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The Good and Bad of Chinese Media Stocks

Chris Hill, The Motley Fool

In this episode of MarketFoolery, host Chris Hill chats with Motley Fool analyst and China investing whiz Emily Flippen about some market news and Chinese stocks. The quarterly report coming out of Home Depot (NYSE: HD) was pretty rough, but the stock market rewarded the retailer with a pop. Are we really that relieved it's not worse?

Similarly, shares of Baidu (NASDAQ: BIDU) were up on a report that was a little less weak than expected. Emily breaks down what happened, then highlights some of the most important points investors should know about Baidu, iQiyi (NASDAQ: IQ), Sina (NASDAQ: SINA), Weibo (NASDAQ: WB), Bilibili (NASDAQ: BILI), and a few others -- including which ones make the better buys now.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

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This podcast was recorded on Aug. 20, 2019.

Chris Hill: It's Tuesday, August 20th. Welcome to MarketFoolery! I'm Chris Hill. Joining me in studio, Emily Flippen. Thanks for being here!

Emily Flippen: Thanks again for having me, Chris!

Hill: We've got some stocks in China that are making headlines. We will get to those in a minute. But we're going to start here in the United States with Home Depot. Second-quarter profits for Home Depot were higher than expected, but they lowered sales guidance for the full fiscal year. Shares of Home Depot are up about 4% this morning. I have to say, I'm a little surprised at that. Are you at all surprised that the stock is up?

Flippen: Well, I feel like Home Depot's earnings are just proof that fear is really starting to drive the market. They missed on revenue. They beat on the bottom line. They also missed on same-store sales. And they lowered guidance for the rest of the year. It seems like investors responded positively because the news simply wasn't worse. With new projections, I guess, for a weakening housing market, alongside concerns about impact of the trade war, the lowered projections for 2019 sales growth was 2.3%. That just wasn't bad enough to get the stock down low. It's interesting to me. A little bit surprising the stock's up on the news. It just goes to show how much people were expecting in terms of the market that we're seeing today.

Hill: I think it's probably also a little bit of Craig Menear, the CEO at Home Depot, who's been there about five years, and the very steady job that he and his team have done over the last five years. Maybe it's granting a little bit of credit to them. And I'm not saying that's not unearned. But the comments that he and the team were making on the call about the potential impact of tariffs, which is why they lowered the revenue guidance for the full fiscal year, and talking about lumber and the impact of lumber prices -- which we're not going to do a deep dive on lumber prices, but suffice to say, about 8% to 10% of Home Depot's sales are directly tied to lumber, and what they are charging for lumber is roughly half of what they were able to charge a year ago. That's real money.

Flippen: And that's impressive because, in that same time frame, they've also managed to raise ticket prices, with average ticket growth of about 2% over the last quarter. So yeah, with 10% of their sales coming from lumber, it is still notable. Maybe you're right that the market's granting them a little bit of leniency here. But I also don't tend to think that the market is always the most lenient. I genuinely think that this is just a testament to the fact that people are scared right now.

Hill: What do you expect from Home Depot for the next couple of quarters? Already, I'm thinking about what they're going to say in three months about both lumber prices and tariffs.

Flippen: They actually lowered guidance, but their updated guidance, and my opinion, is still kind of aggressive. While Home Depot has been great on executing, it'll be interesting to see whether they have to lower guidance again next quarter.

Hill: Let's move onto China. We'll start with Baidu, also known as the Google of China. Expectations for Baidu's second quarter were low, I think that's fair to say. Baidu beat those expectations. The stock is up about 8%.

Flippen: Yes. To say expectations were low is probably a bit of an understatement for Baidu, who last quarter posted a surprise unprofitability. The fact that they were again profitable this quarter was great for investors, but they still have a long way to go. While they did beat, the numbers were all still pretty dismal. The core advertising business actually declined year over year. That makes up about 75% of Baidu's total revenue. They're really relying on their other initiatives -- AI [artificial intelligence], self-driving, voice recognition. Those are all areas that offer the most optionality for Baidu. But in the short-term, how Baidu works with expanding into app-based search is going to be really interesting. Right now, Baidu really is the leader. Web-based search has been their bread and butter, but they're seeing increasing competition from app-based search. And Americans out there might be thinking, "What is app-based search?" In reality, there's a quite a few super apps in China -- Tencent's WeChat being one of them -- and indexing on those apps are actually really impressive. You can think about it in terms of news outlets from companies. They're probably posting on their WeChat before they're posting on their websites. That gives Tencent the ability to index and archive and provide better search results than maybe Baidu. So their push into app-based search -- growing the number of app-based users is going to be really important for Baidu, at least over the short term, until they get some of those AI-based initiatives really starting to make an impact on their top line.

Hill: It's a little surprising only because Baidu is so overwhelmingly dominant in search. For the extent to which Google is dominant here in the United States, it's even more so for Baidu in China. So the fact that they could, in some ways, be upended like this is a little surprising. But to your point, all the more important that if you're thinking about buying shares of Baidu -- and even with the rise today, this is a stock that's down over the past year -- you really want to see them executing on those other options.

Flippen: And you always have to ask yourself, especially with Chinese companies -- and I hate buying into this, but I think it's especially true and Baidu is what we're not seeing going on behind the scenes. It wasn't too long ago that Baidu's CEO was presenting at a conference, and a member from the audience came up and poured water over his head. It was not immediately clear why, but to say that the average person in China reflects negatively upon Baidu would not be an overstatement. People are aware of the fact that Baidu is often used as a hand for the Chinese government and censorship. It's important to remember that, while Baidu is a giant in China and it's so vital in so many respects for life in China, it's not always a company that leaves the best impression -- let's say that -- in users' mouths. It was also not too long ago that their fake advertisements for medicine killed people in China. So like I said, this doesn't always get the best press. Baidu is really big and really important, but you can't buy into the concept that it is too big to fail because ultimately, they stop getting users, they stop getting ad revenue, then the business declines.

Hill: You look at iQiyi, which is the video-streaming service that Baidu spun off but still has some measure of ownership there, and this is another one that has me scratching my head a little. Very dominant. They crossed the 100 million subscriber mark. That's up about 50% over a year ago. And yet, certainly from a stock perspective, iQiyi continues to struggle.

Flippen: That's also a little bit of an understatement. iQiyi has had a terrible year. To say that Baidu owns a little bit of it is also an understatement. They actually own about 58% of the company. While it provided great things for Baidu in the last earnings report, the growth was just not enough for iQiyi's quarter. Revenues rose 15%, but their costs rose 14%. They're pulling a Netflix when you look at how much their content costs. They spent 5 billion yuan on content this quarter, but their revenue was 7 billion yuan. It's fair to say that this is an expensive business to run. You also see people not necessarily buying into the business model. iQiyi, often called the Netflix of China, and that is representative of part of iQiyi's business, but you can, in some ways, also call it the YouTube of China, because they have this very large advertising-based business where people can watch videos for free if they watch what is, in my opinion, an absurd number of ads. They're actually seeing huge decreases in ad revenue despite the fact that they're seeing increases in their membership fees. They're relying more on the Netflix model, less on the YouTube model. But this is still really hurting their business in the same vein that Baidu is being hurt by their advertising revenue.

Hill: Do you look at either one of these stocks, down significantly over the past 12 months, as value plays right now? Or do you think there are enough question marks with either or both that you just look at them and say, "Even at this price, I'm not a fan"?

Flippen: There's a number of Chinese companies, in my opinion, that look like value plays when you look at them from an American perspective -- but you always have to remind yourself that you're never seeing the full picture. While that might not be a deal-breaker for a lot of people, you always have to acknowledge the fact that these valuations are given with respect to the fact that you don't know them as well as you may know Netflix or their American counterparts. So in my opinion, if I'm looking to get into streaming, I think there are safer ways to do it as opposed to iQiyi. I think Baidu being beat down so terribly, and all the optionality that it still has with their other business lines, is actually probably a better play. But I think the biggest risk for Baidu, like I already said, is the public perception in China. It's been increasingly negative.

Hill: Let's add two more to the mix with Sina and Weibo. Sina, an online media company in China; Weibo, which was spun out of Sina four or five years ago. It seems like a similar story to what we just discussed with Baidu and iQiyi. You've got well-known brands with some level of dominance to them, and yet, stocks down more than 40% over the past 12 months. Is it a similar situation with these two, as you see with Baidu and iQiyi?

Flippen: I actually don't see them as similar. Baidu and iQiyi, like I said, they have optionality. iQiyi still has the optionality to be the Netflix of China. They're growing their user base. They have 100 million users last quarter, compared to Netflix's 150 million users. So to say that iQiyi is no longer relevant would be a huge understatement. I actually think they have a lot of optionality to expand their user base in a way that will allow it to continue to post really impressive revenue growth. Whereas Sina and Weibo, it's the same story for both of them -- which is, while they still have a substantial number of users, their revenue growth is actually flat or declining. I think, in terms of the social media presence that Sina and Weibo are, that is going to be declining. Like I said, they have huge numbers of users, so I could easily be wrong about that. But it seems, in my opinion, that the relevance that these two social media companies have is slowly declining. Sina did crush earnings expectations, but it was actually still a substantial decrease compared to last year. So whenever I see a beat for these companies, it's a beat because these companies have been beat down. All of this still decreasing year over year.

Hill: This might be an unfair comparison, but when I was looking over some of the coverage of Sina, it reminded me of Yahoo when Yahoo was a stand-alone public company, and in... maybe not its final days, but certainly its final years. Same sort of thing. Yes, there are numbers you can point to in this business that are large in terms of engagement in terms of how many tens of millions of people are using it every month, that sort of thing. But overall, it just seems like, certainly in the case of Yahoo -- and I would argue, right now with Sina -- yeah, you can put those numbers aside. It's just an uninspiring business. It's not something that I look at as an investor and think, even with the stock being beaten down, and even with the number of people using it -- whatever bull case you want to make, it's hard for me to get excited about that.

Flippen: I tend to agree. I think bulls, especially in the case of Sina, don't point toward their advertising business, which, as the Chinese story goes right now, is declining. They point toward their live streaming business. They say it had a 20% increase year over year. There's lots of optionality in live streaming. In my opinion, if you're interested in live streaming in China, I can give you five companies off the top of my head that are probably better live-streaming plays than Sina, have better user engagement, it's their sole purpose. If you're a Sina bull or a Weibo bull, you're a bull based off valuation, which, like I said, sometimes in China can be a trap.

Hill: Are any of the live-streaming companies you can think of off the top of your head, are they stand-alone public companies? Or are they part of something like Tencent?

Flippen: Standalone companies, although some of them are spin-offs. One of [my] personal favorites, Bilibili --

Hill: [laughs] Sorry.

Flippen: -- which focuses on anime, comics, and gaming. [laughs] Yeah, Bilibili. It's a real name. Ticker is BILI. Not making it up. There's also a number of other companies that have recently become public that compete with Bilibili. One's HUYA, or DouYu. All of these companies are stand-alone streaming companies whose main job it is to provide video content. Much closer in the vein of iQiyi as opposed to Sina, which is a struggling social media company that happens to do a little bit of live streaming in the back -- which, by the way, is posting slower live-streaming growth than all of those other companies.

Hill: You know what? I shouldn't laugh at Bilibili. I just looked it up, it's nearly a $5 billion company. The stock's up more than 25% over the past year. Humorous name aside, they appear to be getting it done. Alright, Emily Flippen, always good talking to you! Thanks for being here!

Flippen: Thanks again for having me!

Hill: As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery! This show is mixed by Austin Morgan. I'm Chris Hill. Thanks for listening! We'll see you tomorrow!

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Chris Hill has no position in any of the stocks mentioned. Emily Flippen owns shares of Bilibili, HUYA Inc., and iQiyi. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Baidu, Bilibili, and Netflix. The Motley Fool has the following options: long January 2021 $120 calls on Home Depot. The Motley Fool recommends Home Depot, HUYA Inc., iQiyi, Sina, and Weibo. The Motley Fool has a disclosure policy.

This article was originally published on Fool.com