PDD & Baidu – Bargains for the Brave

Rotten earnings point towards a state in deep depression.

• Poor results from both Baidu and PDD point directly to the moribund Chinese economy underpinning the view that nothing will improve until the Chinese state lets the private sector off the leash.
• PDD reported worse than expected results as its rapid market share growth has slowed markedly as rivals react to its recent successes and the company guided for a meaningful slowdown as a result of weak domestic spending by consumers.
• Q3 24 revenue / EPS was US$14.2bn / $2.65 below estimates of $14.7bn / $2.79.
• The company has said that it will continue investing but as there is little visibility in terms of what revenues will do, margins are likely to come under pressure.
• What the company is saying is that the macro environment remains extremely difficult which combined with strong competition from Alibaba, JD and so on, it has to fight harder for every sale that it makes.
• Baidu also offered no cheer with Q3 24 results where revenues declined and its early lead in generative AI does not seem to have helped it very much.
• Q3 24 revenues were RMB33.6bn (-3% YoY ) broadly in line with consensus estimates but Baidu operating income fell by 5.5% to RMB5.9bn indicating that there is not much Baidu can do other than react to market conditions.
• This is because Baidu is very profitable despite its lack of growth meaning that there is not that much fat to cut to find profit growth.
• Baidu is seeing growth from its AI Cloud business (12% YoY) but it is not large enough to have a big impact overall (21% revenues) and it is another indicator that the AI boom is passing China by.
• Google, Azure and AWS have reaccelerated growth into the high 20s and low 30s in terms of YoY growth triggered by the huge swell of interest to deploy generative AI services while China has registered barely a ripple.
• This is a sign of how depressed the mood in China has become as it relates to investment in new technologies and start-ups.
• The last few years have seen a massive clampdown on the private technology sector reminding everyone in China that they operate with the permission of the Chinese state which can be withdrawn at any time, without warning and for no reason.
• The reaction of the private sector has been to cease technology investments which in my opinion has substantial and negative implications for China’s long-term outlook.
• China’s goal is to become a leading technological and geopolitical power, but with its private sector in deep freeze, it is falling further and further behind.
• This is why I continue to believe that China is doing more to harm and hinder its own ambitions than the USA can ever achieve through its export controls although these are also hindering the development of advanced semiconductors in China.
• The net result is that the new technology investment, consumer sentiment and the stock market are likely to remain in a state of deep depression until the Chinese state changes its mind.
• As it demonstrated with Covid Zero, this can happen at any time and without warning meaning that those with stomachs of iron should be positioned now.
• Alibaba, PDD and Baidu are all trading on less than 10x 12-month forward PER in a stark reflection of just how bad sentiment remains.
• The time to buy is when everyone else is a seller but in this specific situation, there remains a huge unquantifiable risk meaning that this easily be a big value trap.
• If I were going to increase my allocation, I would look most closely at Baidu which at a 12-month forward PER of 7.7x is the cheapest generative AI investment in the world by many orders of magnitude.
• I have a position in Alibaba which I am happy to sit on but I am far from convinced that I should buy any more.