EUR 850.00 For Business Accounts Only

Morningstar | Reducing FVE for Wide-Moat Baidu by 3% to USD 218 Given Reduced Profitability in the Near Term

We reduced Baidu’s operating profit to CNY 4.5 billion in 2019, with an operating margin of 4.1%, based on our assumption that the cost structure will increase by approximately 950 million sequentially in the second, third and fourth quarters this year. This is in line with the company’s guidance it will contain the sequential increase in cost during the rest of the year to 1 billion per quarter. We continue to assume the operating margin will rise back to 12.5% in 2023, versus our previous assumption of 12.9%, compared with 15.2% in 2018. Baidu core (excluding iQiyi) operating margin is forecast to drop to 16.2% in 2019 from 30.5% in 2018, before rising to 17.7% by 2023. We think our assumptions of only a small margin recovery for Baidu core have sufficiently incorporated the ever-increasing competitive environment in the Internet sector. Given search, especially search for general information, is still a necessity, and wide-moat Baidu has a dominant market share of over 70% in search, we are confident Baidu will resume growth and is currently undervalued with a 5-star rating. Our five-year net revenue and operating profit growth forecasts are 13% and 9% now versus 14% and 10% respectively previously. We reduced our fair value estimate by 3% to USD 218 per share.

The assumed increase in the margin and recovery of revenue growth are based on the eventual dissipation of Baidu’s short-term headwinds and its strong position in search. We expect to see a lower base associated with the revenue disruptions after moving the landing pages of Baidu’s customers to the firm's platform by the beginning of second-quarter 2020. We think most of Baidu’s customers will stay at its platform given its dominance in search, and ad conversion can ramp up as the customers get their new landing pages up and running. The increase in advertising supply in the market, for example, from Bytedance and Tencent, has reduced the pricing of ads in the market. We have observed a relatively stable supply of advertising after Chinese New Year and do not anticipate substantial increases in this supply in the near term given current economic weakness. As the economy recovers gradually and some of Baidu’s customers see a stabilization in regulations associated with their industries, we expect advertising demand to bounce back eventually, which will offset some of the effects from a higher supply of advertising. The resumption of gaming licence approvals late in 2019 should boost the advertising demand of the gaming sector. We also see a rebound in the margin from the gradual monetization of new mobile users acquired by Baidu. Should the return on investment not be justified, we expect the scrapping of aggressive investment plans in mobile apps, which will also lead to an increase in the margin. Baidu’s previous exit from the O2O businesses and the resulting increase in margin shapes the basis of our thinking.