Baidu Q3: Signs Of Recovery But Low Valuation May Be Justified (NASDAQ:BIDU)

Baidu (NASDAQ:BIDU) recently reported its FY 2023 Q3 results as Seeking Alpha has covered here. Q3’s revenue of $4.83 billion was the highest since December 2021 and was up 6% YoY. EPS of $2.86 was up more than 20% YoY and was also the 2nd highest since December 2020, barring the $3.09 in Q2 2023. Mr. Market seems to have taken favorably to the earnings report as the stock is up more than 10% since the report.

This article evaluates The Good, The Bad, and The Ugly from the Chinese giant’s Q3 and what they may mean for the stock in the near-term. Let us get into the details.

The Good

• Despite the stock’s recent struggles (up just 4% YTD), Baidu continued its rich history of beating both revenue and EPS estimates as the streak now extends to at least 16 consecutive quarters on both fronts. While Q3 revenue beat was by just 2.50%, the 22% EPS beat suggests that Baidu operated more efficiently than expected when it came to controlling costs and improving margin.
• Advertising recovery was one of the items being monitored ahead of the Q3 report and Baidu delivered on this front with a 7% increase in online marketing services revenue. (Page 9).
• ERNIE was mentioned quite a few times in the earnings report, as the company is focusing on AI to reinvent its existing products on both consumer and enterprise fronts. Recent analyst reports suggest that Baidu is clearly ahead of its peers in the Chinese market with ERNIE leading the way and the company is not afraid to spend more towards its ERNIE R&D.

• Baidu’s driverless ride-hailing service, Apollo Go, is gathering steam as it provided more than 800,000 rides in Q3, showing nearly 75% growth YoY. The Chinese Ride-Hailing segment is expected to grow more than 50% in revenue between 2023 and 2027. Being the first to offer driverless services here, Baidu can be expected to continue its strong growth here in the next few quarters as well.

• Although this is not directly attributed to Q3, Baidu stock’s valuation appears attractive due to a combination of consistently beating earnings expectations (including Q3) and the stock’s lukewarm YTD performance (up just 3.50%). The stock is trading at a discount compared to its peers in its sector as well as to its own 5-year average. No wonder, Seeking Alpha’s quant ratings present the stock in a good light. However, there are certain risks to be factored in as covered in the sections below.

The Bad

• While revenue went up just 6% YoY, general administrative expenses went up almost double that YoY at 11%. While I welcome the increase in R&D expenses towards ERNIE, general expenses are to be monitored closely especially with revenue (advertising primarily) not out of the woods yet with worsening deflation worries.

• Baidu’s interest expense on debt went up nearly 20% YoY to reach $117 million in Q3 2023 as the company’s debt is now nearly $12 billion. While investors would ideally want the company to pay as little as possible in this area (interest expense), the company’s massive cash (and equivalents) pile of $26 billion should quickly dissipate any liquidity concerns.

The Ugly

• “Prices are falling” is something US consumers have been longing to hear for a while. But the same words have a different meaning in China these days. Prices are and have been falling to such an extent that deflation may already be there. Being as advertising heavy as Baidu is, this is worrisome for the company and its investors as advertising budgets may be cut due to margin pressure that the companies are likely to face as their prices fall.
• Baidu announced (Page 3) in its Q3 report that it spent $126 million in Q3 towards share repurchases. Despite that, total shares outstanding has been holding steady at close to 350 million. If anything, this number has actually gone up a little over the last few quarters as shown below and this means Baidu is merely offsetting its dilution through these repurchases.

Risks And Conclusion

A market capitalization of just $42 billion seems unfair for the undisputed internet leader in a country which is the 2nd largest by both GDP and population. Especially when you factor in the $26 billion in cash and equivalents or the $14 billion net-cash position (subtracting debt). However, things are far from clear with respect to the Chinese economy, not to mention the constant fears about political back and forth and delisting. The company is expected to grow at a snail’s pace over the next 5 years and hence its low forward multiple of 11 seems justified. However, once you back out the net-cash (33% of the company’s worth), the forward multiple drops to an even more attractive 7.37.

If you have no exposure to Chinese stocks, initiating a small position in Baidu is not a bad idea here. I am rating the stock a “Buy” here on the following, in order of importance:

a. Undervaluation

b. Cash strength

c. ERNIE’s prospects

But patience will be key as no one can predict the political moves and speed of recovery in a country as big as China.