2024-01-11 11:30:09 ET
Summary
- China's economic malaise is affecting investor psychology for China stocks, but PDD Holdings Inc. has been able to preserve or grow investor capital.
- PDD Holdings' TEMU marketplace is a success outside of China and is expected to play a larger role in the company's business model.
- The company's long-term initiatives in agriculture align with China's vision and may lead to a smaller valuation discount compared to other platform companies.
- The company still has more upside longer term, but today's price structure makes it hard to have new entries. Hold for now.
China's Malaise has stumbled nearly every ADR. Is Pinduoduo still a breakout target?
Last week, we received news on China's shadow bank Zhongzhi filing for bankruptcy. And this week, we are seeing that PDD Holdings Inc. (PDD), sometimes referred to here by its former name Pinduoduo, is seeing "suspicious" revenue show up in one of its segments. Let's not also count out the upcoming Taiwan Elections that are set to take place on January 13th where the current incumbent party - the DPP - is likely to keep its political leadership. The DPP is much less willing to engage in cross-strait relations with China.
It appears that with the start of the New Year in 2024, the same malaise continues to be deeply rooted in investor psychology for China stocks, and the sector price action shows it. Within the KraneShares CSI China Internet ETF (KWEB) in 2024, which has already depreciated -4% this year on top of the -20% decline last year, PDD is one of the few stocks left that helped investors preserve (or grow) capital.
The stock is likely unable to escape pressure from broader China selling, but once the sector stabilizes, more upside is ahead for PDD. At today's elevated juncture, I rate it a Hold.
Investors should take comfort in the fact that the founder of PDD - Colin Huang - still owns 26.5% of all shares outstanding. This is a significant sign of continued faith in the company's long-term prospects.
The Catalysts for PDD and Fundamental Outlook
Pinduoduo's TEMU marketplace is a very material success outside of China, and investors are factoring in its future growth prospects to become a larger role in PDD's business model in the coming years. After all, TEMU was the #1 most downloaded iPhone App in the U.S. in 2023.
Many consumers are currently looking for the best value for their budgets, and the products on the TEMU marketplace are highly appealing to this large cohort of shoppers. PDD's third quarter results surpassed sell-side analyst consensus figures by 24% and saw year-over-year revenue growth of over 90% while operating income (non-GAAP) grew close to 47%. The company's success over the past year is now leading to a very swift and broad upside re-rating of expectations.
To put it in perspective, Wall Street had modeled for mid-teens to low 20% compounded annual growth rates for top line revenue. After the latest successful quarters, expectations for PDD are now raised to 30% CAGR, while its TEMU segment is now forecasted to grow at 50%+ in the next 3-5 years.
With this growth profile, Pinduoduo is single-handedly the undisputed strongest E-Commerce company fundamentally inside China's broadly soft consumption environment. We can see below that the latest update on e-commerce market share from Goldman Sachs Investment Research exhibits PDD gaining at the expense of JD and BABA. I will share the latest market share data for 2023 once it is released in 2024. Asia-pacific investment research firm ABCI International Securities believe that PDD has over a 20% market share in 2023, though that is an estimate.
The company does focus on Tier 3 cities in China, where citizens tend to be more price conscious than consumers in Tier 1 cities due to lower income per capita. PDD's CEO Chen Lei discussed his goal in 2021 to use subsidies to grow the number of active buyers (now estimated at 882 million) to become the largest social e-commerce platform in China. Depending on the metric you use to measure this objective, Pinduoduo has achieved significant scale with its 882 million active buyer network.
PDD's longer-term initiatives in agriculture will help farmers' productivity, raise living standards, and increase household incomes. Its groceries and agricultural produce next day grocery pickup business - Duo Duo Grocery - is a differentiator among other e-commerce platforms as it taps into a market that is for now lowly penetrated. By achieving efficiency and scale in its agricultural initiatives, PDD will be able to develop a network to help famers and consumers connect. This longer term business model is currently aligned with China's vision of elevating the living standards within the rural provinces in the Mainland. This alignment with government policies is likely to lead to a smaller valuation discount compared to other traditional platform companies such as Alibaba (BABA) and JD.com (JD).
Risks, Thoughts on Entry and Valuation
The largest risk to PDD in 2024 is likely characterized as increasing geopolitical tension between the U.S. and China (as well as the EU) on its valued TEMU segment. PDD's TEMU segment is a differentiator among China Internet companies, as it is one of the few platforms that have figured how to sell well into North America (and now in Europe). As of the latest quarter, Citi's Research Strategist Alicia Yap estimates that TEMU accounted for about 13% of PDD's quarterly revenue, whereas it was de minimus before its launch in September 2022. With investors swiftly raising expectations on this crown jewel TEMU segment, there comes the risk that there are shocks to investor sentiment if the company is put into the U.S. regulatory crosshairs due to raised tensions between the U.S. and China.
With the U.S. closely monitoring technology export curbs to China and also the European Union Bloc planning anti-subsidy investigations into China's EV imports, we have to assume that policymakers have the ability to issue a "surprise" ruling that restricts TEMU's operations if the East-West relationship significantly sours. There are a growing number of YouTube videos that have gained traction surrounding TEMU's business practices such as data-gathering and concerns over the marketing design of its app, which use gamification techniques to acquire users and encourage them to quickly spend on the platform.
Because Pinduoduo's TEMU app has seen controversial headlines, it has also been a target of short-selling research firms such as Grizzly Research to discuss their adverse opinions on the company's business model. These sensational reports can dampen investor sentiment and cause investors concern.
Despite these concerns, investors have been bullishly positioned on PDD, and their technical structure and valuation history reflects this sentiment. The company's growth prospects are likely to continue to remain bright, and in the absence of a Black Swan event from regulators banning TEMU, the stock will likely outperform the broader China sector.
We've held PDD since the low $100s in long-term investment retirement accounts and believe the existing market participants should Hold for more upside. Given its elevated technical structure, there is the risk that the stock experiences a "look above and fail" type of sequence if China as a sector remains weak. Severe corrections will open up opportunities to accumulate this name into its longer-term uptrend. At today's price structure, PDD Holdings Inc. is a Hold for now as it is difficult to make the case for new entries.
For further details see:
PDD Holdings: The Only Survivor In China ADRs, Can Their Outperformance Last?