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Stock Strategist

Baidu Still a Buy

Our thesis of significant profit improvement is playing out.

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Despite a double-digit runup on the day after third-quarter results were released, Baidu’s (BIDU) shares are still significantly undervalued relative to our $218 fair value estimate. We have seen substantial sequential improvement in revenue, operating profit, and Baidu core operating profit in the second and third quarters, and the most recent results provide further evidence for our thesis that Baidu will cut back on investment and increase margins if returns on some of its investments are not ideal. Management also sees stabilization in the overall business, with the growth in industry ad supply slowing. We note that rival WeChat Moments still has a lot of room to release inventory, though we believe this will happen gradually.

Third-quarter revenue was CNY 28.1 billion, close to the high end of the guidance range of CNY 26.9 billion-28.5 billion. Management expects fourth-quarter revenue of CNY 27.1 billion-28.7 billion, or down 1% to up 6% year over year, while guidance for Baidu core is 0%-6% year-over-year growth. Operating income in the third quarter was up from CNY 233 million to CNY 2.4 billion thanks to an 11% sequential decline in selling, general, and marketing expenses, operating leverage resulting from the 7% sequential increase in the top line, and a 5% sequential reduction in traffic acquisition costs, which management attributed to stronger mobile ecosystem. On a year-over-year basis, operating income still declined 47%. The net loss was CNY 6.4 billion in the quarter, attributed to an impairment of CNY 8.9 billion on the sale of 7% of Trip.com. Baidu's core revenue and operating income were up 8% and 146% sequentially.

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Chelsey Tam does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.