老股董 commented on a stock · Nov 27, 2022 01:05

Baidu Q2 earnings review: You need a heavy rain to overtake the car 15 times

$Baidu (BIDU.US)$ Investments require a bit of persistence, and when it comes to price investing, there are only many bear market opportunities. There is an awesome F1 driver named Elton Senna. He once said that when the weather is nice, you can't overtake 15 times; you can only do it when it's raining, because opportunities are always at a turning point. With this statement, I doubt he is borrowing a racing car and talking about stock trading. He must be trading stocks too.

There isn't much that needs to be manipulated in the bear market. Supported by the great belief of “saving capital,” we resolutely say no to all foolish and ridiculous operations. All that's left to do every quarter is to sort out my investment portfolio over and over again and check how each F1 car is in good condition, is there not enough fuel? Do you want to protect your tires, Yunyun.

So let's review Baidu's earnings report from an investor's perspective.

1. Value-based cash flow business

Baidu's business is complex, but using Occam's razor to break it down, it can simply be divided into two parts. This does not refer to the official financial report's classification: core income+non-core (iQiyi+Ctrip+Kuaishou's equity); rather, my personal favorite division: 1. Value-based cash flow operations and 2. Growing businesses require cash flow, which are mainly reflected in financial reports as marketing (advertising) revenue and non-marketing (non-advertising, mainly including cloud and AI-related) revenue. Advertising revenue can generally be estimated at 8-10 times the price-earnings ratio, and the current cash flow rate is basic; but only if it can be supported, so as soon as the financial report comes out, I'll first check whether advertising revenue is resilient.

The condition reflects like Pavlov's dog.

1. Value-based cash flow business

The market is pessimistic about advertising expectations because the market is too poor. The advertising campaigns of business owners in 2022 were comparable to the deflation of the 90s, and their hands were too tight to break. The market is full of sorrow. If you look at the overall industry, just look at the financial reports of Weibo, Mango Supermedia, and FanZhong Media. The year-on-year decline in advertising revenue in Q3 was 27%, 26%, and 34%, respectively. Many of Mango Supermedia's programs can't find sponsors; they can only broadcast naked; they are being forced to become self-media that loves to generate electricity. Therefore, the advertising market is affected by the overall economy, and it is definitely extremely uncomfortable.

I expect that with Baidu's advertising revenue falling 10% year over year in Q2, Q2 will be better, falling between 5-10%. However, in fact, there was a slight surprise. The year-on-year decline was 4% (compared to Tencent advertising), and there was a slight increase month-on-month. Therefore, it can be said that Baidu's mobile ecosystem's advertising business outperformed the market; after that (which is expected to begin in 2023), the mobile ecosystem may be further repaired.

Ad revenue did not drop much. Non-advertising revenue increased 25% year over year, so overall revenue increased 2% year over year to RMB 25.2 billion.

Furthermore, returning to the effects of reducing costs and increasing efficiency, Baidu's core operating profit margin has increased quite a bit due to a series of cost and personnel adjustments. Administrative sales expenses (SG&A) fell 29% year over year, and R&D expenses fell 7% year over year, thus increasing the operating margin (operating margin) of Baidu's core business from 15% a year ago and 14% a quarter ago to 20% in Q3 (see chart below). Cut costs and increase efficiency, don't deceive me.

In this second winter of the internet, large and small factories are all fighting for overall operational efficiency and the health of their financial models, so it is important to have a business that can generate cash flow through strong hematopoiesis. Taking Q3 as the boundary, Baidu's book cash+short investment was 184.5 billion dollars, while the overall free cash flow generated in Q3 was 6.6 billion yuan (that is, money that can be used to distribute dividends, repurchases, donations, and acquisitions of small companies, and reorganize at will without affecting the operation of any company). Therefore, the mobile ecosystem side alone gave Baidu's stock price the bottom line.

2. A growing business that requires cash flow

The first value-type cash flow business is currently safe depending on hematopoietic capacity, so how about the second block of growth requiring cash flow business?

I believe that the main reason for purchasing Baidu is the monetization of Baidu's AI.

For example, in Q3, the revenue of Baidu Smart Cloud increased by 24% year over year, leading to a 25% year-over-year increase in non-advertising revenue. Due to the impact of the pandemic on budgets and delivery, the interest and willingness of individuals to move to the cloud have significantly decreased, resulting in unsatisfactory growth rates for Alibaba Cloud and Tencent Cloud during the same period. However, Baidu Cloud has consistently been able to surpass the average growth rate. Some may be surprised by the rapid progress of Baidu Cloud. Primarily, this is because the starting point was relatively low. Additionally, Baidu Cloud serves as the vehicle for monetizing Baidu's AI technology. Various industries, such as manufacturing, energy, transportation, and government, can directly generate cloud revenue through smart clouds due to the early implementation of AI solutions. Moreover, the profit margins of smart cloud services are increasing. By scaling operations and transitioning from low-profit customized projects to standardized solutions, operating profit margins are on the rise.

Another key component for AI monetization is autonomous driving, which I believe will be pivotal for Baidu's future valuation. Despite some focusing on Baidu's cash reserves as a basis for undervaluation, it is my view that this perspective is somewhat naive. For instance, excluding iQiyi, with book cash and short-term investments totaling 184.5 billion yuan, Baidu's market capitalization sits at only 2,400 yuan. When considering the minimal debt, the valuation appears remarkably low. However, the evaluation can appear questionable when comparing the tech company's value to its book cash reserves. The rationale is straightforward. Baidu's autonomous driving endeavors encompass Robotaxi, the foundational Baidu Map, Xiaodu, ASD intelligent driving accessories, and the concentrated brand image associated with launching these sub-businesses, all interlinked through an autonomous driving ecosystem.

There are two things to pay attention to in the financial and operating model of autonomous driving:

Based on recent cumulative orders of 11.4 billion dollars, assuming they are digested in the next 3 years, future revenue from autonomous driving (including high-definition maps, Dueros in-vehicle systems, and ASD smart accessories) is likely to maintain a year-on-year increase of at least 50%. It is expected that future revenue from autonomous driving will account for a relatively large share of total revenue from the end of 2023 to 2024.

Robotaxi Radish Express provided 474,000 rides in the third quarter, up 311% year on year and 65% month on month. By the end of the third quarter, Radish Express had provided a cumulative total of 1.4 million ride-hailing services. Currently, the percentage of revenue generated by Robotax is still quite small and can be ignored.

An analyst asked a question at the earnings conference. I think it's pretty sharp: What are the differences between Baidu's autonomous driving and Robotaxi and competitors? Boss Li's answer: 1. This track requires a huge upfront investment threshold, making it difficult for new players to get in, and most of them are still young players; 2. Automakers are less likely to choose to do their own research, but instead cooperate with Baidu. They like Baidu's specific technology, such as ANP, AVP, and high-precision maps. 3. Baidu's cash flow can support continued investment.

The outlook for “degree ratio” is rising

In summary, Baidu has three blocks of business. One part generates cash flow, one part is about to generate cash flow, and the other part requires cash flow but has a relatively large X factor. This made me think of Han Han's previous income, which began by selling books to feed racing cars, then racing cars to feed and write books, and finally, he started a directing career with huge profit margins that he had never anticipated. This path can be compared to Baidu's business shift.

Then there is the most evocative passage in the financial report:

“Currently, the market demand for Baidu Apollo's intelligent automotive solutions is growing. Recently, its cumulative target and contract amount is expected to reach 11.4 billion yuan. In the third quarter, Baidu deepened its partnership with one of China's largest automotive technology companies to apply ANP (Apollo Pilot Assisted Driving), AVP (Autonomous Parking), and high-precision maps to one of its popular models, which once again proved that car manufacturers are fond of Apollo autonomous driving solutions (ASD).”

Some people ask: Who is one of the biggest automotive technology companies in China?

I'm guessing: who else is, of course, BYD Bendi.

In fact, Baidu collaborates quite widely with car manufacturers. For example, Tesla uses Baidu Maps domestically, and you can meet Xiaodu in Tesla cars. However, the current collaboration between BYD and Baidu is very complementary in any way you look at it. As the car company with the highest sales volume on the new energy vehicle Blue Star, BYD's own autonomous driving is currently quite rough in the industry; and Baidu, as ASD's leader, allows BYD to make up for shortcomings as quickly as possible and provide a complete set of solutions, including ANP smart driving functions, computing platforms, and software algorithms. A boss said that electric cars are in the first half, smart cars are in the second half, and this boss is also starting to warm up in the second half.

4. valuations

Finally, let's talk briefly about valuation. The advertising business search and information flow is the bottom position, which can estimate 8-10 times the expected profit in 23 years; while the cloud and autonomous driving business are the backbone of future valuations, and it is also where Baidu's equity investment can grow. Cloud can give 2 times P/S; however, Xiaodu and Apollo are more difficult to estimate. Using comparable corporate law, it's probably at least 8 billion US dollars or more (Xiaodu was valued at around 5 billion US dollars during early financing, and the 2022 market was not good at 40% off 3 billion; My Little Pony Zhixing valued at 8.5 billion yuan; Apollo was at least not bad; the market price was at least 6 billion yuan off 5 billion, which is reasonable). Concentration hasn't been achieved yet, and it's being ignored for the time being. However, Baidu's cash, iQiyi, Ctrip, and Kuaishou shares can all be discounted and valued. The sum total of zero is at least significantly higher than the current market value of 32 billion dollars under my own, ignoring, and very skimpy valuations. It is also because the market is too pessimistic about China's securities market, which provides a lot of room for the average valuation to return in the future.

Boss Lee's letter mentioned, "Countless experiences in history have proven that the crisis itself stimulates innovation, and innovation drives growth; and this statement is a bit different from Elton Senna's overtaking car 15 times on rainy days."

This article does not represent any investment advice

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