Baidu Earnings: Advertising and Cloud on Pace for Recovery, Ernie Costs May Hit Bottom Line

We keep our fair value estimate of USD 183 (HKD 180) for Baidu after the firm reported first-quarter 2023 revenue of CNY 31.1 billion, reflecting a 10% increase year on year, and 3% better than the Refinitiv consensus. Better-than-expected revenue was driven by further recovery in its advertising business, which led to operating margin increase of 650 basis points year on year. Baidu indicated that advertising demand remains strong in industries such as healthcare, e-commerce, travel, and local services—which are benefiting from China’s reopening. While no specific guidance was given for the advertising business, the firm expects it to outpace China's macro gross domestic product growth rate. While we believe that Baidu’s margin expansion story remains intact, it may increase more gradually, given the incremental costs associated with Ernie. We do not anticipate Ernie to provide meaningful incremental revenue until 2024, but our valuation already reflects higher costs. General and administrative expense increased 20% year on year, reflecting increased headcount for its new artificial intelligence products, including Ernie. Despite higher costs, we believe that Baidu still has attractive upside given its dominant positioning in advertising, coupled with high operating leverage, and outperforming long-term growth.