Baidu Inc (ADR) (NASDAQ:BIDU) has just become a victim of its own success. Despite reporting a seemingly great earnings report last week, BIDU stock has gotten hammered.
Is Wall Street being irrational? Our Nicholas Chahine makes the case. He thinks BIDU stock still has strong upward momentum and that investors are overreacting to short-term noise. He suggests selling put options as a way to benefit. That’s an interesting strategy, since the stock still looks expensive, as even he concedes.
Baidu’s proponents do have a great point with momentum. The stock has shown enormous technical strength — at least until the past week. Earnings growth is back after a disappointing 2016. But here’s a few things to consider before buying the pullback.
BIDU Stock Cons
Risky Side Projects: Baidu has a leading position in search. Like with Alphabet Inc Class A (NASDAQ:GOOGL) (NASDAQ:GOOG), Baidu isn’t content to just dominate its niche. It also has a bunch of moonshot projects, including a multi-billion streaming service that doesn’t appear close to reaching profitability even after years of operation. Even bigger, it’s now trying to convert from being a “mobile” company to an “AI” company.
It’s boosted R&D spending tremendously as it seeks to achieve these aims. The company claims it will have self-driving vehicles ready to go in 2021. However, that’s quite awhile to wait and see if the increased R&D budget bears fruit. Baidu has previously sold off underperforming divisions and there’s no guarantee its current grandiose ambitions won’t end in write-downs later.
Expensive Stock: Baidu is trading for close to 50x trailing earnings. This number could come down quickly — earnings rose by 182% and net income by 158% — far outstripping the headline growth rate. However, it’s unclear how much of this earnings growth is repeatable, or was driven by one-offs such as the beneficial move in the Chinese yuan.
In any case, BIDU stock trades considerable richer than GOOGL stock. It’s not clear that this premium is justified. Baidu faces a great deal of regulatory risk. The fact that a scandal and increased government oversight could zero out Baidu’s growth rate for a year speaks to the risk of operating in the Chinese economy.
Technical Issues: BIDU stock may be stalling out. The stock peaked previously at $250 in 2014. While it briefly topped that level in October, it failed to close the month above the previous high.
BIDU stock bears are going to say that, as such, this represents a double top. After three years, Baidu finally reached new heights, only to get smacked right back down. The heavy volume selling over the past few days far exceeded buying volume on the way up, leading to what looks like a clear technical top.
BIDU Stock Pros
Growth Is Back: Baidu had a lousy 2016. As mentioned, BIDU stock peaked in 2014, and traded downward from then on. In 2016, the company was hit by a major scandal, and its growth outright stopped. A Baidu user with cancer paid for an alternative treatment promoted on Baidu’s search results that lacked medical evidence and later died. Baidu faced government oversight and lost advertisers in the wake of the scandal. However, the ill effect started to wear off toward the end of 2016.
This year, in fact, the company is growing again. It showed 28% year-over-year growth again as of this past quarter. That built on the results from the previous quarter, which were enough to send BIDU stock from $200 to $270. Bears bought into this narrative that Baidu’s growth story had ended. Now BIDU stock is up 50% year-to-date, even after this past week’s decline, as BIDU is back to its traditional fast-growing self.
Better Than Understood Quarter: Bank analysts appear to have been slightly confused about what to expect from Baidu this past quarter. Despite Baidu reporting more revenue than the top end of its previously-announced guidance, Baidu’s result still fell short of consensus estimates. It seems that folks may have underanticipated revenue would be lost with the divestment of several former Baidu subsidiaries.
Consequently, this leads to misleadingly low revenue and earnings growth rates if looked at in isolation. For next quarter, the company is forecasting sequentially flat numbers, but they’ll be up 28-34% excluding the now-sold mobile games and the deliveries businesses. The analyst at Cantor reiterated a positive outlook with a $350 price target, saying that the Street had miscalculated revenue estimates.
Stronger Yuan: One of the headwinds for Chinese stocks had been the falling Chinese yuan. The currency hit its peak at 6.0 in 2014. Since then, it had been all downhill, falling to 7.0 late last year. A 15% move like that took almost 15% of the value of Baidu’s business away from its U.S. holders. That’s because the company sells ads in China, but its reports, when translated into dollars, look significantly less impressive when the yuan is sliding.
However, the yuan has now reversed. That’s contrary to expectations: Analysts were expecting weaknesses with the Chinese financial system to cause further capital flight. Instead, it’s been the U.S. dollar that has lost steam this year. The 5% (and counting) rebound in the yuan this year adds that much value back into BIDU stock. More importantly, a stronger yuan makes its reported revenue and EPS growth stronger.
Verdict on BIDU
Chinese stocks are having an outstanding 2017. And BIDU stock has been one of the big winners. The company has decisively overcome concerns that its growth model had broken down.
However, don’t recklessly chase BIDU stock here, even after this recent pullback. The stock may be showing a double top around $250. And the recent earnings growth is benefiting from what could be transitory currency swings. On the other hand, analysts appear to be missing some of Baidu’s potential strength. I’d wait to see how BIDU fares while trying to retake the $250 level before making any big moves, though.
At the time of this writing, the author held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.
