China’s AI stocks are surging. Here are the names to watch

Published Sun, Feb 25 20244:14 PM EST

Evelyn Cheng @in/evelyn-cheng-53b23624 @chengevelyn

Chinese artificial intelligence stocks are surging, even if the broader market recovery remains more muted. OpenAI's Sora text-to-video product reveal came towards the end of China's Lunar New Year holiday. Locals rushed to discuss and share the tech's possibilities online, and when markets reopened on Feb. 19, AI-related stocks took off. Wind Information, the equivalent of the Bloomberg terminal in China, even launched a Sora concept stock index of mainland China A shares that rose more than 20% in a week. Other Wind AI-related indexes saw similar gains in the last several days. Now in the week ahead, tech giant Baidu — which Morgan Stanley calls the "best AI play in China Internet" — is set to release earnings. The investment analyst team led by Gary Yu has a $140 price target and overweight rating on Baidu's U.S.-listed shares. That's more than 25% above where Baidu closed Thursday. Yu pointed out how Baidu is integrating its ChatGPT-like Ernie chatbot with Samsung's new Galaxy S24 smartphones , and has a strategic collaboration with Honor , a smartphone brand spun off from Huawei. "We believe the current AI cloud integration between Galaxy AI and Ernie is just the first step," Yu said. "Though current monetization scale could be limited, we expect there could be further expansion into other phone models, or potential development into an edge AI model in the long run, which is an untapped market as of now (i.e., processing of data and algorithms directly from an endpoint device without an Internet connection)." Baidu is set Wednesday before the U.S. market open to release results for the last three months of 2023. The company operates a range of tech businesses, including a search engine, cloud services and robotaxis. The macro environment of slower growth in China is a headwind for Baidu's core ads business, while regulators keep a close eye on AI. That's not stopping businesses from giving AI tools a try. Checks by Benchmark analysts led by Fawne Jiang found advertisers are increasingly adopting generative AI-powered ad tools, thanks partly to their cost-effectiveness. Generative AI ads will likely contribute more than 100 million yuan ($14 million) to Baidu's results in the fourth quarter, Jiang said in the Feb. 21 report. She noted Baidu indicated previously that AI ad revenue is expected to bring in more than 1 billion yuan this year. "We are particularly interested in the number of new enterprise customers and trend of average spend of existing customers incorporating new services," Jiang said. Benchmark has a price target of $210 a share on Baidu and a buy rating. JPMorgan China internet analyst Alex Yao has an even higher price target of $215. He predicts generative AI ads will bring 2 billion yuan in revenue for Baidu this year, for a total AI contribution of more than 9 billion yuan to the company — which isn't yet fully priced in, according to a report earlier this month. Including the boost from AI, Yao expects Baidu's core ads revenue will grow by 7% this year as the economy recovers. But for the fourth quarter of 2023 he's cut forecasts by 2 percentage points to 6% year-on-year growth. Baidu was an early bidder for " Godfather of AI " Geoffrey Hinton and his tech back more than a decade ago, according to Cade Metz in his 2021 book "Genius Makers: The Mavericks Who Brought A.I. to Google, Facebook, and The World." While Hinton went to Google instead, Metz describes how Baidu gathered its own comparable talent and built similar research in artificial intelligence. When Baidu launched Ernie bot in March 2023, the company also showed off text-to-video capabilities, although it's not clear how widely they are available or how comparable they are to Sora's. Relatively small market cap stocks such as Shenzhen-traded Sinodata have jumped on the Sora news bandwagon. The company claims it's a Microsoft solutions partner for data and AI, and through Azure, can get priority access to Sora's API when it is released. Microsoft didn't immediately respond to a request for comment. Sinodata shares climbed more than 16% in a week despite a letter of concern from the Shenzhen Stock Exchange about whether the company was misleading investors. For all the interest in AI stocks, China markets this year are still grappling with worries about whether Beijing is doing enough to support economic growth. In the wake of a volatile drop lower in mainland stocks, the country swapped out the head of its securities regulator just before the Lunar New Year holiday. That regulator in the last week has pushed for further crack down on so-called market manipulation. The Shanghai Composite gained more than 4% in the last week to recoup losses for 2024, although the S & P 500 is already up by more than 6% for the year so far. EPFR data show that, as of mid-February, weekly inflows to China equity stocks have been above the recent average. Net inflows to China Equity Funds is around $45.7 billion so far this year, more than half the net inflow of $77.56 billion for all of 2023, EPFR said. U.S. regulation, however, has created both risks and opportunities around China-related AI. Nvidia 's latest earnings revealed its China revenue has fallen to single-digit percentage share of the data center business — down from more than 20% months earlier. Baidu shares fell last month after reports linked it to Chinese military testing publicly available AI systems — the company said it had no business collaboration. Bernstein analysts expects local AI chip players will be able to cover nearly all domestic demand for high-end semiconductors in the next two years. "We like Cambricon as the best alternative to Huawei in China," the analysts said in a late Jan. report. They have a price target of 160 yuan on Shanghai-listed shares of Cambricon — upside of 12% from Friday's levels. Huawei is not publicly traded. Bernstein analysts have an outperform rating on Baidu and a $140 price target. They also like Kingsoft Office, which has incorporated generative AI into its consumer-facing software. "Kingsoft Office stands out as the player with a product ready for large scale launch, but monetization still needs to be proven," the Bernstein analysts said. They have a price target of 380 yuan on Shanghai-listed Kingsoft, up more than 50% from Friday's levels.