The equity research division of Morgan Stanley published an investors report highlighting its upgrade of Baidu Inc (ADR) (NASDAQ:BIDU) to Overweight on Monday, July 21st. Morgan Stanley analysts Philip Wan and colleagues suggest that Baidu’s margins will rebound over the next couple of quarters as discretionary spending tails off, and also expect sales to continue to accelerate.

Risk-Reward View: Improved mobile position, better margin outlook

Baidu

The MS analysts flesh out their arguments to justify their upgrade of the firm from Equalweight to Overweight in the report, and also offer an explanation of how they calculated their lofty price target of $239.30.

Baidu’s strong sales growth

Wan et al. highlighted Baidu Inc (ADR) (NASDAQ:BIDU)’s strong sales growth — 59% year-over-year in the first quarter of 2014 compared to 43% for full year 2013 and the company guided for 2Q14 sales to grow 56-60% year-over-year — in the report. “Baidu’s sales growth has accelerated driven by improving monetization on PC and mobile as well as incremental sales from acquired businesses. We anticipate operating leverage in coming quarters driven by the scaling back of discretionary spending, implying upside risk to our earnings estimates.”

Baidu top line growth has accelerated since 3Q13

Mobile looking up

The Morgan Stanley report highlighted that improving mobile monetization has been a key factor in the firm’s strong sales growth, representing around 20-25% of Baidu Inc (ADR) (NASDAQ:BIDU)’s total revenues in the first quarter (up nearly 10% from a year ago).

Wan commented: “Baidu should benefit from the growing mobile gaming market after consolidating 91 Wireless, one of the leading app stores in China. According to the company, key metrics, including number of paid clicks, click-through rate, and cost per click (CPC) all improved from a year ago. Baidu expects the CPC gap between mobile and PC to narrow in coming quarters. Improving customer targeting capability on mobile and optimizing advertising formats (i.e., click to call, click to download) will spur greater advertising budget allocations to mobile.”

Price target of $239.30

Wan and his MS analyst colleagues base their lofty $293.30 price target for Baidu Inc (ADR) (NASDAQ:BIDU) assuming earnings growth of around 30% over the next three years (through 2016). They say their price target “implies ~30x 2015e P/E. We raise our earnings forecasts by 5-13% for 2014-16e, mainly due to higher operating margin assumptions.”