Baidu (BIDU) has lost revenue and is struggling with soft economic conditions. It is forecasting its second-quarter sales may grow at the slowest pace in more than two years. Baidu forecast that revenue growth may slow to 56 percent this quarter on concerns China's economic slowdown may curtail advertising spending by companies. It is not the only company.
A competitor - Sohu Inc (SOHU) - reported EPS of 61 cents per share, beating estimates for 48 cents. That's the good news, but what came after continues to plague the bearish stock. The company said it expects second-quarter earnings to be 40 cents per share to 45 cents per share, well below estimates for 81 cents per share. Why is this? Along with better-than-expected EPS came a 22% drop in brand advertising tied directly to the softening economy. Because of lackluster auto sales and the slowing real estate market, many automakers and real estate developers decided to defer their marketing plans.
With the weakening Chinese economy, the stock has dropped quite dramatically. It formed a double top between the end of March and mid April when it peaked at just over 150 and since then it has chased the bears clear down to the 118 level.
China's economic growth has decelerated from overheated to slower than the powers that be wanted in just half a year. Export demand has slowed. This is understandable with Europe in a tizzy. But at home-consumer spending has also slowed. This could cause unrest for the workers. Signs of a slow down loom as spending on power almost divided itself in half form 7% in March to 3.7% in April. This is always a bad sign for manufacturing that relies on exports. In terms of at-home consumer spending-- sales of home appliances during the week long May Day holiday were down 30 to 40 percent from a year earlier.
I do not expect the economic conditions to change a whole lot soon. With the softer forecast for the 2Q2012 caused by a slow economy, big customers are spending more cautiously and advertising money is not flowing as freely right now. Long term, the company may be a good investment eventually but I see it possibly moving in a trading channel for the next couple quarters with a bearish lean. So instead of long-term investing, I would tend to gravitate toward a short-term income strategy.
The Options Play
The trading channel I see is between 115 and 125. We are looking on the upside with a Bull Call Spread out to September to give the stock room to jump periodically.
- Buy a September 2012 call with a strike of '120' (priced at $11.00)
- Sell a September 2012 call with a strike of '125' (priced at $8.60)
- Net Debit to Start: $2.40
- Maximum Profit: $2.60
Reasoning behind the Trade:
- Slow economic conditions in China will keep advertising dollar low so the stock will not be too bullish.
- Strong company has analysts giving it a price target of 185 so it has room to grow.
- Our trade is within what we consider our trading channel.