Shares of Baidu (NASDAQ: BIDU), a Chinese company providing internet search and online marketing solutions, have vastly underperformed the U.S. stock market in 2021.
There’s one very strong, very negative reason why BIDU stock is underperforming. And that single reason could be enough to stay away from the stock despite its overall great fundamentals and attractive valuation.
BIDU Suffers As China Cracks Down on Big Tech
An article on Fortune titled “As China’s tech crackdown widens, investors may take a ‘sell first, talk later’ approach” and another one on South China Morning Post titled “Beijing hints that it is Big Tech antitrust scrutiny could be permanent with new five-year blueprint” explain why Baidu shares are down about 27% in 2021 and traded at $137 as of Aug. 19, 2021.
BIDU stock has a 52-week range of $115.59 to $354.82. The reason it is now 62% below its 52-week high is China’s regulatory assault on its technology industry for reasons such as antitrust terms, anticompetitive behavior of big tech companies, and antimonopoly concerns, as well as data security and data privacy.
Personally, when I read “New five-year rule of law blueprint calls for stronger antitrust law enforcement” and that “China’s antitrust law enforcement is understaffed at the moment, an official said in an interview this year,” it looks like selling pressure will continue on big tech Chinese names such as Baidu.
Regulatory changes and risks are critical threats in any industry and sector, not just the high-flying technology sector.
What I don’t get and cannot explain is the fact that this government decision has wiped several billion off the market capitalization of large companies such as Baidu, at a time when there’s an ongoing business and technological “war” between the U.S. and China. I’m no politician, but undermining your own companies efforts to dominate in the global technology industry doesn’t sound too smart from a strategic point of view.
Regardless, this crackdown on the Chinese technology sector itself is a very negative development for BIDU stock, one that could get more severe and become a lengthy regulatory process.
Earnings Beat: A Positive Factor That May Not Last Enough
On Aug.12, 2021, there was positive news that Baidu’s “quarterly results topped Wall Street estimates… as the Chinese search giant benefited from a rebound in advertising sales and higher demand for its artificial intelligence and cloud products.”
Total revenue reported was strong too, rising “… to 31.35 billion yuan from 26.03 billion yuan in the second quarter ended June 30, topping analysts’ average estimate of 30.96 billion yuan, according to IBES data from Refinitiv.”
Furthermore, core revenue increased substantially. According to CFO Herman Yu:
“Baidu Core revenue grew 27% year over year in the second quarter, boosted by AI cloud growing 71% year over year. Baidu’s search and feed business were solid, and we continue to execute and lead on our new AI business, including AI cloud, autonomous driving, and smart assistant.”
Fundamentals: Strong Performance Where It Matters, Net Profitability and Free Cash Flow
When it comes to investing, analyzing a company’s performance over at least 3 to 5 years can reveal trends in key financial metrics. BIDU stock has a strong sales growth, is profitable, and has improved its net margin to 20.99% in 2020 compared to 1.84% in 2019.
On top of this, Baidu has a strong balance sheet and strongly positive free cash flow. Baidu in the past years has also had a stock repurchase plan; this is by itself positive, as it signals management has confidence in the future of its stock and likely consider it undervalued. Indeed, from a relative valuation perspective BIDU stock does appear undervalued.
Baidu Now Has An Attractive Valuation
Data from MSN Money shows that compared to industry average price ratios, BIDU appears to be relatively undervalued.
The Price/Sales Ratio, Price/Book Value, and Price/Cash Flow Ratio for Baidu shares are 3.53, 1.96, and 9.23 respectively. The average Price/Sales Ratio, Price/Book Value, and Price/Cash Flow Ratio for Baidu’s industry are 7.09, 7.69, and 27.67 respectively.
Business Model: Diversification into Several Sectors
Baidu isn’t just an internet search services company but more than that as it now operates in business sectors such as AI, Cloud and EVs. Autonomous driving is also a big bet for Baidu. And all of these sectors can provide future growth, as the company has a strategic goal to become carbon neutral by the year 2030.
Baidu Shares: Tempting but Hard to Ignore its Risks
If there was no news at all about China’s crackdown on its technology sector, then I would hardly hesitate to name BIDU stock as a stock to buy. It has plenty of merits, good fundamentals, growth, and an attractive valuation. But until the dust is settled once and for all in these regulatory woes, I would suggest being more conservative and waiting to see the results. No need to jump in now as there is a risk of further decline in the stock price.
On the date of publication, Stavros Georgiadis, CFA did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
