The Chinese company has stronger growth rates but lower valuation multiples than its peers
By Oliver Rodzianko
Summary
- PDD’s unique consumer-to-manufacturer model cuts costs by bypassing intermediaries, offering lower prices and growing its market share, although it faces quality control challenges.
- The company’s revenue growth far surpassing peers, coupled with low price-earnings ratio and price-to-FCF ratios, indicates a significant undervaluation despite slower future growth estimates.
- Risks include macroeconomic pressures like FDI declines, competition from platforms like Douyin and potential regulatory scrutiny over gamification tactics.
PDD Holdings Inc. (PDD, Financial) is arguably one of the most attractive Chinese e-commerce investment on the market right now. Its distinct business model that cuts out intermediaries allows it to offer cost-competitive products. While it has faced quality control challenges and there are pressures from instability in the broader Chinese macro economy, the investment is still unmistakably attractive due to its high growth rates but lower valuation multiples than many of its peers.
Operational analysis
The company’s main dominant revenue generator (around 90% of total sales) is Pinduoduo, which has a unique business model that combines group buying with social shopping by leveraging platforms like Tencent’s (TCEHY, Financial) WeChat. It has rapidly expanded and is now one of China’s largest e-commerce platforms with almost a billion users. By focusing on entertainment value alongside pricing competitiveness, Pinduoduo has successfully taken market share from the likes of Alibaba (BABA, Financial) and JD.com (JD, Financial).
The company’s consumer-to-manufacturer model is one of the most distinct elements of its business strategy. By directly connecting consumers with manufacturers, it bypasses traditional intermediaries in the supply chain. This allows the company to reduce costs associated with logistics and distribution, providing lower prices for products, which is appealing to price-sensitive shoppers. Furthermore, the C2M model is good for local agricultural producers as it allows farmers to sell perishable goods more efficiently, reducing waste and improving income.
One of the drawbacks of this cost-conscious approach is that it has been criticized for the presence of counterfeit and substandard products on its platform. While major Chinese e-commerce platforms like Alibaba have faced similar challenges, PDD’s focus on affordable goods means that it is particularly vulnerable to the risk of low-quality products finding their way onto its marketplace. The company has been included on the U.S. government’s Notorious Markets for Counterfeiting and Piracy list as a result, which highlights that this issue is indeed quite severe.
To support its reputation, management has collaborated with over 400 luxury brands to combat counterfeit goods, introduced a product rating system, shut down numerous stores and blocked listings that do not meet quality standards. I think this is an incredibly important approach for management to take, and it shows a willingness to sacrifice short-term profits to improve its long-term brand.
Another element that particularly stands out to me about PDD is that it improves user engagement through gamification. Much like Duolingo (DUOL, Financial) creates language-learning incentives through rewards and games, Pinduoduo has implemented a daily check-in system that rewards users for logging into its app regularly. It also has mini games that users can play within the app for rewards and discounts, and membership cards for further incentives like early access to sales and special event invitations. The sense of community and habit forming is certainly good for the company’s growth prospects.
Financial and valuation analysis
The GF Score for PDD Holdings is only 80 out of 100, which is a result primarily of its short period of profitability (three years of the past 10) and poor momentum, with a decline of over 36% in price year to date. However, the GF Value Line suggests the stock is significantly undervalued, which I think is accurate given its strong future growth estimates and historical investor sentiment on the company.
Its price-earnings ratio is currently 10, which is down significantly from its 10-year median of nearly 24. Further, its price-sales ratio, while high at 2.83 compared to the sector median of 0.65, is still a significant contraction from its own 10-year median of 8.65. I am also bullish on PDD Holdings’ price-to-free cash flow ratio of 7.23, which is lower than the industry median of 11.19 and significantly lower than its own 10-year median of 19.37.
There is a lot of bearish sentiment in the stock market surrounding Chinese companies, but this has opened up significant undervaluations. As such, prices could begin to grow again soon. PDD is the notable outlier amongst Alibaba, JD.com and Tencent, as it has grown much more in price over the past three years.
For example, PDD has stellar revenue growth, which far outpaces its peers. Over the past three years, it has achieved 281.23% revenue growth. Second place is far below this, going to JD.com at 33.20% revenue growth.
The company has also achieved the highest three-year free cash flow per share growth of its peers in my set, with Alibaba notably showing a contraction over the period.
In my opinion, such strong growth and a clever cost-competitive business model are reasons to be bullish on PDD over its peers. This is especially true as the company has the second-lowest price-to-free cash flow ratio, with only the deeply undervalued JD.com coming in under it. Therefore, I think the market has definitely been inefficient here, and PDD is definitely a buy.
However, PDD Holdings has also shown slowing revenue growth compared to historically, with three-year revenue growth of 46% compared to 59% as a 10-year median. Its future three-to-five-year total revenue growth rate estimate is also a lower 35%. Therefore, I think there is the potential for periods of volatility and a contraction in the price-sales ratio as the company’s growth rates continue to cool off from the peak growth we saw from 2023 to 2024. Nonetheless, the recent indication of a growth slowdown from analysts is one of the reasons why the stock has arguably become significantly undervalued now, as sentiment in the market is momentarily reduced, opening up a buying opportunity.
Risk analysis
Despite the company having a strong gaming system to boost user engagement, I believe this could come under more scrutiny in the future by the Chinese government. This comes at a time when the government is cracking down on both big tech and game developers in the country. Pinduoduo has already faced scrutiny for selling counterfeit goods and is affected by the ongoing monopoly scrutiny. Also, we have recently seen minors being limited to three hours of gaming per week, and I think further scrutiny of the company’s activities, especially related to its gamification and user engagement tactics, could occur in the near future. This is a reason to be cautious about the high growth currently anticipated for the company.
In addition, emerging platforms in China, like Douyin (known as TikTok internationally) and Kuaishou (KUASF, Financial), are reshaping the e-commerce landscape. Douyin, in particular, is notable as it has leveraged short video content to create e-commerce experiences; this directly competes with Pinduoduo in entertainment shopping, and Douyin is increasingly popular with younger audiences, taking market share. Further, both Douyin and Kuaishou have harnessed influencers and key opinion leaders to promote products, which is another significant strategy that is threatening PDD’s core user base. Both competitors also offer competitive pricing, sometimes even undercutting Pinduoduo’s parent company.
The geopolitical climate has also made foreign investors more cautious about investing in China, which is reflected in the drop in foreign direct investment in China since 2022, causing downward pressure on Chinese stock valuations. The country is also facing slower economic growth, influenced by an aging population, lower investment rates and higher labor costs. Further, there is an increasing concern about higher socialist policies being integrated under Xi Jinping, which differ from the heavier capitalist integrations of Deng Xiaoping; this could put pressure on PDD’s growth rates over the long term.
Conclusion
Despite the risks of investing in China right now, the valuation of PDD Holdings looks incredibly attractive. I believe the investment is going to continue to grow quite quickly over the next few years based on analysts’ estimates of its future earnings and revenue growth rates. Also, its low price-to-free-cash flow ratio and much higher free cash flow growth over the past three years relative to peers certainly make the stock a favorable investment.
The company continues to be a leader in cost-competitive e-commerce in China, and tactics like gamification to boost user engagement show proficiency in its ability to continue to drive growth and compete with emerging players.
Disclosures
I/we have no positions in any stocks mentioned, and have no plans to buy any new positions in the stocks mentioned within the next 72 hours.