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The Problem with IQ Stock Might Be the U.S., Not China

Vince Martin

iQiyi (NASDAQ:IQ) stock keeps slipping. The stock touched an eight-month low earlier this month, and even with a recent rally sits 43% below February highs.

The Problem with IQ Stock Might Be in the U.S., Not China

Source: Faizal Ramli / Shutterstock.com

There are some fundamental reasons for the decline. Trade war worries have pressured the Chinese economy. As a result, iQiyi’s advertising sales dropped 16% year-over-year in the second quarter after a flattish performance in Q1. That weakness was just part of a Q2 report that looked concerning for IQ stock.

That said, other Chinese companies are seeing similar pressures. And their shares have held up better. Alibaba (NYSE:BABA), for instance, trades just 13% below its 52-week high. JD.com (NASDAQ:JD), which like IQ is more of a growth play, is 7% off its highs.

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The divergence in IQ stock suggests that at least part of the problem could lie with U.S. investors, rather than Chinese economic conditions. What that means for the stock might depend on whether those U.S. investors are right.

iQiyi Stock Underperforms

As noted, IQ stock has underperformed larger Chinese consumer plays. But the divergence holds looking elsewhere in the group. In fact, among 42 Chinese stocks with a market capitalization above $2 billion, only three are farther from their highs than IQ stock.

Admittedly, two of those three are Baidu (NASDAQ:BIDU) and Sina (NASDAQ:SINA), which, like iQiyi, have seen pressure on ad sales. That said, IQ hardly has the same exposure to advertising. Roughly 30% of its second quarter revenue came from advertising. For Baidu, the figure was over 80% excluding iQiyi, which is included in its financial statements. (Baidu still owns a majority stake in iQiyi.)

Meanwhile, IQ stock hasn’t had a steep post-earnings fall, as both BIDU and SINA have. And yet it has performed almost as poorly. Obviously, trade war and macro worries have played a part. But essentially every other Chinese stock faces similar exposure, as even the largest companies still have minimal international exposure.

The relative decline does make IQ stock intriguing for Chinese bulls — as I’ve argued twice before. But the fall might not suggest the stock actually is cheap if the decline is coming, at least in part, from a rational response by U.S. investors.


Is NFLX Stock Hitting IQ Stock?

IQ stock seems to be underperforming Chinese peers despite decent earnings performance. (Both quarters have looked solid, though the company did miss second-quarter earnings per share estimates by a penny.) That might signal an opportunity. Bigger declines during the trade war should in turn lead to bigger gains if and when that dispute is resolved.

I have made a similar case for IQ stock before, most recently in June. More so than other Chinese plays — even leaders like BABA and JD — IQ seemed to have the most potential for a rally when sentiment toward Chinese stocks improved. That thesis played out at the beginning of this year: iQiyi stock nearly doubled on its way to February highs.

But there has been a notable change since February. U.S. investors are much, much less willing to pay up for unprofitable growth stocks. Netflix (NASDAQ:NFLX), for instance, to which iQiyi is often and not always accurately compared, has seen its shares drop over 25%. The pressure on recent IPOs like Uber (NYSE:UBER) and Lyft (NASDAQ:LYFT) has been well-documented as well.

The weakness in NFLX stock, in particular, may be causing IQ stock to slide. Much of the fundamental case for IQ since its IPO has been based on the valuation gap on a price-to-revenue basis between the two streaming companies. Some investors may see a cheaper NFLX as implying a cheaper IQ.

But the broader pressure on stocks similar to IQ might be more to blame. Investors even are focusing on profitability in cannabis stocks. Cash-burning, loss-making stocks are not in vogue on U.S. markets right now. iQiyi stock is one of those stocks at the moment.

To Buy or to Sell?

If that indeed is the case, that makes the case for IQ perhaps more complex. Many investors believe a trade war resolution will boost stocks (though I’m personally skeptical on that front), and it might seem like consumer-focused IQ stock would be an obvious beneficiary.

But if the problem includes pressure on unprofitable growth names, the trade war catalyst isn’t as strong. And given the obvious near-term risks to waiting for some movement on that front, it’s tough to recommend IQ stock at the moment.

Of course, for risk-loving investors, the decline makes the stock even more attractive. IQ stock right now is valued at a little over $100 per subscriber. Netflix subscribers, when NFLX traded near $400, were worth as much as $1,000 each on the public markets.

That kind of gap suggests iQiyi stock could have enormous upside if investors return to growth stocks and sentiment toward the Chinese economy improves. For investors willing to bet on both those developments, there may be no better opportunity in this market.

As of this writing, Vince Martin has no positions in any securities mentioned.

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