Quarterly Results While sentiment is important in the short-to-mid term and driving the stock market, in the long term the fundamental performance of the business will be important and in almost every case the stock performance over several decades is also matching the business performance. Therefore, let’s look at the last quarterly results once again and Baidu continues to struggle a little bit. On August 22, 2024, Baidu reported second quarter results and while the company missed revenue estimates slightly, it could beat expectations for earnings per share by $0.29. When looking at total revenue it declined slightly from RMB 34,056 million in Q2/23 to RMB 33,931 million in Q2/24 – resulting in 0.4% year-over-year decline. But while the top line declined a little bit, operating income increased 14.1% year-over-year from RMB 5,210 million in the same quarter last year to RMB 5,944 million this quarter. And finally, diluted earnings per share increased from RMB 1.77 in Q2/23 to RMB 1.88 in Q2/24 – resulting in 6.2% year-over-year bottom line growth. Baidu Q2/24 Earnings Release And while the earnings per share increased in the low single digits, free cash flow – one of the most important metrics – declined from RMB 7,926 million in the same quarter last year to RMB 6,261 million this quarter resulting in a decline of 21.0% year-over-year. Looking at the different segments, Baidu is often reporting its revenue in two different categories. On the one side, we have the so-called “Baidu Core”, which generated RMB 26,687 million in revenue (resulting in 1.1% year-over-year growth). Operating income increased even 23% year-over-year from RMB 4,568 million in the same quarter last year to RMB 5,608 million this quarter. The second segment is IQIYI, which reported a declining revenue as well as a declining operating income in the second quarter. Revenue declined 4.7% year-over-year from RMB 7,802 million to RMB 7,439 million and operating income declined 43.9% year-over-year from RMB 610 million to RMB 342 million. Online Advertising Now let’s look in more detail at the core business and a huge part of the core business of Baidu was online advertising, but in the last few years the advertising business was rather under pressure. This pressure is stemming from competition as well as low levels of customer spending, which is resulting in low advertisement spending. This is especially visible in small-and medium-sized advertisers and especially in real estate and automobile. Baidu’s Core online marketing revenue declined by 2% year-over-year, but the online marketing revenue was still RMB 19.2 billion and therefore responsible for more than half of total revenue. One of the “problems” Baidu is facing right now is the shift towards GenAI search results. About 18% of the search results contain GenAI content (the ratio is up from 11% in mid-May) and although the AI-generated search results deliver more accurate and direct answers, the content is not monetized so far. Of course, this content will also be monetized at some point in the future and management is pointing out that these search results provided by GenAI are in many ways better. Not only are users able to refine their questions and follow-up through multi-round conversations, but Baidu can also recommend other content and services leading to a high users’ time spent and retention. Statcounter When looking at the search market in China, we see one major problem that Baidu is facing right now. Although the search engine is still clear market leader, we can see it losing market shares in the last 2-3 years. And on the other hand, we can see Microsoft’s Bing gaining market shares and becoming a serious competitor to Baidu. But according to studies the online advertising market in China is expecting to grow in the double digits. GrandViewResaerch for example is expecting  a CAGR of 16% between 2024 and 2030 and we can assume that Baidu might also be able to profit from the overall growing market (provided it does not lose further market share at a high pace). Cloud AI While the online advertising business is struggling a bit, the cloud business combined with the company’s push towards artificial intelligence is contributing to growth. And as management underlined during the earnings call once again, Baidu is one of the leading companies in China regarding AI: Our decade-long investment in AI provided us with the first-mover advantage and technological leadership. We were the first public company globally to launch a GPT-like model in March of last year. And since then, we kept leveraging our self-developed four-layer AI architecture for model upgrade. Last October, we launched ERNIE 4.0. That's China's first GPT-4-type model. And this June, we launched ERNIE 4.0 Turbo, which offers superior capabilities over 4.0. In the second quarter, AI Cloud generated RMB 5.1 billion in quarterly revenue and grew 14% year-over-year. Management is attributing growth mostly to two different factors: One, the introduction of diverse high-grade training data science – spanning from general to specialized industry-tailored data sets. Second, the cross-selling of CPU Cloud services to existing GPU cloud customers. During the earnings call, management was also pointing out that Ernie is used in different industries – in the healthcare industry for example it is helping to automatically generate medical records for doctors, which significantly reduced the administrative burden on doctors. In the recruitment industry, customers could upgrade the matching process between job descriptions and resumes and therefore reduce the labor costs in this process by over 50%. Baidu is also launching additional ERNIE models, including models to make Ernie more affordable. In June, the company introduced ERNIE 4.0 Turbo, which offers superior capabilities compared to ERNIE 4.0 for typical use cases, but it is cheaper and faster to run. And ERNIE handles about 600 million API calls and generated about 1 trillion tokens every day and management believes this is the highest in China. While this was the information provided in the last earnings call, Ernie is now processing over 700 million inquiries daily (according to a recent news story). And Baidu’s AI Cloud Platform Quiafan has helped user fine-tune over 30,000 large models and built more than 700,000 enterprise applications. Intelligent Driving – Apollo Go Baidu is also among the leading companies when it comes to intelligent driving. In the second quarter, Apollo Go provided about 899,000 rides to the public in the second quarter – resulting in 26% year-over-year growth (cumulative rides have surpassed 7 million in the second quarter). Of course, management also pointed out during the last earnings call, that Baidu’s market share in the entire ride-hailing service market is still very small (even in China). And similar to Alphabet (GOOG), we don’t really know how profitable this business can be, but I remain confident that we are looking at a huge contributor to revenue (and also the bottom line) in the future. Stock: Undervalued In case of Tencent (OTCPK:TCEHY), another Chinese technology company and great long-term investment, it is rather the growth story that is compelling (see my last article). In case of Baidu, it is not so much the growth potential, which is also existing but with question marks attached. It is rather the extremely compelling valuation. When looking at simple valuation multiples, we can already see that Baidu is not really expensive. At the time of writing, Baidu is trading for a price-earnings ratio of 13.77, which is not only below the average of the last ten years, but also a rather low valuation multiple on an absolute basis. And while we can still argue how cheap the stock really is when using the P/E ratio, the price-free-cash-flow ratio seems to be an absolute no-brainer as Baidu is trading for only 7.65 times free cash flow. Data by YCharts To get a more precise result if Baidu is a good investment at this point and what an intrinsic value could be, we once again use a discount cash flow calculation. As always, we calculate with a 10% discount rate and use the last reported number of diluted shares outstanding (2,804 million but as we are calculating an intrinsic value for the ADS, we must divide the number by 8 resulting in 350.5 million shares). Additionally, we are calculating with the free cash flow of the last four quarters. According to Y-Charts, the free cash flow is $4,856 million (this is also the amount used to calculate the P/FCF ratio above). However, according to the company’s financial reports  the free cash flow in the last four quarters is only $3,243 million and this is the number we will use for our calculation. In my last article I was rather cautious about growth rates for Baidu – and the business clearly struggled in the last few years. Therefore, let’s remain cautious about the growth potential of Baidu and assume only 3% growth from now till perpetuity. This is a great target that should be reasonable and achievable for Baidu as the Chinese economy is already expected to grow with a higher pace in the years to come. When calculating with these assumptions, we get an intrinsic value of $132.18. We can also point out that 3% growth till perpetuity is rather cautious and analysts for example are expecting earnings per share to grow with a CAGR of 8.10% in the next six years till fiscal 2029. So, let’s also be a little more optimistic and calculate with 4% growth till perpetuity. With all other assumptions the same, we get an intrinsic value of $154.21 for the stock and therefore we can argue that Baidu is still deeply undervalued at this point. Don't Forget The Balance Sheet By the way, I also mentioned the price-to-book-value-ratio in previous articles about Baidu and this is a metric I am not using very often in my articles. The reason why I mentioned this ratio when writing about Baidu is simple. It is showing us how absurd the valuation of Baidu is right now. At the time of writing, Baidu is trading for 1.06 times book value (and in the last few weeks, it has been trading as low as 0.8 times book value). Data by YCharts And the low price-book-value-ratio is hinting towards another topic we already mentioned in the past but must talk about again. The intrinsic value calculation above, which already concluded that Baidu is undervalued, has one short-coming. It is only looking at the future free cash flow Baidu might be able to generate. However, it is excluding the fact that Baidu already has huge amounts of cash on its balance sheet – and this is money we should not really ignore as it can either be distributed to investors (via dividends) or used to invest in the business and make investments in other businesses, which should generate additional cash flow in the years to come. Baidu Earnings Release Q2/24 When looking at the balance sheet (and I will look at the numbers in USD as the stock we are looking at is also trading in USD), Baidu has $5,990 million in cash and cash equivalents as well as $14,699 million in short-term investments. Additionally, Baidu has $9,976 million in long-term time deposits and held-to-maturity investments on its balance sheet and there are in my opinion also rather liquid investments that can be converted to cash quite easily. Data by YCharts On the other hand, Baidu a total of $10,260 million in long-term debt, but even when subtracting these amounts $20,405 million in rather liquid assets remain. This is resulting in about $58 in liquid assets per share Baidu can use. And not only is this almost enough to justify the current share price, but we also should add this amount to the intrinsic value calculated above resulting in a fair share price around $210 for Baidu. Technical Picture Finally, we can also look at the chart and we see Baidu currently pressing against a resistance level that has been in place for several quarters. If Baidu can jump over the white trendline, it would be a first good sign that the downtrend and bear market could have come to an end. However, before the stock cannot jump over $160, the stock will remain in its downtrend, and we should also remain rather cautious. TradingView On the other hand, I am pretty confident that Baidu found its bottom between $70 and $80 as the stock has now bounced off that level for several times – recently in 2024, in 2022, in 2020 and in 2013. And we can see the price level between $70 and $80 certainly as a strong support level for the stock. Conclusion I remain long-term bullish about the stock and business. I still think the business has growth potential in the years to come. But even with low growth rates, the stock remains undervalued and the huge cash reserves and liquid assets alone should make the stock a screaming bargain at this point. Of course, we should not expect the stock prices to keep soaring like many Chinese technology stocks did in the last two weeks. At this point, a correction is not unlikely, and it might take some time before we see even higher stock prices. On the other hand, I would also not be surprised if several Chinese technology stocks – including Alibaba (BABA) and JD.com (JD) – continue to soar as many are extremely undervalued and with sentiment changing, valuation multiples could also change quickly  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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