Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Baidu (BIDU 0.72%) -- "the Google of China" -- crushed its critics last month.
The company reported strong double-digit sales growth -- and triple-digit growth in operating profits -- for fiscal Q1 2018, sending shorts scampering for the exits.
Baidu's success is even winning some converts on Wall Street, and forcing naysayers to rethink their short calls on the stock. Here's what you need to know.
Image source: Baidu.
What Baidu said last month
Announcing Q1 2018 earnings results on April 26, Baidu reported that its quarterly sales surged 31% year over year to $3.3 billion. Operating profit margin nearly doubled to 22%, and operating income rocketed 128% in comparison to Q1 2017 numbers. On the bottom line, Baidu earned $2.98 per American depositary share -- a 344% improvement.
Free cash flow for the quarter was $1 billion, or roughly twice the $513 million that Baidu generated in Q1 2017. That brings the company's trailing free cash flow number up to $4.8 billion.
To me, these look like pretty impressive numbers, but Baidu CFO Herman Yu described Q1's performance as only "solid." However, he then proceeded to argue that the company will do even better going forward, as it continues "scaling down or exiting non-core businesses and doubling down on investments in AI-powered businesses to generate significant long-term return to our shareholders."
What analysts are saying today
This morning, analysts at investment banker Bernstein finally finished their own review of Baidu's numbers, and announced they are upgrading Baidu shares as a result -- from underperform to market perform, as explained in a note on TheFly.com today.
On top of the numbers that Baidu has already produced, Bernstein noted that "a 20% growth prognosis with an equivalent earnings expansion CAGR deserves more credit than our earlier Underperform rating."
"20%"?
Now, you may be wondering where that "20% growth prognosis" number came from. (I'm a Baidu shareholder myself, and I certainly am wondering.)
It didn't come from Baidu. In the company's earnings report, Baidu gave fiscal Q2 guidance for sales growth of between 26% and 33%, to a range of $4 billion to $4.2 billion in Q2 revenue. Baidu did not give guidance for how much it expects earnings or free cash flow to grow.
Nor is 20% the consensus on Wall Street. Rather, S&P Global Market Intelligence shows analysts think Baidu will grow its earnings at about 17.5% annually over the next five years.
My guess? Twenty percent is Bernstein's own proprietary estimate of how fast Baidu will grow going forward. And while it's not fast enough to convince Bernstein to actually recommend buying Baidu, it does appear to be good enough to convince the analyst to retract its sell rating.
Is that the right call?
Valuing Baidu
Here's how I look at it. On the one hand, yes, at a valuation of more than 32 times GAAP earnings, Baidu stock looks a bit pricey on the surface.
However, with $93.7 billion in market capitalization, $17.4 billion in cash, and $8 billion in debt, Baidu carries a debt-adjusted market capitalization (or enterprise value) of only $84.3 billion. Divide $4.8 billion in trailing free cash flow into that number, and you come out with a 17.6 EV/FCF ratio for Baidu stock today.
Baidu doesn't pay a dividend, so the stock's valuation is more or less entirely tied to its growth rate, and at Wall Street's consensus estimate of 17.5%, 17.6 times FCF seems to me a fair price to pay for Baidu. On the other hand, if Bernstein is predicting that Baidu stock will grow faster than 17.5% -- if it will grow at 20%, to be precise -- then Baidu stock could in fact be worth more than it's selling for today.
It could, in short, be worth a buy rating -- and that's what Bernstein should assign it.
