Baidu: Recent Developments Are Favorable (NASDAQ:BIDU)

Elevator Pitch

Baidu, Inc.’s (NASDAQ:BIDU) [9888:HK] shares are deserving of a Buy rating.

BIDU’s shares have gone up by +66.4% (source: Seeking Alpha price data) since my previous article previewing the company’s Q3 2022 earnings was published on November 17, 2022. In the same time frame, the S&P 500 rose by a mere +5.1%.

Notwithstanding Baidu’s recent share price outperformance, my view is that BIDU’s stock can continue to rise, taking into account the company’s recent developments. The increase in BlackRock’s (BLK) equity interest in Baidu and news relating to the potential introduction of an AI chatbot are positive developments, which point to further upside for Baidu’s shares. Therefore, I have chosen to maintain a Buy rating for BIDU.

New AI Chatbot Could Be In The Works For Baidu

A January 30, 2023 Seeking Alpha News article cited a report from Reuters mentioning that BIDU could potentially introduce a new “artificial intelligence chatbot service” which might be integrated “with its search engine” over time.

Assuming that this piece of news turns out to be true as per Reuters’ sources, this will be a very significant development for Baidu. By introducing its own AI chatbot, Baidu can reduce the risks relating to the potential disruption of its leading search engine services by chatbots launched by competitors. More significantly, a new AI chatbot will send a clear message to investors and rivals that BIDU isn’t going to cede its leading position in China’s AI market anytime soon.

Based on Chinese research firm iResearch’s China AI Industry report, the size of the Chinese AI market is projected to expand by a +25% CAGR from RMB727 billion in 2020 to RMB2,713 billion in 2026. Baidu is in an excellent position to leverage on the strong growth of the AI market in China in the years ahead, considering its research efforts relating to AI and the strong growth of its AI business.

BIDU is ahead of its Chinese peers in the AI space in terms of R&D (Research & Development) spending and patent applications as per an April 26, 2022 China Daily news commentary. According to China Daily, Baidu’s R&D-to-sales ratio is the highest in a list of the country’s 500 largest corporates, while it has in excess of 16,000 AI patent applications in China. An earlier article published in China IP Magazine in July 2021 also highlighted that Baidu owns the most number of AI patents in China, putting it ahead of other Chinese technology giants like Tencent (OTCPK:TCEHY) (OTCPK:TCTZF) and Huawei.

Separately, Baidu revealed at its recent Q3 2022 results briefing in late-November last year that revenue generated by its AI Cloud business expanded by +24% YoY to RMB4.5 billion in the third quarter of the prior year. Also, it is noteworthy that BIDU specifically referred to AI Cloud as “a major growth driver for Baidu Core non-advertising revenue” in its management commentary at its most recent quarterly earnings call.

It is no surprise that Baidu’s efforts and success in the area of AI has attracted investors’ interest in the company’s shares as discussed in the subsequent section.

BlackRock Increases Its Equity Interest In BIDU

Seeking Alpha News recently reported on February 1, 2023 that BlackRock “raised its passive stake” in Baidu from 3.5% previously to “6.6% as of the last quarter.”

This recent disclosure serves as both an endorsement of Baidu’s attractiveness (AI leader) as an investment candidate, and an indication of the institutional investors’ underweighting of Chinese listed companies.

As per a February 2, 2023, UBS (UBS) research report (not publicly available) titled “Investor Positioning Suggests Further Room For Foreign Inflows”, the “top 40 global investors holdings of” Chinese companies’ shares as a proportion of their respective portfolios was 1.2% as of end-2022. This is much lower than what it was two years ago (2% as of December 31, 2020).

Baidu is one of MSCI China Index’s 10 largest component stocks, so BIDU should be a beneficiary of an increase in investors’ allocation to Chinese companies. Considering that China has already given up on its zero-COVID strategy and that there has been a “rally” in Chinese stocks since the start of 2023, this should compel more institutional investors to increase their exposure to Chinese index stocks like Baidu.

Baidu’s Valuations Are Still Undemanding

BIDU is currently valued by the market at a consensus forward next twelve months’ normalized P/E multiple of 16.8 times according to S&P Capital IQ data. This is pretty attractive compared to Baidu’s historical valuations and its future earnings growth expectations.

The 10-year average forward P/E ratio for Baidu is much higher at 23.6 times. Also, Baidu’s consensus FY 2023-2025 normalized EPS CAGR is +20.5%, which implies that BIDU’s PEG (Price/Earnings-To-Growth) ratio is just 0.82 times. A stock is deemed to be undervalued, if its PEG ratio is under 1.

Bottom Line

I retain my Buy rating for Baidu. BIDU’s shares are undervalued, and it is likely that Baidu’s stock price can go up further judging by recent events as discussed in this article.