Some Fine China For Your Portfolio
Baidu Inc. (BIDU) is the third largest internet company in China, has a market cap of over $80 billion, and is the second most widely used search engine in the world. The company has enormous growth prospects, continuously beats EPS guidance, and appears to be undervalued considering its robust revenue growth and future earning potential. Due to China’s constant growth in internet usage and a low internet penetration rate of roughly 52%, Baidu is likely to grow EPS at a faster pace than is currently expected. The company also appears to be able to sustain a relatively high growth rate for its top and bottom line for a number of years going forward.
Baidu’s current valuation of 24 times this year’s earnings is very likely to decrease to under 20 next year. This seems like a relatively low price to pay for a company with a dominant position in China’s search segment which provides direct access to the country’s nearly $1 trillion online spending market that has been expanding by 32% annually for the past 5 years.
Baidu Growth Potential
China continues to expand economically, and is currently growing GDP at roughly 6.8%. Due to the country’s continuous economic expansion, more and more people in China are on the internet and using mobile every year. The country easily has the most internet users in the world, about 730 million as of October 2017. China also has 5 of the 10 largest internet companies in the world, has an internet penetration rate of only 52% vs the U.S.’s 88%, has online spending of $967 billion vs the U.S.’s $1.1 trillion, and has been growing internet spending at 32% annually for the past 5 years.
Therefore, Baidu has enormous growth potential within China that could be sustainable over a prolonged period of time, at least 5-10 years. The company has a leading position in China’s search market with 76% of total queries performed through its site. Baidu has an even more dominant position in China’s mobile search market with about 82.5% of the share.
Although Baidu has enormous growth and profit potential within China, the company may be able to grow market share outside of its home country as well. Baidu has just a 2.75% share of the total world search market, compared to Google’s behemoth share of approximately 92%. However, many Chinese people outside China use primarily Baidu. The company is expanding globally and is currently a leader at the forefront of the developing AI industry as well as other breakthrough technologies and market segments. For example, the company plans to make self-driving car technology available in 2018, and in time these developing businesses should introduce powerful new revenue streams to significantly increase Baidu’s top line.
Baidu’s Profit Potential
Baidu consistently beats EPS estimates by quite a wide margin, roughly 25% on average the past 2 years. Moreover, Baidu has beat EPS estimates 26 out of the last 30 times the company has reported since 2010. It seems safe to say that analysts regularly underestimate the company’s EPS potential.
Next year’s average revenue projections are at $15.8 billion for Baidu, a 23% increase from this year’s revenues. However, analysts’ average projected EPS growth is just 4% yoy. Judging by the company’s perpetual ability to surpass analysts’ expectations concerning EPS, and the disproportionately low average EPS growth forecasts in relation to next year’s revenue growth, it appears many analysts may be lowballing 2018’s EPS numbers.
So, what is Baidu likely to earn next year? Over the past two years, Baidu has surpassed quarterly consensus earnings estimates by an average of about 25%. The 25% mark is also consistent with the estimated average 23% yoy revenue growth forecast. If we apply a 25% increase to 2018’s average EPS estimate of $9.52 we arrive at earnings of $11.90 for next year.
At the current price of $235, and applying an $11.90 EPS for next year implies that Baidu is presently trading at about 19.75 times next year’s earnings. My estimate is firmly within reason as higher range analyst estimates have 2018 EPS at over $13.00.
Therefore, the current forward valuation seems very cheap for a company that is experiencing roughly 30% growth in its ad business. To put things in context Google’s revenues are projected to rise by just 18% next year and the company trades at about 25 times next year’s projected earnings. It seems that with higher revenue growth and a lower home market saturation rate, Baidu shares should be trading at a premium and not the other way around. Google is still a relatively inexpensive stock considering its dominant market position and robust growth, however, Baidu shares look outright cheap here.
Threats to Baidu
Alphabet (GOOG), (GOOGL) is the largest internet search company in the world, therefore it naturally poses some level of threat to Baidu. However, Baidu derives the vast majority of its revenues and growth from within China, where Google has a smidgen of the online search market worth only about 1.84%, and a less impressive 0.6% of the mobile market’s share. In comparison, Baidu owns about 76% of China’s online search, and 82.5% of mobile search. Google has failed to dominate search in China, and due to its limited popularity and influence is not likely to takeaway noticeable market share from Baidu going forward.
Although Baidu crushed EPS estimates by 90% last quarter $3.98 vs $2.04, the company’s revenue forecast for next quarter came in lower than expected, $3.34 – $3.52 billion vs $3.73 billion consensus estimates. The stock took a hit due to the lower than expected guidance, declining by as much as 18% from recent highs. However, the revenue guidance “miss” does not appear to be the result of any systemic growth issues at Baidu. Instead, it is likely that revenue growth projections simply got ahead of themselves, and the company’s forecast still represents a very healthy yoy revenue increase of 22% – 29%.
Baidu’s stock dropped on heavy volume following the revenue guidance miss in late October. Since then, the stock has held the $230 – $235 level and appears to be in the process of making a triple bottom. If the $230 – $235 level holds over the next days and weeks, BIDU has the potential to go significantly higher and is likely to start hitting all-time highs again.
The technical indicators appear sound right now, and are not illustrating any noticeable abnormalities in price action. BIDU looks to have had a healthy correction of roughly 18%, is now going through a normal consolidation period, and is likely to move higher over the coming weeks and months.
BIDU 1-Year Chart
BIDU 5-Year Chart
Valuation and Financial Highlights
Market Cap: $81.6 billion at $235 a share
Quarterly Revenue Growth: 29%
Quarterly Earnings Growth: 160%
2017 P/E: 25 at $9.16 EPS Estimate
2018 P/E: 19.75 at $11.90 EPS Estimate
Profit Margin: 18%
Total Cash: $17.72 billion
Total Debt: $7.84 billion
52 Week Change: 43%
Shares Short: Under 3%
The Bottom Line
Baidu is a powerful online leader in China, the world’s biggest search market with a relatively low penetration rate, and high ad spending growth. The company has a strong balance sheet, is growing revenues at a high rate, and has enormous profit potential. The current valuation seems cheap for a company with such impressive prospects, and next year’s EPS estimates appear to be low, suggesting Baidu is likely to surprise to the upside going into 2018 and beyond, which should translate to a higher stock price going forward.
Note: This article expresses solely my opinions, is produced for informational purposes, and is not a recommendation to buy or sell any securities. Investing comes with risk to loss of principal. Please always conduct your own research and consider your investment decisions very carefully.
Disclosure: I am/we are long BIDU.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I have been an investor in BIDU since 2007