While we maintain our fair value estimate of $183 (and HKD 180) for Baidu 09888, we anticipate short-term headwinds for Baidu’s advertising revenue for both second-quarter 2023 and the rest of year as recovery begins to taper off. In addition, we are also reducing growth estimates for cloud revenue in 2023 as enterprises are more cautious with their budgeting for the rest of the year. We are reducing our second-quarter year-on-year revenue growth for Baidu core advertising to 9% from 12%, and to 6% from 10% for cloud. As for the second half, we lower our year-on-year revenue growth estimates to 6% from 10% for advertising, and to 10% from 15% for cloud. In addition, we expect Baidu core operating margins (excluding stock-based compensation costs) to decline to 19% from 25% in the second half due to incremental expenses from the buildout of Ernie. While we lower our expectations for the rest of the year, we expect continued recovery for advertising and reacceleration of the cloud business into 2024 and for operating margins to increase again once Baidu scales its Ernie product as our long-term assumptions remain unchanged.
We think that Baidu shares could decline slightly with expectations of lower-than-expected growth for the second half of 2023, but given our view that long-term growth assumptions for advertising recovery and cloud remain intact, the pullback could provide an attractive entry point.
We also have some clarity on future operating margins for its cloud business and expect it to reach 20% in the long term before including Ernie’s financial contribution. We expect the traditional (pre-artificial intelligence) cloud business to reach positive operating margin in the second quarter, not accounting for Ernie. Assuming that Ernie is successful and can scale in the long term, the company expects Ernie’s operating margin to go beyond its traditional cloud business.
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