Baidu Earnings Q3 2015 Preview: Margin Pressure To Continue

  • Baidu earnings Q3 2015 are expected to be reported on Oct. 29 after market close.
  • Baidu's top line is expected to continue expanding at a healthy clip due to the company's success in monetizing mobile search.
  • Baidu's bottom line, however, is expected to remain weak due to the company's heavy investments in 020 ventures.
  • Baidu's shares are likely to remain depressed for the rest of the year but have good upside potential over a 2-5 year timeframe.

Chinese search giant Baidu (NASDAQ:BIDU) is expected to report Q3 2015 earnings on Oct. 29 after market close. Baidu said during its second quarter earnings call that it expects revenue of RMB 18.17 billion - RMB 18.58 billion ($2.86 billion-$2.92 billion), good for 34.4% to 37.4% Y/Y growth. Although the company did not provide any income guidance, analysts see Baidu reporting GAAP EPS of $1.23 compared to EPS of $1.79 for the prior year quarter. Meanwhile, Baidu has failed to meet consensus earnings estimates for the last three quarters running.

Baidu Earnings Surprise History

Fiscal
Quarter End
Date
Reported
Earnings
Per Share
Consensus
EPS* Forecast
%
Surprise
Jun2015 07/27/2015 1.64 1.8 -8.89
Mar2015 04/29/2015 1.09 1.13 -3.54
Dec2014 02/11/2015 1.45 1.6 -9.37
Sep2014 10/29/2014 1.79 1.62 10.49

O20 Ventures Pressuring Margins

Baidu shares are down 34.4% YTD partly due to the ongoing weakness in the Chinese market, and partly due to the company’s anemic bottom line growth. The Hang Seng Index is down 22% YTD which implies Baidu has fared worse than the average large tech company in China during the selloff. But this has little to do with Baidu’s top line, which is still expanding at an impressive clip. During the second quarter, Baidu reported revenue of $2.67 billion, good for 38.3% YoY growth. The company, however, reported GAAP EPS of $1.64, representing an anemic 3.3% growth from the prior year quarter. Most of the company’s other chief growth metrics including online marketing revenue and mobile search monthly active users were in the pink of health while its traffic acquisition costs and content costs remained under control.

Baidu, however, introduced a new revenue segment that revealed why the company’s bottom line had come under so much pressure lately. Baidu for the first time reported results for its O2O (Online-to-Offline) segment that represents a merger between the traditional retail experience and modern ecommerce. Baidu has been investing a lot of money in 020 ventures--during the last quarter, the company reported that SG&A expenses grew 81% Y/Y to $627.4 million due to the company’s heavy investments in O2O. Baidu’s O2O ventures are growing rapidly: the company reported that although O20 online penetration was still in the low single-digits, the segment transacted Gross Merchandise Volume, or GMV, of RMB 40.5 billion ($6.5 billion) during the last quarter. The company pointed out that Baidu Nuomi and Baidu Takeout Delivery, two if its 3 sub-segments of O20, were growing at 200% and 100%, respectively.

But here is the rub with Baidu’s 020 ventures: the company is not making any money from them. You can tell this much by reading Baidu’s response when asked about monetizing its 02O businesses:

They're all growing very, very fast and together with our peers and competitors, we are educating the Chinese consumers the better way to order services. So eventually, we will be able to take a cut, a sizeable cut from that, but whether that's three-year or five-year, it's really hard to tell at this point.

So Baidu is not taking any cut from the huge amount of O20 business it’s handling, and has no plans to do so in the near future. Baidu further pointed that its consolidated 020&Others segment had a huge impact of -25.3% on the company’s gross margin. O20 alone contributed about 80% of that impact. And the margin pressure is unlikely to ease off any time soon: Baidu said that it plans to invest RMB $20 billion ($3.15 billion) in its 020 ventures over the next three years.

Takeaway

Trading at a forward PE of 25.23 and forward Price-to-Sales ratio of 4.7, Baidu shares actually look quite cheap when you consider that the company is expected to grow its earnings at a healthy 24.16% CAGR over the next five years. The ongoing margin pressure due to the company’s heavy investments in 020 ventures as well as the weakness in the Chinese market is likely to keep the Baidu stock price depressed for the rest of the year. But with a top line growing at an eye-popping clip while mobile growth continues to supply the cash needed for its 020 investments, Baidu shares have good upside potential over a 2-5 year time frame.

 

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