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Chinese tech giant Baidu (BIDU) is set to report fourth quarter fiscal 2018 earning results after the closing bell Tuesday. Investors will be eager to see to what extent has the company’s profitability improve.
Although the company reported a net profit of $1.8 billion in Q3, topping estimates, the profit arrived at a reduced operating margin of 16%, down from 21% in the year-ago quarter. Reduced margin typically means either reduced operating efficiencies, loss of pricing power or higher expenses. There’s plenty of evidence of the latter as company’s expenses rose more 26% in Q3. This has been a trend for several quarters.
The company continues to increase its investments in the core search business and artificial intelligence (AI) technologies, which could explain the lowered margin. Baidu CEO Li has been on record saying that the company spends roughly 15% of its annual revenue on R&D, with AI-related research taking up almost all of that budget. Plus, its efforts to bolster its presence in the autonomous driving space to compete with Google (GOOG , GOOGL), among others, has been another key initiative aimed at strengthening revenue growth for years to come.
On Tuesday investors will nonetheless want to see evidence that these expenditures, along with its efforts to divest non-core business, will soon pay off. Investors, who have raised concerns about a potential decline in the Chinese economy, where Baidu controlled more than 70% of China’s Internet search engine market in December, will also want the management to speak confidently about its outlook for 2019 and beyond.
In the three months that ended December, Wall Street expects Baidu to earn $1.79 per share on revenue of $3.9 billion. This compares to the year-ago quarter when earnings came to $2.15 per share on revenue of $3.39 billion. For the full year, earnings are expected to rise 6% year over year to $9.73 per share, while full-year revenue of $15.04 billion would rise 23% year over year.
As with most tech stocks, BIDU shares have gotten punished over the past three months. Bears have cited increased regulatory environment and trade sanctions as reasons to be wary. But the decline don’t correlate to the strong fundamentals of the company. While there are concerns about declining operating margins, it needs to be said in the context that the company’s Q3 profit still reflected a year-over-year increase of 50%.
Analysts, meanwhile, have scaled back their expectations over the past three months. The company’s recent divestments of non-core business, aimed at boosting the bottom line, will be closely watched. Recent divestments of its financial services and advertising tools segments will be discussed, along with any other non-core business that could potentially be sold off.
From a valuation perspective, there are tons of upside potential in Baidu stock, which — at around $170 — is trading some 37% below its consensus analyst price target of $234.