Short-term advertising growth is under pressure. The impact of AI investment on profit margins is manageable. The short-term Baidu core advertising and iQiyi membership business are under pressure but cost reduction and efficiency continues. We lowered the company's 2024-2026 non-GAAP net profit forecast to 26.8/28.7/31.9 billion yuan (previous value: 27.4/31/34 billion yuan), corresponding to the year-on-year growth rate of -6.8%/7.2%/10.9%, corresponding to the adjusted EPS dilution of 9.3/9.8/10.7 yuan, currently The stock price of 82.2KD corresponds to 8.2/7.7/7.1 times PE in 2024-2026. Considering the future expansion of generative AI's contribution to cloud revenue, break-even in key regions of driverless driving, and subsequent expansion, it is expected to drive up valuation and maintain a “buy” rating.

2024Q2 revenue fell slightly short of expectations, with profit exceeding expectations in 2024Q2, Baidu's revenue falling 0.4% year on year, which was slightly lower than Bloomberg's agreed forecast, mainly due to iQiyi's revenue falling short of expectations; non-GAAP net profit of 7.4 billion yuan, down -7.5% year on year, better than Bloomberg's agreed expectations (6.68 billion billion), stemming from Baidu's core cost reduction and efficiency, which still increased operating profit margins. By business, (1) Baidu's core online marketing: The 2.2% year-on-year decline in 2024Q2 revenue was weaker than the Internet advertising market. According to QuestMobile data, 2024Q2 China's Internet advertising market grew 10.9% year on year, due to macro-environmental impact, increased competition in in-app search ads, and an increase in the proportion of AI-generated content in search but not yet monetized. About 18% of 2024Q2 search pages generated AI results, up 7 pcts from month to month. (2) AI and intelligent cloud: In 2024Q2, smart cloud revenue increased 14% year over year, with AI cloud accounting for nearly 9%. (3) Intelligent driving: The number of orders for the 2024Q2 Radish Express increased 26% year-on-year, and a 100% driverless ride-hailing service will be provided in Wuhan starting June 19.

Continued pressure on the revenue side is waiting for AI to be monetized, and steady performance on the profit side is more guaranteed. Short-term advertiser industry is pressured by weak real estate, automobile and SME customer demand, increased competition, and growth in AI generated content by companies. Medium- to long-term AI is expected to drive improved ad monetization efficiency and increased demand for the cloud. On the profit side, the steady profit margin of AI cloud is expected to be higher than that of traditional businesses. The goal of intelligent driving is to prioritize break-even in key regions, reduce non-core business investment and cost optimization, and profit margins are expected to remain stable.

Risk warning: The macroeconomy falls short of expectations, AI progress falls short of expectations, and the monetization of intelligent driving falls short of expectations.