BIDU-SW: Not only AI stories, but also ads improving to prop up the shares

After the Hong Kong stock market closed on May 16th Beijing time, Baidu.US (9888.HK;$Baidu(BIDU.US)) released its Q1 2023 financial report. Excluding iQiyi and only looking at BIDU-SW's core business:

Due to better-than-expected advertising recovery and significant cost optimization, both revenue and profit exceeded expectations.

BIDU-SW's core gross margin increased by 5pct compared to the previous quarter, returning to the level of 2021. In addition to the growth of high-margin advertising, the fact that the growth rate of other revenues such as smart cloud did not accelerate compared to the same period last year and the previous quarter indicates that there are still some cost optimizations that are actively removed by the cloud business from inefficient projects, and smart cloud achieved profitability in Q1.

In addition, considering the growth of other revenues did not accelerate and the decline in costs and R&D expenses, Dolphin Analyst believes that although Ernie Bot, which has attracted much attention, was released in mid-March, there may not have been much revenue recognition in Q1. Therefore, the impact of AI investment on profit margin may be seen in the next quarter.

Specifically:

1. Advertising recovery exceeded expectations. Although adjustments were made due to the epidemic since the beginning of the year, due to the fact that the country is still in the high incidence period and the Spring Festival holiday is earlier, many advertisers have allocated more budgets to the post-holiday period. According to Questmobile data, the year-on-year growth rate of the Internet industry in Q1 is expected to be only 2.3%.

Nevertheless, it is higher than market expectations (~2.8%). In terms of month-on-month comparison, it is also accelerating on the trend of recovery.

2. Other businesses, mainly cloud and intelligent driving, have not recovered as expected. The year-on-year growth of other businesses is 11.5%, which is weaker than market expectations (~14%) and did not accelerate compared to the previous quarter. Dolphin Analyst believes that in addition to the epidemic factor, the adjustment of its own business (actively removing low-efficiency projects) should still have a significant impact on the current growth rate.

3. The efficiency improvement of expenses is coming to an end. Content costs and bandwidth costs are still being optimized in Q1, and R&D expenses have not recovered. In addition, with the recovery of the high-profit advertising business, the gross profit margin and operating profit margin of BIDU-SW's core business are both significantly increasing. However, sales expenses have already recovered to a growth rate of nearly 16% in Q1, and AI investment expenses such as Ernie Bot are expected to be gradually recognized in the next quarter. From the tone of BIDU-SW's official statement, the company's future investment in AI will not be small, and the specific impact can be observed in the conference call.

4. iQiyi's "Kuangbiao" continues to contribute to profits: In Q1, the phenomenon drama "Kuangbiao" was added, which continued to improve iQiyi's performance. Finally, BIDU-SW Group's overall revenue was RMB 31.1 billion, a year-on-year increase of 10%, exceeding market expectations (~RMB 30 billion). Meanwhile, iQiyi also contributed nearly 1 billion yuan in free cash flow and 600 million yuan in net profit in this quarter.

Hosted page ads with relatively high gross profit margins rebounded to 49% of core advertising revenue in the first quarter. Although there were short-term fluctuations (hosted page ads are closely related to offline and local merchants), the proportion is still expected to increase in the medium and long term.

Let's take a look at BIDU-SW's cash: as of the first quarter, BIDU-SW had a book cash (cash + investment) of US$28.3 billion. After deducting short-term interest-bearing debt and minority shareholder equity, it had a net cash of nearly US$17.2 billion, accounting for 38.5% of the current market value. The single-quarter free cash flow was 4.5 billion yuan, and excluding iQiyi, it was 3.5 billion yuan.

Dolphin Analyst's Viewpoint

After the hype of AI, BIDU-SW's market value has fallen back to the level at the end of last year. Dolphin Analyst believes that the recent adjustment has little to do with BIDU-SW's own fundamentals, but more to do with the correction of Chinese concept stocks.

In the last quarter's financial report, Dolphin Analyst suggested that everyone should dilute the hype of AI, and also felt that there was some bubble in the short-term stock price.

However, BIDU-SW's rebound in fundamentals this year is a certainty. Therefore, after the short-term adjustment, for BIDU-SW, which has a market value of less than 45 billion yuan and a net cash of 17 billion yuan, combined with the advertising business that exceeded expectations in the first quarter and the release of operating leverage under cost reduction and efficiency increase, Dolphin Analyst believes that the recent correction has actually provided some safety margin.

Based on the judgment that BIDU-SW is expected to achieve alpha returns, we have recently added BIDU-SW to Dolphin's portfolio.

However, the relevant investment of Ernie Bot will also have some impact on BIDU-SW's profit margin in the short term. To understand the monetization method and business model of Ernie Bot, we also need to listen to more descriptions from the management.

Detailed interpretation of this quarter's financial report

BIDU-SW is a rare Internet company that breaks down its performance in detail:

BIDU-SW Core: Covers traditional advertising business (search/information flow advertising) and innovative business (intelligent cloud/DuerOS Xiaodu speaker/Apollo, etc.);

iQiyi business: members, advertising, copyright transfer authorization, etc.

The two businesses are clearly separated, and iQiyi's data as an independently listed company is detailed. Dolphin Research will also break down the two businesses in detail. Due to the offsetting items of about 1% (between 200-400 million yuan), Dolphin Analyst's segmented data for BIDU-SW Core may differ slightly from the actual reported data, but it does not affect trend judgments.

This financial report focuses on the performance of BIDU-SW Core business, and Dolphin Analyst will make another comment on iQiyi's performance, which will be released on the Longbridge app for interested readers to download and read. Ad rebound exceeded expectations

During the conference call last quarter, due to the slow recovery of consumption at that time, the management gave a relatively conservative guidance (ensuring positive growth) and deliberately lowered the market's expectations for BIDU-SW advertising. Before the financial report was released, the market's consensus expectation for the growth rate of core advertising revenue was 2.8% yoy. Dolphin Analyst also noticed that the expectations of some top investment banks were hovering around 1-2% yoy.

In fact, BIDU-SW's core advertising revenue not only exceeded expectations, but also performed well compared to the industry as a whole (Questmobile expects 2.3% yoy). Although QM's forecast data is generally lower than the actual data because it does not include app store advertising, content sponsorship advertising, and in-game advertising, etc., from the trend, Q1 this year is significantly slower than Q4 in terms of year-on-year growth rate.

This is also basically consistent with some advertising agents' research information we have been tracking. Due to the high incidence of infections at the beginning of the year, the Spring Festival holiday was earlier than in previous years, and other reasons, the research experts' caliber was also a decrease in month-on-month growth rate (4Q 7% yoy vs 1Q 4% yoy).

Based on BIDU-SW's financial report, Dolphin Analyst calculated that BIDU-SW's core advertising revenue was 16.6 billion, a year-on-year increase of 6%, significantly higher than the market's expected growth rate of 2.8%.

Compared with the industry, the reason why BIDU-SW can lead significantly is not only due to its own base effect, but also related to more obvious recovery in post-epidemic tourism, local business, medical and other fields. Compared with the US market at the beginning of the epidemic, Google's rebound growth rate was also leading its peers after the unblocking.

From BIDU-SW itself, the marketing and operation advertising SaaS solution launched in the second half of 2019 ("marketing + operation" type of advertising SaaS solution) has relatively high gross profit margin and has contributed a lot to the rapid growth during the low period of traditional search advertising in the past two years.

Last quarter, the contribution of marketing and operation advertising revenue to the overall core advertising revenue declined significantly, which also attracted investors' attention. The management explained that it was a short-term fluctuation, mainly because most of the merchants on the managed page are offline and local merchants, which were greatly affected during the lockdown period in the fourth quarter. In the first quarter, the proportion of managed page revenue has rebounded to 49%.

In the first quarter, BIDU-SW's average monthly active users of the APP was 657 million, and with an increase in customer acquisition investment, it brought about a net increase of about 9 million people.

2. Other Innovative Businesses: Repairing Below Expectations

All non-advertising revenue in BIDU-SW's core, other than advertising, is included in other revenue in BIDU-SW's core, which can contribute to 30% of BIDU-SW's core revenue. The main contributor is the intelligent cloud business.

Specifically, it includes both software and hardware integrated intelligent businesses, including intelligent cloud services for both B2B and B2C (accounting for more than 70%), intelligent speakers, Apollo autonomous driving, and non-advertising revenue from the mobile business.

Although the control was relaxed in the first quarter, innovative businesses such as smart cloud did not accelerate growth as expected by the market. In Q1, BIDU-SW's other core revenue was about 6.4 billion, a year-on-year increase of 11.5%, which is the same as the growth rate in the fourth quarter of last year, and did not benefit from adjustments in epidemic prevention policies or commercial deliveries. The Dolphin Analyst believes that the performance of cloud business in the first quarter may be related to the integration and adjustment of projects-it actively divested low-efficiency cooperative projects.

1. Smart Cloud is still divesting low-quality businesses

Under the strong supervision of the Internet in the past two years, compared with Tencent Cloud's entertainment-focused customers and Alibaba Cloud's Internet-focused customers, BIDU-SW itself is more evenly distributed in terms of customer industry and has a lower base in terms of scale, so the overall slowdown is slightly slower.

As the main support for innovative businesses, the revenue of intelligent cloud in the fourth quarter was about 4.2 billion, a year-on-year increase of 8%. Although it accelerated compared to the 4% in the previous quarter, the base in Q1 also slipped. This is not a normal repair trend, because the Dolphin Analyst tends to think that the action of divesting low-quality businesses is still ongoing.

Regarding the release and application of Ernie Bot, the Dolphin Analyst recognizes the particularity of this technological change, but still believes that there is no need to rush to price it into the valuation in the short term. At the same time, we will also closely monitor the subsequent productization and the landing of the business model, especially the key nodes of industrial development.

2. Intelligent Driving

Compared with the cloud business, which has already taken shape, BIDU-SW's intelligent automotive sector, a long-term story, has also taken steps to land.

1) Assisted Driving is a product of BIDU-SW's full-automatic driving road laying eggs along the way and selling assisted driving solutions to the entire vehicle factory-ANP (road automatic driving), AVP (automatic parking), and high-precision maps: According to news and other information, it has been installed on multiple brand models such as GAC Aion, Great Wall, and Weimar. The overall business order amount has exceeded 10 billion, and the company expects to gradually confirm it into revenue in the second half of this year. 2) Robo Run's Autonomous Driving Fleet Service: In the first quarter, Robo Run provided a total of 660,000 ride-hailing services, a year-on-year increase of 236% and a month-on-month increase of 18%.

3) Autonomous Driving License Plate: BIDU-SW obtained Beijing's first unmanned hypothetical online car-hailing service operating license on March 17th.

III. Advertising Repair + Reduced Investment, Gross Margin Continues to Improve

Due to the recovery of advertising revenue, optimization of self-costs, and iQiyi, which has not been a drag since last quarter, the gross margin of the first quarter continued to maintain a new high of 29%. From the data, the gross margin of the entire group has emerged from the shadow of the epidemic and recovered to a historically high range.

Among them, BIDU-SW's core gross profit increased by 18% year-on-year, and the gross profit margin increased by 5pct month-on-month to 59%, which is higher than market expectations. Compared with previous years, the first quarter has recovered to the level of 2021. Under the adjustment of its own projects in the intelligent cloud business, the core gross profit margin has accelerated out of the epidemic impact.

However, due to the continuous research and development investment and increasing trend of AI products such as Ernie Bot, the next quarter's financial report may see some impact on profit margins. As for how much it will affect, it may be necessary to see how the management answers during the conference call.

IV. Marketing Expenses Recovered and Growth Resumed

In the first quarter, sales expenses had already recovered to a positive growth of 16%. Although research and development expenses are still slightly down year-on-year, considering that AI-related expenses will be included in the next quarter, BIDU-SW's operational efficiency in expenses has entered the final stage after a year of continuous improvement.

Baidu core operating profit exceeded expectations by nearly 1.4 billion, but due to more marketing and less research and development expenses, the overall performance was in line with expectations, so the main expectation gap still came from the gross profit margin.

Dolphin Investment Research "BIDU-SW" Historical Articles:

Financial Report Season (Showing the Past Year)

February 23, 2023 Conference Call: "[Relying on Macro for Advertising, Focusing on Quality over Quantity in the Cloud, and Unhesitatingly Investing in AI (BIDU-SW 4Q22 Conference Call Summary)](https://longportapp.com/en/topics/4298055? invite-code=)》

2023 February 22 Financial Report Review "Surviving the epidemic, welcoming ChatGPT, will BIDU-SW have a second spring?"

2022 November 22 Phone Conference "BIDU-SW: Advertising will recover once unsealed, AI will continue to invest heavily (minutes)"

2022 November 22 Financial Report Review "BIDU-SW: Valuation is all 'cash', what is the market still afraid of?"

2022 August 30 Financial Report Review "Advertising depends on the weather, and the reversal still depends on the cloud"

2022 August 31 "Reducing costs and increasing efficiency, paving the way for AI cloud and autonomous driving"

2022 May 26 Phone Conference "BIDU-SW's intelligent cloud and autonomous driving business return to market focus (1Q22 phone conference minutes)"

2022 May 26 Financial Report Review "When things are at their worst, BIDU-SW's turning point may not be far away?"

2022 March 1 Phone Conference "Advertising is now dependent on the weather, BIDU-SW's crazy new business fantasy"

2022 March 1 Financial Report Review "Advertising is still in purgatory, but BIDU-SW's 'change of heart' may have a chance"

Depth

2022 December 21 "The spring of advertising cannot be stopped despite the ups and downs of consumption"

2021 March 17 "Seriously digging into BIDU-SW's bottom line: How much room for revaluation is left for the 'Hong Kong version' of BIDU-SW?" Risk Disclosure and Statement for this Article: Dolphin Investment Research Disclaimer and General Disclosure