While many of its peers have rallied over the past few years, Baidu Inc (ADR) (NASDAQ:BIDU) stock has just been flat. That gives BIDU stock an interesting setup heading into its second-quarter earnings report, which is due after the market closes on Thursday.
One of the market’s biggest storylines over the past several years has been the boom in Chinese internet stocks. As the China urbanization story spilled into a China digitization story, China’s internet-related markets have just exploded. This includes markets which are largely developed in the United States, like e-commerce, digital advertising and social media.
In fact, over the past three years, JD.Com Inc(ADR) (NASDAQ:JD) and Alibaba Group Holding Ltd (NYSE:BABA) are each up about 60%. Meanwhile, Tencent Holdings Ltd (OTCMKTS:TCEHY) has surged 140% higher in that same time frame.
But there have been no such gains for BIDU stock over the past three years. In fact, the Chinese internet search giant is down about 12% in that time frame.
Why? Well, the company’s growth story was unhinged in early 2016 after it found itself at the center of a tragic online advertising controversy. Since then, growth has flat-lined.
But things could get better. And Baidu earnings after the bell on Thursday could be the turning point.
Here’s why.
Baidu’s Growth Will Return
Baidu used to be a huge growth machine. As internet usage spread rampantly across China, the value of display advertising increased dramatically. In 2015, Baidu reported revenue growth in excess of 35%. That growth continued into the first quarter of 2016, when Baidu reported revenue growth of 31.2%. That lapped 34% revenue growth in the first quarter of 2015, so growth wasn’t showing many signs of slowing.
But then tragedy hit the search platform. In May 2016, a student tragically died as a result of attempting a faulty cancer treatment found through the Baidu search engine. There was huge public backlash. Baidu implemented many changes. Chinese authorities stepped in. Advertisers pulled out.
All in all, BIDU saw its huge revenue growth story quickly come off the tracks. Revenue in the second quarter of 2016 (the first quarter affected by the advertising scandal), grew only 10.2%. Over the next two quarters, revenue growth continued to fall off, until it was finally flat in the fourth quarter of 2016.
But BIDU management believes that the revenue impact from the advertising scandal is now largely behind them. In fact, in the first quarter of 2017, revenue growth did come back some. Baidu said revenues rose 6.8% in the quarter. That followed 31.2% growth in first quarter of 2016, so revenue growth on a two-year stack basis is pretty big.
The upcoming Baidu earnings report is pivotal because it’s the first one that laps the 2016 advertising scandal. It’s an easy lap (revenues only up 10.2% in 2Q16 versus the 31.2% lap in Q1), so the growth numbers should look pretty good. I think it will be something like 15% to 20%.
Bottom Line for BIDU Stock
The second-quarter earnings report is also an opportunity for the Chinese tech company to put its biggest headwind behind it. With that headwind in the rearview mirror, BIDU stock is free to fly higher without the valuation getting riskier. Revenue growth rates will climb back up to the 20% range and earnings growth will take off. Big earnings growth means the valuation can stay the same, and the stock can still climb higher.
Baidu is also at the forefront of China’s AI transformation. The company is pushing AI-enabled new businesses like AI-cloud, financial services, DuerOS and autonomous driving. As these businesses scale, BIDU’s long-term growth prospects become more promising.
The company is set to put its biggest headwind behind it and has AI tailwinds ahead of it. That means buy the stock now.
As of this writing, Luke Lango was long BIDU stock.
