Baidu Inc - ADR

##Symbol##BIDU

On June 19th I published an article, Why Baidu May Be Ready to Rise. I'll reprise some of that content but hyper focus on earnings due out today after the market closes. BIDU is truly unique in that it's a mega cap growing at the pace of a small cap and for once, it's a technology stock trading nowhere near all-time highs.

I remind all readers that a report just like this one is available for any company for free on CMLviz.com. Yes, literally for free. No e-mail. No login. Free. Forever. Period.

Fundamentals

Baidu is sometimes referred to as China's Google and has increased revenue (TTM) for 25 consecutive quarters and now boasts over $8 billion in annual sales. But the major concern for the firm is its operating margin. At its peak, BIDU earned over $2 in revenue for every $1 in operating expense. That revenue number has fallen to $1.20 for every $1 in expense. The stock is down across a three-, six- and twelve-month time horizon and has been left behind in the great technology rally.

The net effect of its dropping operating margin has been a rather abrupt drop in price to sales, which was ~35 in 2011 and now sits below 10. A valuation premium naturally falls as a company grows from infancy to a mega cap, but make no mistake, the operating margin decline has had a non-trivial impact on valuation and continues to be a major concern for the company. But, thereis a strong bullish thesis surrounding the firm that goes beyond the earnings release today and well in tot he future.



Much like its Chinese mega cap counterpart Alibaba (BABA), BIDU is now faced with generating substantial revenue outside of China and that means its competing with not just Google (GOOGL) for search, but also with Google and Apple in the connected car services segment. The potential for growth in all areas is massive given how regionally hyper focused the revenue stream is, but the competition is equally massive.

But there's one thing the investing world may be overlooking that's quite bullish for BIDU, and we'll discuss that in the conclusion. And this "one thing" is quite substantial.

Technicals   |   Support: 186.58   |   Resistance: 207.63   

Swing Death Cross Alert: The short-term 10 day MA is now below the 50 day MA.

BIDU's -3.37% drop today has a material impact on its technical outlook.

BIDU is hitting a technical breakdown right now. The stock has a one bull (lowest rated) technical rating because while it's trading above its 10-day moving average, its trading below both the 50- and 200-day moving averages and the 10-day MA is below the 50-day MA ("swing death cross"). Further, the stock is down -3.37% today.

Earnings Estimates

Revenue
Consensus estimates are for $2.9 billion.

EPS
Consensus estimates call for $1.80.

When risk becomes the game, the option market becomes the playground. As of right now, the option market reflects an upside potential in the stock price in the immediate-term. I have included the option skew chart for BIDU below for the options expiring July 31st. For those unfamiliar with the option market and skew you can read Understanding Option Skew; What It Is and Why It Exists


Let's look at the core elements that drive the company's fundamental rating.

Fundamentals Rating Summary

METRIC	CURRENT	1YR AGO	2YR AGO	DIRECTION
Revenue (TTM US$ Millions)	8,433	5,706	3,863
Operating Margin (QTR)	1.204	1.33	1.59	FALLING
Net Income (TTM US$ Millions)	2,113	1,771	1,708	RISING
Levered Free Cash Flow (TTM US$ Millions)	1,595
Research and Development (US$ Millions)	369	205	130	RISING
Research and Development Expense/Revenue	0.180	0.134	0.136	RISING

Stock Returns and Chart

BIDU is down -8.3% over the last three months and down -14.8% over the last six months. The stock price is down -12.2% over the last year. As I side before, it has been an ugly ride for BIDu and it has totally missed the technology gravy train that many of its peers have enjoyed. This is one technology stock trading nowhere near all-time highs.

Before we dig into the fundamental trends that drive the rating, let's look at a stock chart with regression channel and 10-day momentum (on the bottom).

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Now let's examine the visualizations of the critical financial measures.

METRIC	CURRENT	1YR AGO	2YR AGO	DIRECTION
Revenue (TTM US$ Millions)	8,433	5,706	3,863

BIDU may have the prettiest revenue chart in all of financial markets. It rivals that of Netflix (NFLX) and Amazon (AMZN). Even more impressive, it's not really doing much outside of China (yet). While growth outside of China seems compelling, don't forget the road that Alibaba just took, which was to broaden its offerings in China (video streaming / Netflix competitor) while also pursuing international growth. BIDU has now become as creative in an effort to grow business in its core region (China). That includes a video streaming offering to compete with BABA and to keep NFLX out of China. This type of action from management shows shrewdness in thought in that the, while international expansion sounds nice, there is still a lot of room for BIDU to grow within China.

Revenue (TTM) is trending higher meaning that it has increased for at least five consecutive quarters (in this case over 25 straight quarters).

BIDU grew revenue by 47.8% year-over-year. Any number over 20% has an added impact on the fundamental (star) rating.

What do all these numbers mean?
BIDU's fundamental rating benefited these results:
1. The one-year change was positive.
2. The one-year change was greater than +20% (an extra boost to the rating).
3. The two-year change was positive.
Finally, the up trend (consecutive quarters) in revenue benefited the fundamental (star) rating.

Let's look at Revenue (TTM US$ Millions) in the chart below.


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METRIC	CURRENT	1YR AGO	2YR AGO	DIRECTION
Operating Revenues/Operating Expense	1.204	1.33	1.59	FALLING

If BIDU wins the prize for prettiest revenue chart, then it may very well also win the prize for ugliest operating margin chart. Operating revenue over operating expense simply shows us how much revenue (in dollars) is generated for every dollar of expense. The ratio must be (at a minimum) above 1.0 in order for a company to turn an operating profit. For the latest quarter BIDU showed a ratio of 1.20, but believe it or not, back in 2011 BIDU actually showed an operating margin of over 2.0. That's a HUGE number. For context, recall that Facebook's (FB) operating revenue over operating expense peaked at 1.74 (which is also huge).

If you're looking for a reason that the stock price has not risen with the rest of technology, this is it.

What do all these numbers mean?
A year ago Operating Revenues/Operating Expense was 1.33. In the last year we can see operating margins are decreasing but are greater than 1.0 for the most recent period.

BIDU's fundamental rating was affected from the operating margin numbers in two ways:
1. The current value is above 1.0 (the firm generates an operating profit).
2. The one-year change was negative (lowers the rating a little bit).

Let's look at Operating Revenues/Operating Expense in the chart below with the total assets in the orange line.


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METRIC	CURRENT	1YR AGO	2YR AGO	DIRECTION
Net Income (TTM US$ Millions)	2,113	1,771	1,708	RISING

This is an interesting metric for BIDU. First and foremost, the firm makes a lot of money. This isn't a "growth" story where profits come later, rather it's a growth story where [profits are already present to the tune of $2.1 billion in the trailing-twelve-months. But (there's always a but), the last two quarterly results have seen rather sharp drops. Now, a part of that is a natural cyclicality in earnings (which we can see in the chart), but, BIDU's most recent quarter showed its lowest net income since June of 2013.

Still, net income over the trailing twelve months (TTM) for BIDU is rising, with a year-over-year increase of 19.3%.

In our next chart we plot Net Income (TTM US$ Millions) in the blue bars and the quarterly results in the gold line. Check out that gold line drop.


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METRIC	CURRENT	1YR AGO	2YR AGO	DIRECTION
Research and Development (US$ Millions)	369	205	130	RISING

Of all the interesting things happening at BIDU, R&D may be at the top. The firm spends a lot. Research and Development in the most recent quarter for BIDU was $369 million which is up an astounding 80% from last year's $205 million. That's not a typo. Further, we can see that R&D today relative to two-years ago is 183% higher (also not a typo).

Even further, R&D spent per dollar of revenue has increased from $0.13 to now $0.18 in just a year. The net results is a firm who has seen R&D rise from $40 million in 2012 to now nearly $370 million. I always give the caveat that technology firms have a nasty habit of putting stock based compensation into R&D (I have no idea why), but in any case, the trend is rather obvious and rather abrupt. BIDU is spending. This spending is crushing operating margins today, in the hopes of brining in profits tomorrow.

In our final time series chart we plot Research and Development (US$ Millions) in the blue bars and R&D per dollar of revenue in the orange line. note that both are exploding higher.


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Tale of the Tape

In our final visualization, we take a look at a cool head-to-head comparison of Google and BIDU across nine critical fundamental measures in one image


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Across the top row we can see the scale of Google. We're talking GIGANTIC. It towers over BIDU in terms of revenue, earnings and revenue per employee.

Across the second row we can see margins, and here's where BIDU looks quite tasty. BIDU has greater gross margins and net income margins while still spending more in R&D per dollar of operating expense than Google.

The final row shows us an even brighter picture for BIDU. The firm is growing revenue and earnings MUCH faster than Google and for that it receives a substantially higher price to sales ratio. In English, every dollar of revenue for BIDu yields nearly $9 in market cap, whereas every dollar in revenue for Google yields just $5.50 in market cap. That's the price of growth.

Summary
BIDU is a remarkable company. BIDU is an enormous company but, it's growing like a small cap. It's been mostly isolated to China but continues to grow. The margin pressure may be coming from application development and those expenses (see R&D) could (should) be capitalized. That means all that R&D we see which is hurting operating margins could turn into even larger growth and a re-expansion of margins. If that happens, there is a major upside potetnial for this company as it still is a Dominant player within China (the capital 'D' was on purpose).



BIDU now invests in on-line video and on-line travel and many feel those two areas may generate margin "pain" in 2015, but profits in the years to follow. The fact that BIDU is reinvesting in China (like it's other tech brother Alibaba) could be a bullish sign for the firm. Its on-line video business, which is in a very crowded segment in China, has grown to over 5 million subscribers and realized something on the order of 700% year-over-year growth. The investment thesis that surrounds growth inside China, like for Alibaba, is a very compelling one.

Now, let us not forget the other side. With all of this investment and margin cutting, if BIDU does not realize a compelling growth stride from these moves, the company is in bad shape. It will have exhaused efforts in R&D and within China and if those don't work, my goodness, it could be in trouble.

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