$BIDU Q4 Earnings Preview

by Enis February 4, 2013 1:52 pm • Commentary

Event:  BIDU reports their Q4 earnings after the close tonight.  The options market is implying about a 7% move following the results, which is well above the 4 qtr average of 4.75%, and the 8 qtr average of 4.5%.

Sentiment:  Wall Street analysts remain fairly optimistic on the stock with 22 Buys ratings, 6 Holds and 3 Sells, with an avg 12 month price target of around $138.

Options volumes have shown a preference for calls over puts to start 2013, though not overly skewed.  The 20 day average call to put ratio is around 1.4.  However, open interest is evenly split between puts and calls.

Price Action / Technicals:  The technicals suggest BIDU has been in a long-term downtrend ever since it made its all-time high in July 2011 at 165.96.  The 200 day moving average has been acting as resistance so far in 2013:

BIDU 1 year chart, courtesy of Bloomberg
BIDU 1 year chart, courtesy of Bloomberg

The 100 level holds additional importance since BIDU closed 2012 at 100.29, so it’s a level many fund managers are watching.  In short, resistance around 113-115, and support around 100.

Valuation / Fundamentals:  This is what I wrote back in September about BIDU, with the stock trading around $112.50:  

First off, BIDU is a cash machine.  Its market cap of $40 billion is around 15% that of GOOG, which is closer to $240 billion, but both companies generate free cash flow of a little more than $10 billion per year.  BIDU’s return on assets and return on equity are both above 35%, its projected earnings growth is still above 30% for the next 2 years, and it sports a P/E only slightly higher than GOOG, at close to 30.

Granted, investor confidence in Chinese accounting has been seriously tested on numerous occasions in the past 2 years.  Clearly, investors approach BIDU with a healthy dose of skepticism from an accounting standpoint relative to a global stalwart like GOOG.  But if you believe the figures, then BIDU’s underlying business results are impressive.

The recent weakness in the stock (BIDU is down about 10% YTD) has largely been due to competitive concerns.  Investors are nervous that newcomers are encroaching on BIDU’s turf.  Similar to how YHOO lost out to GOOG in global search almost 10 years ago, QIHU and Tencent have purportedly developed better search algorithms and more user-friendly experiences.  And they’re beginning to chip away at BIDU’s 85-90% market share in Chinese search.

These headlines hit the tape this week, highlighting the concerns:

• QIHU increased market share of search traffic 1-2pp since last round of checks on 8/27, Deutsche Bank analyst Alan Hellawell says (rates BIDU hold) in note.
• QIHU gained share mainly at expense of BIDU; ests. BIDU has 75%-80% search mkt share vs 80%-85% before QIHU introduced search engine
• QIHU may be gaining share due to conversion of more QIHU browser users to its search engine

The stock is now 5% lower than when I wrote that in September.  So from a fundamental standpoint, the upside in the stock looks favorable.  But since it’s a Chinese name, it’s clear that market players are skeptical about the accounting.  I have no insight on that front.

Vol Snapshot: 30 day Implied volatility (red line below) has moved higher ahead of earnings which is to be expected.  However, BIDU realized volatility (blue line) is near 2 year lows.  In that context, implied volatility seems priced too high, with some traders obviously expecting an outsized earnings move relative to history.

[caption id="attachment_22301" align="alignnone" width="653"]BIDU 30 day implied vs. realized volatility, courtesy of LiveVolPro BIDU 30 day implied vs. realized volatility, courtesy of LiveVolPro[/caption]

My instinct is to favor structures that are net selling volatility.

My View:  BIDU seems disproportionately cheap based on its financial metrics and relative to peers.  Even though there are competitive concerns, part of the discount is certainly a result of distrust of the numbers.  Having said that, BIDU is now priced at the same level as it was in late 2010. However, the company’s expected earnings for calendar year 2012 (once we get the 4th quarter results) are 3 times the level for 2010.

My bias is to the upside on BIDU, but I respect the fact that I don’t know this company inside/out.  As a result, I’m not sure if I’ll do a trade, but if I did, it would be structured so as to take advantage of the high implied volatility.