Baidu: Both Sides Of The Coin

| About: Baidu, Inc. (BIDU)

Baidu (BIDU) just reported its 2012 Q2 report on Monday, July 23rd, reporting $1.24, 12 cents ahead of the analyst estimates. This makes it Baidu's 13th consecutive quarter of beating estimates. This article presents a few pros and cons of buying Baidu right now. We published a piece back in May that talked about Baidu's attractive aspects. This article revisits some of them, adds a few new developments but also includes some areas of concern to give investors a well rounded picture. Let us get started with the positives first.

Historical Valuation: Since the last article, Baidu's share price has dropped from the $120s range to the $110s. So, the PE has fallen further, just a couple of points below its all time low during the 2008 crisis. The PEG sits at 0.6, the same level as Apple (NASDAQ:AAPL). For a company expected to grow at least by 40% over the next 5 years and is undoubtedly the market leader, the valuations seem reasonable.

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(Source :Ycharts.com)

Technical Indicators: The market in general has rallied since May but Baidu has not participated in the rally. The stock remains oversold, with its Relative Strength Index [RSI] still well below 50.

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(Source: Nasdaq.com)

Price Targets: The average analyst target price has come down from $185 to $175 but with the fall in the stock price as well, the expected gains from this point on still stands at the same 60% as the previous write-up. Again, stocks like Baidu move up wildly if some positive development comes out of its earnings or on the business front. So, even though 60% seems far off, it might be attained quickly. Whereas, the technical base for the stock seems set at the $100 to $110 range.

Apple and Mobile Developments: In the original article, we noted about Baidu moving into the mobile space, by creating its own low-cost mobile device. The recent development we are talking about is Apple's decision to include Baidu as the default search engine in its iPhones sold in China. In addition to the joy of snubbing their common rival Google (NASDAQ:GOOG), this partnership makes complete business sense. The number one high-end phone maker collaborating with the number one search engine. The two companies are expected to share the Ad sales.

Extrapolating Numbers: Baidu's current Trailing Twelve Month [TTM] Earnings per share [EPS] is $3.34. With the new results, the TTM jumps to $3.85. Applying even today's PE of 33, we get a share price of $123, a 11% spike for those who are keen on trading.

Challenges:

Slowing Chinese Economy: There are well known worries about a slow down in the Chinese economy. Inflation is a red flag and so are the housing and banking sectors. Since Baidu's bread and butter is the ad revenues, the other sectors struggling directly impacts Baidu's revenues.

Law of Large Numbers: Baidu's market share is approaching 80% and when a company starts to dominate so much, the talks about "how much higher can it go" start surfacing. It was not long ago Baidu was blasting at a 90% growth rate but if the company meets its 2012 Q2 EPS estimate of $1.12 per share, that would indicate a YOY of just about 50%. Its still an impressive number but the slow down is evident.

The Master of "One" trade: We need not look beyond Google to prove this particular point. Google and Baidu have done an amazing job in their search business but have very little to show for else where. What happens after Baidu rakes up even more market share in the search sector is something that should keep investors worried.

Our Take: We believe the stock is currently undervalued based on its recent trading range. We expect it to do well until the earnings growth slows down and comes in line with the PE. Meanwhile, keep a tight watch on how Baidu's mobile vision progresses, both on the hardware side and on the Apple deal. That will answer the "What next" question most likely.

Disclosure: I am long AAPL.

Additional disclosure: May initiate a position in BIDU over the next 72 hours.