Robert Way
Back in May, I wrote that while PDD Holdings (NASDAQ:PDD) looked attractively valued, controversy surrounding the company kept me on the sidelines. More recently I lowered my rating to “Sell” in September given a lack of disclosure of where its growth was coming from, particularly with regards to Temu.
With the U.S. government getting more aggressive towards banning Chinese companies in the U.S., including the House passing a bill to ban TikTok, PDD faces increased risks that its Temu platform could get banned in the U.S. At the same time, the stock trades at a huge premium to other Chinese e-commerce giants, despite a lack of disclosure on how much revenue and growth is coming from Temu. With the company seeing falling gross margins, it appears Temu is becoming a larger part of the company and/or its Pinduoduo platform is being increasingly promotional.
Company Profile
As a reminder, PDD operates the Pinduoduo e-commerce platform in China and the Temu platform internationally. The Pinduoduo platform is based on group purchases whereby lower prices are given on team purchases. PDD generates most of its revenue from online marketing services and merchant fees for value-added services.
The group purchase aspect of PDD is what differentiates it from other Chinese e-commerce companies, and has resonated with Chinese consumers.
The company’s Temu platform, meanwhile, directly connects international customers with Chinese and other global manufacturers and brands. The platform has seen explosive growth due to the inexpensive prices of its offerings and deep discounts the site gives.
Q4 Earnings
For Q4, PDD saw revenue soar 123% to $12.52 billion, crushing the $10.84 billion consensus. That equated to the company beating analyst estimates by $1.68 billion, or over 15%.
Revenue from online marketing services jumped 57% to $6.86 billion, while transaction service revenue surged 357% to $5.66 billion.
Gross margins came in at 60.5%, down from 77.6% a year ago. Gross profits rose 66% to $7.58 billion from $4.58 billion. The company credited the big jump in costs of revenue to increased fulfillment fees, payment processing fees, maintenance costs, and call center expenses. However, I would venture that the big decline is coming from a combination of Temu being a bigger part of the pie and competitive pressures impacting Pinduoduo.
Sales and marketing expenses increased 50% year over year. However, as a percentage of revenue, S&M was 30.0% versus 44.5% a year ago.
Adjusted earnings per ADS were $2.40, topping the consensus by 75 cents.
The company generated $5.2 billion in operating cash flow in the quarter and $13.3 billion for the year.
PDD turned in another quarter of explosive revenue growth that continues to fly in the face of a difficult Chinese economy and an increased competitive environment. Its 123% revenue growth compares to net product growth of 3% for JD.com’s (JD) retail unit and 2% growth at Alibaba’s (BABA) Taobao and Tmall.
Now PDD doesn’t break out where its revenue growth is coming from, nor what percentage of its revenue is coming from Temu. However, it is notable that its gross margins have been crushed and gross profit growth, while strong, was still half of its revenue growth. This is likely a combination of increased competition in China impacting gross margins as well as very weak margins from Temu.
Temu, of course, has come under the crosshairs of U.S. lawmakers, who allege the products on the company’s website are made from forced labor. Several members of Congress have pressed President Biden to add Temu to the list of companies in violation of the Uyghur Forced Labor Prevention Act, which would ban all products from the site from being allowed to be imported into the U.S.
Temu, meanwhile, has reportedly been looking to reduce the share of the site’s sales in the U.S. from 60%, down to as low 30%. It is looking to shift those sales to other regions, including Europe, the Middle East, South Korea, and Japan. That could be difficult, as no consumer likes to buy junk more than Americans, although the company has been recently increasing non-U.S. user more quickly than U.S. users, according to the above-linked article citing Sensor Tower data.
Valuation
PDD trades at near 13x the 2024 EBITDA of $11.2 billion and near 10x the 2025 EBITDA consensus of $15.0 billion.
On a PE basis, it trades at near 23x 2024 EPS estimates of $5.76. Based on the 2025 consensus for EPS of $7.37, it trades at near 18x.
It’s projected to grow revenue by 38% in 2024 and 28% in 2025.
The stock trades at a much higher valuation than its Chinese e-commerce peers but is also projecting much stronger growth.
PDD Valuation Vs Peers (FinBox)
Chinese stocks currently trade at very low multiples, while it can be argued that PDD trades at a low valuation given its growth. However, the company is a bit of a black box given its lack of disclosure, such as not breaking out things like Temu or the Gross Merchandise Volume (“GMV”) (it used to break this out but stopped) on its platform.
If PDD can generate $35 billion in adjusted EBITDA in 2032, which is the current consensus, and you assume its growth rate by then falls in line with its Chinese rivals (its hyper growth won’t last forever) and place the ~3.5x multiple its rivals trade at today, it would be a $110 stock, which is above where it trades today (without discounting back). Discount the stock back using a 5% rate, and you’d get about a $75 stock.
Conclusion
The market has been difficult for most Chinese stocks not named PDD. However, PDD isn’t immune to all the arguments as to why Chinese stocks trade at the levels they do. It too has a VIE structure and is subject to the whims of the Chinese government. PDD also has additional risk with Temu getting banned in the U.S., as well as from its lack of disclosures. Let’s also not forget the company has been accused of spying on its Chinese users as well.
While the company is admittedly killing it today, there are a lot of longer-term risks at play. These include increased competition, risks associated with operating in China, Temu getting banned in international markets, and the company re-rating to peer levels when its growth matures. As such, I continue to rate the stock a “Sell.”
The biggest things to watch moving forward is if the U.S. actually starts banning popular Chinese social media and e-commerce sites, as well as if other countries follow suite. Investors should also see if PDD eventually starts breaking out its segment results. Gross margins is another areas to watch to see if they continue to deteriorate or if they begin to stabilize and improve.
Risks to a “Sell” thesis would be investors continuing to reward the stock for its revenue growth, and valuing it more as a U.S.-based company.
Moving forward, I expect PDD to continue to put up strong revenue growth with some continued margin deterioration. However, I think the stock could come under pressure as the U.S. takes more meaningful actions to crack down on sites like Temu. My target price is $75.
