JPMorgan Takes a Stand on Alibaba,, and Baidu

Don't look now, but over at investment banker JPMorgan, there's been a shake-up among the analysts covering Chinese stocks -- with significant implications for the stocks the company covers.

After all, according to our data on Motley Fool CAPS, JPMorgan is one of the best-rated stock pickers on Wall Street, ranking in the top 10% of investors we track, and outperforming the S&P's record by nearly 5%. And now we're hearing that something on the order of a dozen Chinese companies just got "assumed" at JP with new ratings, price targets, or both.

Here's what the banker has to say about three of the hottest Chinese stocks on the market: Alibaba (NYSE: BABA), (NASDAQ: JD), and Baidu (NASDAQ: BIDU).

JPMorgan says one of these three stocks is going down. Image source: Getty Images.

JP's optimistic on Alibaba

I won't keep you in suspense. Out of the three big Chinese stocks named above, the one JPMorgan like best is "the Chinese" -- Alibaba. As detailed in a write-up on today, JPMorgan sees Alibaba as a buy. And with a new analyst on the case, it's even more optimistic about the stock, raising its previously published price target by $6 to $135.

Alibaba has "solid" prospects for growth in its core e-commerce division, says JP, while cloud computing services and the company's new UCWeb acquisition both have the potential to turbocharge the company's growth over the medium to long term.

But not so on

JP's less excitedabout Alibaba's biggest rival in the e-commerce space, Last month, Wal-Mart (NYSE: WMT) announced that it is selling its own "Yihaodian" Chinese e-commerce stake to, and taking a 5% stake in JD in exchange. In effect, Wal-Mart is making a $1.5 billion investment to tie up with JD in hopes the company can steal market share from Alibaba and help Wal-Mart make a bigger dent in the Chinese market.

Up until now, JPMorgan has been similarly enthusiastic about JD's ability to challenge Alibaba, rating JD overweight. But today's shake-up sees JP taking its rating down one notch to neutral with a $29 price target. JP worries that while free cash flow looks good at, profit margins may be weakening. To avoid getting caught off guard, the analyst is pulling back on its recommendation, and adopting a neutral stance for the time being.

And bailing on Baidu

But what about Baidu, the Google of China? JPMorgan is more pessimistic about this one than most. According to data from S&P Global Market Intelligence, 17 out of 32 analysts surveyed believe Baidu will outperform the market over time, while only four analysts rate the stock a sell.

JPMorgan is now one of those four.

Downgrading the shares to underweight this morning, and lowering its price target to $164, JPMorgan warned that Baidu's core market for internet search is under attack and facing increasing pressure as advertisers move away from desktop search platforms toward new business on mobile. JP sees few other growth drivers available to take the place of vanishing search revenue, meanwhile, and believes this indicates it's time to not just hold, but actually sell Baidu stock.

The most important thing: Valuation

Is JPMorgan right? With a share price of $171 today, and no ongoing dividend payments to ease the pain, the prospect of Baidu stock falling to $164 certainly does indicate that a sell rating is appropriate. On the other hand, JPMorgan's prediction of no growth at Baidu stands in stark contrast to the consensus view on Wall Street, where most analysts predict the stock will grow earnings at better than 30% annuallyover the next five years.

I have to say (and mind you -- I'm biased here, because I own Baidu stock myself) that 30% seems like a nice growth rate for a stock currently priced at just 12.7 times earnings (and 11.6 times its debt-adjusted market cap of $55.3 billion). Granted, there's a big caveat to that valuation argument, inasmuch as Baidu's reported free cash flow for the past four reported quarters totals just $2.3 billion, which is less than half the company's reported $4.8 billion net income for the period. But it still works out to an enterprise-value-to-free-cash-flow ratio of 24. If Baidu truly can achieve 30%-plus growth from current levels, the stock seems more like a buy than a sell to me.

At the same time, I have reservations about JPMorgan's full-throated endorsement of Alibaba (which coincidentally, I also own). There, reported net income of $7.2 billion is much more in line with actual free cash flow of $7.1 billion, indicating much higher quality of earnings than we see at Baidu. The resulting enterprise-value-to-free-cash-flow ratio of 33.5, however, is starting to look aggressive relative to consensus expectations of only 24% long-term earnings growth at Alibaba.

The JPMorgan recommendation I most disagree with, though, is its contention that is still worth holding onto. Priced at $37.2 billion, the stock has never earned a profit, and JD reported negative free cash flow in three of its past five years. (JD was last clocked burning cash at the rate of $690 million per annum, by the way.) Fact is, if there's one recommendation on JPMorgan's list that I'd bail on, it would be

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Rich Smith owns shares of Alibaba and Baidu. The Motley Fool owns shares of and recommends and Baidu. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.