Chinese Agriculture’s Upcoming Revolution
A revolution in Chinese agriculture is brewing, and it’s not coming from the farms. Surprisingly, e-commerce giant PDD Holdings Inc (NASDAQ:PDD) may be poised to disrupt the trillion-dollar industry more than any actual farmer.
While investors obsessed over PDD’s Temu early success story in the U.S., or are concerned about the loss of China decades as the result of sanctions from Western countries, they’re missing a silent ag-tech revolution being spearheaded by the unlikeliest of innovators. China’s regulatory environment is unpredictable, but for now, Beijing seems supportive of this high-tech agricultural vision. President Xi is even urging China’s youth to return to rural areas to modernize farming.
PDD built its business on a team purchase model by leveraging partnerships with WeChat. However, it has faced criticisms around its growth strategy of relying heavily on promotions and subsidies and the sustainability of its business model. In addition, the company’s enigmatic founder stepped away to pursue food research in 2021. Now PDD is aggressively expanding into agriculture, leveraging its troves of consumer data.
It might sound crazy that an e-commerce app could transform farming. But remember when people doubted Netflix could change Hollywood? PDD could similarly disrupt the ancient agriculture industry using technology and data.
The possibilities are endless. Imagine rice farms optimized to grow the most popular grain textures identified by AI. Or tomatoes engineered for the ideal sweetness and crunch that data shows consumers crave.
While PDD’s past seems at odds with its agricultural ambitions, dismissed innovators often rewrite the rules. Don’t sleep on this Chinese commerce underdog as it quietly seeds the future of food.
PDD’s Founder Opts for Ag-Tech Beyond E-Commerce
In July 2021, PDD’s founder Colin Huang stepped down as chairman while the company was still booming. This strange move left investors puzzled – why exit right when the business is soaring?
Huang said he wanted to focus on research into food and life sciences. His abrupt resignation to pursue ag-tech seemed to foreshadow PDD’s agricultural pivot.
Even as PDD grew to become China’s second-largest e-commerce firm, ranked by monthly active users, behind Alibaba, Huang appears to have set his sights on a new frontier.
His departure suggests that despite PDD’s e-commerce success, its founder sees bigger opportunities in leveraging technology to revolutionize agriculture.
While dropping out of day-to-day operations, Huang retains influence over PDD through his majority voting rights. This allows him to steer the ship toward his agricultural vision.
Some speculate Huang left to avoid increased regulatory scrutiny of Chinese tech firms. But his continued control behind the scenes signals a strategic shift towards food and agriculture.
PDD’s Early Ag-Tech Moves
In 2021, PDD launched an initiative to help farmers sell produce directly to consumers through its platform. The two main directions of “Billion Yuan Agricultural Research” are “Agricultural Product Circulation” and “Agricultural Product Cultivation”. While investors are familiar with PDD’s investments in agricultural distribution and storage capabilities, they may be less familiar with its initiatives around directly cultivating and producing agricultural products.
What is truly intriguing to us is PDD’s research into transforming traditional agriculture practices through modern technology.
In the past, land, weather, and water quality were taken into primary consideration when farmers farmed crops like wheat. PDD, however, wants scientists to experiment and discover strategies for creating unique, in-demand strains that are suited to user preferences.
For instance, PDD used data analytics to pinpoint the most well-liked wheat variants. Their scientists can then develop techniques to grow this wheat variant at scale. PDD will disseminate these optimized production processes to merchants on its platform. This approach leverages research, data, and technology to shift away from generalized farming toward targeted, demand-driven agriculture.
PDD is also leveraging IoT sensors to provide farmers with real-time microclimate data to optimize crop yields. AI then prescribes targeted interventions like irrigation to boost outputs.
More and more “PDD brands” from agricultural production areas such as Huili pomegranates, Pinghe honey pomelos, Yongquan honey tangerines, Zigui navel oranges, Luochuan apples, Binchuan garlic, Yanyuan ugly apples, and Pujiang kiwis are exhibiting a phenomenon of “one county, one star” and “one product, one star”.
In 2022, agriculture now accounted for 16% of PDD’s revenue. In 2022, PDD allocated nearly one-third of its net profit to technology research and development, with technical staff accounting for about 60%. PDD aims to leverage its 777 million active buyers to unlock data-driven farming advances. PDD has rapidly emerged as a force in China’s $1.2 trillion agriculture industry.
Netflix Disrupted Hollywood
Now PDD Takes on Agriculture Doubters may scoff that an e-commerce company can’t revolutionize capital-intensive farming. But PDD could transform agriculture much like Netflix disrupted Hollywood.
Just as critics initially laughed off Netflix’s move into content production, agriculture seems an unlikely new frontier for PDD.
Yet Netflix leveraged user data, automation, and AI to change how movies and shows are made. It didn’t need fancy studios or celebrity deals.
PDD has a similar opportunity to upend labor-intensive farming through technology. User preferences, automation, and data science can modernize antiquated agriculture.
For example, Netflix uses data to determine what content will have mass appeal before production starts. PDD can identify the tastiest, most popular produce strains to guide R&D.
Beijing Backs Agricultural Upgrading
Despite China’s recent tech crackdowns, Beijing appears supportive of upgrading the country’s agriculture industry.
In the letter, Xi Jinping mentioned that the 20th National Congress of the Communist Party of China has made plans for building an “agricultural powerhouse.”
To this end, the mainland authorities have been continuously encouraging young people to enter rural areas. The Ministry of Human Resources and Social Security of the People’s Republic of China had proposed the “Three Supports and One Assistance” plan, which aims to dispatch 34,000 university graduates to ethnic regions, border areas, and villages to assist in “revitalization and support.”
In April, the Guangdong Communist Youth League Committee also launched the “Three Villages Action” plan. It aims to mobilize 300,000 young people to work in rural areas by the end of 2025, promoting “urban youth going to the countryside, expatriate youth returning to their hometowns, and local youth revitalizing their hometowns.”
President Xi has urged young Chinese to return to rural areas. His administration is offering incentives for agricultural entrepreneurs and innovation. Modernizing China’s farms is critical for the government to realize the dual goals of rural economic growth and self-sufficiency in strategic crops.
PDD’s vision aligns with government priorities to boost productivity through technology. Its data-driven approach could help China secure domestic food supply chains. There are no guarantees in China’s turbulent regulatory environment. But for now, policy signals point to government backing of next-generation agriculture. That’s good news for PDD as the first mover in leveraging e-commerce data to guide R&D. The company will enjoy an advantage if it receives preferential policy support.
Valuation
PDD trades at 19x forward earnings with 32% projected revenue growth in 2023. PDD trades at a PEG ratio of just 0.76x, which appears slightly higher than peers Alibaba and JD.com (NYSE:JD). The broader pessimism around Chinese stocks amid a sluggish growth outlook has compressed valuations across the sector. However, PDD commands a deserved premium to Alibaba and JD given its superior growth and profitability profile. While low on an absolute basis, PDD’s valuation is attractive.
In addition, the total addressable market for agriculture in China is $1.2 trillion. Assuming farmers spend around 10% of revenues on marketing expenses and 2% on transaction costs, this translates to a $144 billion market opportunity for agricultural marketing services. If PDD can capture just 10% penetration of this market, it would boost revenues by $14 billion. This demonstrates the upside for growth if PDD can successfully roll out services to help China’s farmers market and sell their products online. Additionally, PDD has started expanding globally into markets like the U.S. and Southeast Asia. If PDD can successfully market Chinese agricultural products to overseas consumers, the addressable opportunity will grow even larger.
Uncovering the Real Worth of the Marketplace System
We believe PDD’s marketplace model is poised to displace traditional retailers in China, especially within the agricultural sector. There are a couple of key reasons why the marketplace approach fixes inefficiencies in current agriculture supply chains:
First, farmland in China is highly fragmented across small, dispersed producers. This makes aggregation challenging for distributors, who must collect inventory across vast networks of farms before redistributing products to consumers. This multifaceted distribution results in significant transportation costs and product losses along the way.
PDD’s e-commerce marketplace model provides a more direct pathway from farm to consumer. By facilitating transactions between producers and buyers online, PDD reduces intermediaries and ships products straight from their origin to the end customer. This cuts out layers of handling and transportation that drive up costs and product spoilage.
Second, the marketplace model substantially reduces the inventory risk and monitoring costs incumbent upon traditional retailers like Costco or Walmart. These retailers purchase massive volumes from suppliers directly to lower unit costs. However, owning inventory then requires stringent quality control and ties up working capital.
In contrast, PDD’s marketplace never takes ownership of products. It simply connects buyers and sellers online. This allows PDD to offload inventory risk and quality assurance to the network participants. Merchant sellers bear responsibility for inventory and quality, while buyer reviews provide accountability.
Hence, we see great upside driven by PDD’s early lead in ag-tech and underappreciated revenue potential from the agriculture pivot and its marketplace model.
Potential Risks to Watch
While PDD’s agriculture push has intriguing potential, it also faces risks that investors should closely monitor. The regulatory environment in China remains highly uncertain. PDD’s e-commerce business also faces fierce competition from rivals. Additionally, it is still too early to conclude whether PDD can successfully execute its grand vision for transforming agriculture. The company has no track record in agriculture technology or production. Failure to advance its ag-tech efforts would dent the bull thesis. The company will need to demonstrate progress on its ambitious agricultural goals to maintain investor confidence. Regulatory, competitive, operational, and demand risks could derail PDD’s futuristic plans.
Some doubt whether PDD’s promotional strategy is sustainable. Though PDD no longer reports GMV figures, its continued growth in transaction services revenue implies GMV has likely maintained strong momentum. More importantly, PDD has managed to dramatically improve profitability, achieving a 23% operating margin in 2022. This supports the sustainability of its promotion-fueled growth strategy. Despite past criticisms, PDD seems to have found an effective balance between user subsidies and profitability as evidenced by its rising margins even amid rapid GMV expansion
Conclusion
PDD presents a compelling opportunity as an unlikely disruptor in Chinese agriculture. While best known as an e-commerce app, PDD is making smart early moves into ag-tech. Its troves of consumer data, supportive government policies, and innovative marketplace model give it advantages to revolutionize traditional farming.
Just as critics underestimated Netflix’s potential, PDD could defy expectations by leveraging technology to unlock productivity and efficiency gains. Agriculture is ripe for disruption, and PDD’s platform strengths position it to lead the charge.
For investors, PDD offers exposure to both a high-growth company and an emerging ag-tech innovator. Its attractive valuation does not yet reflect the full extent of its ambitions in agriculture.
In a promising alignment, Beijing’s agricultural upgrading policies provide tailwinds for PDD’s vision of data-driven farming. This adds confidence to the long-term growth thesis.
While the path forward is uncertain, underestimating innovators like PDD is often a losing bet. We see a compelling upside for investors willing to look past the surface and recognize PDD’s intriguing potential in China’s massive agriculture industry.