Regulatory Overhang to Weigh Baidu’s Stellar Earnings

The Baidu [BIDU] share price has had an eventful 12 months. It surged from $116.74 at the close on 14 August 2020 to $339.91 at close on 19 February 2021. According to its fourth-quarter 2020 results, released in February, revenues of the Internet-based software company rose 5% to $4.6bn with adjusted EBITDA up 5% to $1.3bn. For the full year 2020, revenues were flat at $16.4bn, but EBITDA was up 49% to $4.2bn.

It was boosted, it said, by turning its “AI innovations into use cases” such as AI call centres, AI Cloud, smart transportation and robotaxis.

However, since February, the Baidu share price reversed direction to reach $157.83 at the close on 27 July. This is despite first-quarter revenues revealing a 25% leap in revenues to $4.2bn and more uptake of its AI products and services.

Investor sentiment was bashed by increased regulatory interference in Chinese tech stocks by the Government. It is particularly interested in e-commerce related stocks and those holding ‘Big Data’ on Chinese customers.

That could include Baidu and certainly includes Alibaba [BABA], which had to pay a $2.8bn anti-trust fine, and Tencent [TCEHY], which altered games controls for children after the government likened gaming to “spiritual opium”.

“Baidu has fallen victim to the impacts of increased regulatory scrutiny from the Beijing government,” wrote Richard Saintvilus for Nasdaq. “China’s regulatory crackdown has sparked fears among US investors that foreign investors will flee Chinese stocks. Cathie Wood's ARK funds recently sold off Baidu shares, among other China holdings, for the same reasons.”

However, hopes that the Chinese government may give more support to the domestic electric vehicle (EV) market in the forms of subsidy and its commitment to be carbon neutral by 2060 have breathed new life into the Baidu share price.

Baidu’s AI transport solutions enable EVs, autonomous driving and tackle air pollution.

The Baidu share price sat at $166.59 at the close on 9 August.

Regulatory Uncertainty Raises Risk

Much of the risk associated with Baidu is related to the Chinese state, rather than its core services. As Chinese companies such as Alibaba have experienced, regulatory crackdown is never too far away.

But the EV sector is a favourite of governments striving to meet carbon emissions targets and that includes China.

There is a risk related to Baidu’s R&D spend and whether its nascent roll-out of AI products will generate demand, but it is focusing on crucial growth areas such as cloud, data and transport.

One element working in Baidu’s favour is its 7.64 trailing PE ratio – which is low compared with other high-growth tech stocks and makes it less vulnerable to higher interest rates.

It is also, as Seeking Alpha states, the “Google of China, with a commanding search market share of over 70%”.

Baidu is releasing its second-quarter earnings on 12 August.

Higher growth lesser profit

Wall Street expects Baidu to earn $2.07 per share on revenue of $4.78bn, compared with the same period last year, when earnings came to $2.18 per share on revenue of $3.84bn.

Analysts will be keen to hear further progress on the uptake of Baidu’s AI products as enterprises recover post-pandemic, and its expectations for the rest of 2021.

However, they remain bullish, and Market Screener suggests a consensus Buy rating.

“Some analysts believe the stock is now undervalued by more than 30%. But even that appears conservative,” writes investor Richard Saintvilus in an article published on Aug 8. “Baidu still has a consensus Street price target of $308, which implies close to 90% upside. For any of this perceived value to matter, on Thursday the company must speak positively about its growth potential, despite the increased regulatory scrutiny in China.”

Gary Yu, equity analyst at Morgan Stanley, adds: “We find it well-positioned in certain industrial applications. We also like its rich cash position and strategic investments. The company appears well-positioned to ride the next internet wave, but patience is needed.”

Leaping ahead

In the first quarter, Baidu reported a 25% leap in total revenues to $4.29bn.

It saw growth in key areas including intelligent driving and AI Cloud. Its Netflix-like iQIYI [IQ] service saw revenues climb 4% to $1.22bn and its subscriber base come to 105.3 million.

“We are delighted to bring innovation across many sectors, including marketing cloud, enterprise cloud, smart transportation, autonomous driving, smart assistant and AI chip, through our decade-long investment in AI,” said Robin Li, co-founder and CEO of Baidu (pictured above).

CFO Herman Yu added: “We will continue to invest heavily in sales, R&D and operations to support the rapid growth of our AI-powered business.”

The main ETF that could be impacted by fluctuations in the Baidu share price is the Invesco China Technology ETF [CQQQ], where it holds a 7.99% weighting, as of 9 August.