Weaker 3Q23 performance due to slower online ad spending and soft cloud demand
- Weaker ad spending from e-commerce platforms due to macro uncertainties
- Expect online marketing revenue to grow only 3% y-o-y in 3Q23, vs. previous market expectations of 8%
- Revised down FY23/FY24/FY25F non-GAAP earnings by 9%/3%/2% accordingly on slower ad growth and higher R&D
- Despite slower 3Q23 growth, expect online marketing revenue growth to pick up in 4Q thanks to shopping festival season, and cloud revenue growth to reaccelerate after launch of Ernie 4.0. Maintain BUY
3Q23 outlook and preview
We expect Baidu to deliver revenue growth of 3% y-o-y in 3Q23, below previous market expectations of 8% y-o-y. The downward revision was largely due to slower growth of 3% y-o-y (vs. 15% y-o-y in 2Q23) in Baidu Core’s online marketing revenue. Ad spending across major e-commerce platforms was weaker than expected in the off-peak season, and ad demand from franchise activities slowed down due to macro uncertainties. Currently, the top ad verticals are e-commerce, healthcare, and travel, which accounted for around 10%, 10%, and <5% of Baidu Core’s online marketing revenue, respectively.
In terms of cloud revenue growth, which accounted for approximately 13% of total revenue in 2Q23, its performance was weaker than expected due to slower progress in smart transportation and government-related projects. Specifically, the government-related smart transportation cloud segment experienced a significant y-o-y decline of around 70% due to budget restrictions, representing a low-single-digit percentage of total revenue (compared to low teens in 3Q22). On the other hand, personal cloud products (Baidu Wangpan, Baidu Wenku) are expected to see double-digit revenue growth as more AI products and functions have been launched for customers use since August 2023. Among the cloud business segments, enterprise cloud and personal cloud accounted for c.60% and 30% of total revenue, respectively.
We expect Baidu Core’s non-GAAP operating margin to stand at 22% in 3Q23, vs. 3Q22’s 26%. The lower margin was ascribed to (1) investment in R&D (mainly AI-related products); (2) incremental marketing expenses for the launch of its AI products, such as Ernie 4.0; as well as (3) the stock-up of AI chips. We expect Baidu Core’s non-GAAP operating margin to stay stable y-o-y in 4Q23, as a larger revenue contribution from the high-margin online ad segment can partially offset an increase in investment on AI development.
Expect 4Q23 ad growth to accelerate to 9% during shopping festival season
Looking ahead, we expect online ad revenue to resume to 9% y-o-y growth in 4Q23, given more online shopping festivals in 4Q, which should boost e-commerce platforms’ ad spending on Baidu. Besides, other key verticals like healthcare and travel agency marketing demand remain resilient and continue to drive segment growth. We expect cloud revenue growth to steadily pick up to 7% in 4Q23, thanks to the launch of Ernie 4.0, which drives personal cloud growth the most. We expect personal cloud to sustain double-digit growth in 4Q23, while it will take some time for enterprise cloud to grow, as corporates are just starting to adopt generative AI products.
Earnings revision and recommendation
We revised down our earnings by 9%, 3%, and 2% for FY23F, FY24F, and FY25F, respectively, factoring in slower ad revenue growth and increased R&D investment to AI development. We expect non-GAAP net earnings to increase by 26%, 15%, and 11% for FY23F, FY24F, and FY25F, respectively. We are confident that Baidu’s AI development will gradually translate into higher ad ROI and, therefore, higher ad revenue in the next few quarters, despite macro challenges. Its cloud growth will also start compensating for the relatively short-term softness in online ad. Maintain BUY on Baidu with TPs of HK$186/US$188 per share. We derive our TPs based on SOTP valuation: (1) Baidu Core: 12x on FY24F non-GAAP net profit (HK$141); (2) cloud and autonomous driving; 3x FY24F P/S (HK$26) and (3) market value of major listed investees (HK$20).
