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Baidu Earnings Preview - Q2 2014

Baidu Earnings Preview - Q2 2014

posted by Vikram Nagarkar | published by Amigobulls on
  • Baidu has diversified into multiple non-core business verticals.
  • Baidu's profitability will be in focus in Q2 2014.
  • Baidu is an attractive long term investment at its current valuations.

 

Baidu Earnings Preview Q2 2014

China’s search giant Baidu (NASDAQ:BIDU) is due to announce its results for Q2 2014 on 24 July 2014. We’re looking forward to this earnings release for multiple reasons. Baidu has recovered from its lows earlier this year after China’s weak macro-economic outlook pushed the stock 22% lower. Since then, Baidu’s stock price has rebounded and surpassed its previous 52 week high. After the recent rally, Baidu’s valuations are now significantly higher than valuations of its peers. Baidu’s valuations factor in strong revenue growth and relatively lower (compared with its track record) but reasonable profit margins.
 
For Baidu to sustain such valuations, the company will need to answer a few key questions with this earnings release. How has Baidu dealt with China’s weak economic outlook? Can Baidu sustain its strong profitability in the midst of expansion and diversification? How is it faring against growing local competition in internet search, and mobile search more specifically?
 

Baidu Q2 2014 Analyst Estimates

 

USD

RMB

Revenue  (billion)

1.92

11.93

EPS

1.29

8

 
Analyst estimates for Baidu’s Q2 2014 revenue stand at RMB 11.93 implying a YoY growth of 57.8%. Estimates have factored in a YoY EPS expansion of 6.4%.
 
Note: We’ve made all the calculations based on figures in RMB to focus on operational aspects and filter out the impact of forex fluctuations. As for the USD numbers, we’ve used the conversion rate (1 USD = 6.2 CNY/RMB) as on today, 23 July 2014.
 

Baidu Revenue Guidance for Q2 2014

As per Baidu’s revenue guidance, revenue for Q2 2014 should be in the range of RMB 11.82 - 12.11. In USD terms, that ranges from 1.91 to 1.95 billion Dollars.
 
In the previous quarter, Baidu’s revenue growth was less than 0.5% away from the higher end of its revenue guidance for the quarter.
 

Baidu Revenue Growth

In Q1 2014, Baidu registered a revenue of RMB 9.49 billion ($1.53 billion). The company clocked a YoY growth of 59% in its local currency, rebounding to its highest level in the last 8 quarters. An encouraging sign, given the relatively weaker economic sentiment surrounding its domestic economy.
 

Baidu Profitability and Cash Flows

Baidu registered operating and net profit margins of 25% and 26.7% respectively. Over the last few quarters, the company’s profit margins have contracted. This has largely been due to higher Traffic Acquisition Costs (TAC), content acquisition costs pertaining primarily to online video portal iQiyi, and spends on promoting its mobile apps.
 
However, one must note that Baidu thrashed EPS estimates by a whopping 20% plus in Q1 2014.
 
Baidu’s operating cash flows stood at 38% of revenue as the company ended the quarter with cash and equivalents of RMB 39.67 billion ($6.38 billion)
 
Note: All USD equivalents of previous quarters are as reported by the company in its earnings release and aren’t based on the latest conversion rates.
 

Baidu Future Outlook

 

Risks

Concerns around China’s economy grew stronger in Q2, which was when Baidu’s stock tanked. It’s common for ad spends to drop, at least in the short term, when economic sentiment is negative, and Baidu depends heavily on ad-revenue. While Baidu has cleared the first and possibly smaller hurdle of Q1 with ease, Q2 will probably be the real test of Baidu’s potential to sustain its solid financials during such phases.
 
It’s very likely that Baidu’s profit margins will contract further given its aggressive expansion and focus on growth. The company’s recent acquisition iQiyi is now producing movies in-house while it’s also mulling deals with studios for content that will entail content acquisition costs.
 
Baidu has launched its Portuguese language search in Brazil and is believed to be all set expand its search platforms to Thailand and Egypt. None of this might impact Q2, but could impact profitability in the coming quarters. Further, its track record outside China has not been very good.
 
In the domestic space, Baidu has been facing increased competition with big names like Alibaba and Tencent entering the fray through tie-ups with UC Web and Sogou/Soso respectively. Alibaba’s recent acquisition of Autonavi is also intended to take on Baidu in the Location Based Services vertical. The emergence of Qihoo as a bigger competitor is something Baidu will be looking at too.
 

Opportunities

With a slightly longer term view of iQiyi though, home productions could turn out to be a worthwhile opportunity. Further, as per a Bloomberg news piece, iQiyi could be an IPO candidate in the coming years unlocking value given its market leadership.
 
Baidu’s track record outside China consists of not so successful attempts in Japan, Singapore and Vietnam. However, the company’s recent approach has been different, as it seeks to leverage local partnerships.
 
Reportedly, Baidu is mulling the setup of an R&D center in Brazil in partnership with a local university and is gunning for pre-installation of its apps through a tie up with France Telecom in Egypt. Further, the Brazilian version of Baidu will reportedly have features that aren’t currently available even in the Chinese version. Baidu’s recently setup Silicon Valley R&D center is also symbolic of its intent overseas.
 

Baidu’s Moat

In spite of the risks, Baidu has a lot going for it. The company is the market leader in search of course (both PC and Mobile), but also in Maps which it is looking to leverage in its LBS vertical with the acquisition of Nuomi.
 
The company’s diversification into spaces like travel, payments, wearable devices, online security and more hold a lot of promise and takes on some of its search competitors in their backyards. For instance, with its award winning Antivirus Baidu takes on Qihoo in one of its strongholds.
 
Baidu is also a market leader in app distribution and online video viewership (with iQiyi). In one line, Baidu is a very comprehensive bundle of online services, many of which are already market leaders.
 
Add to this the potential of new businesses and the fact that user data collected from its wearable devices will be accessible to Baidu, and prospects look even better.
 

Baidu Valuation

Baidu currently trades at $200 a share. Baidu’s PE ratio of 39 and Price to Sales Ratio of 12 translate to valuation premiums over its peers.
 

PE Ratio

PS Ratio

Baidu

39.4

12.1

Google

31.6

6.6

Yandex

24.2

7.8

 
We think that Baidu’s ability to sustain these premium valuations will depend on its ability to sustain its superior growth and profitability. China’s internet user base is expanding at a fast pace. Given Baidu’s strong position in China’s internet economy, we remain bullish about its future prospects. Baidu is one of our top stock picks and has returned over 32% since April 2014, when we added it to that list. Our Baidu stock analysis rates it a buy in line with our long term view of the stock.

Disclaimer: We do not hold any stake in the aforesaid stocks. Please read our detailed disclaimer.

About the author

Vikram Nagarkar
Vikram Nagarkar is a Financial Analyst at Amigobulls. An MBA in Finance, Vikram has a penchant for macro economics, fiscal and monetary policy, apart from the innovative new-age businesses that we cover at Amigobulls. He loves biking, photography, traveling and exploring different cuisines. Connect with him at vikram.nagarkar AT amigobulls.com
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