PDD is currently a high growth profit opportunity

The Chinese company has stronger growth rates but lower valuation multiples than its rivals

By Oliver Rodzianko

Abstract

• PDD’s unique consumer-to-producer model helps reduce costs by bypassing intermediaries, offering lower prices and increasing market share, even as the company faces quality control challenges.
• The company’s revenue growth significantly outpacing that of its peers, coupled with low price-to-earnings and price-to-free-cash-flow ratios, indicates significant undervaluation despite slower future growth estimates.
• Risks include macroeconomic pressures such as a decline in foreign direct investment, competition from platforms like Douyin, and potential regulatory scrutiny of gamification tactics.

PDD Holdings Inc. (PDD, Financial) is arguably one of the most attractive Chinese e-commerce investments on the market right now. Its distinct business model that cuts out the middleman allows it to offer competitively priced products. While it has faced challenges with quality control and there are pressures from the volatility of the broader Chinese macroeconomy, the investment is still undeniably attractive due to its high growth rates but lower valuation multiples than many of its peers.

Operational analysis

The company’s primary revenue driver (around 90% of total sales) is Pinduoduo, which has a unique business model that combines group buying with social shopping, leveraging platforms like Tencent’s (TCEHY, Financial) WeChat. It has grown rapidly and is now one of the largest e-commerce platforms in China with nearly a billion users. By focusing on entertainment value alongside price competitiveness, Pinduoduo has successfully taken market share from the likes of Alibaba (BABA, Financial) and JD.com (JD, Financial).

The company’s consumer-to-producer model is one of the most distinctive elements of its business strategy. By connecting consumers directly with producers, the company bypasses traditional intermediaries in the supply chain. This allows the company to reduce logistics and distribution costs, providing lower product prices that appeal to price-sensitive customers. In addition, the C2M model is good for local agricultural producers because it allows farmers to sell perishable goods more efficiently, reducing waste and improving revenues.

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 inexpensive goods means it is particularly vulnerable to the risk of low-quality products entering the market. As a result, the company has been placed on the US government’s Notorious Markets for Counterfeiting and Piracy list, underlining that this is a fairly serious problem indeed.

To support its reputation, the board has partnered with over 400 luxury brands to combat counterfeiting, introduced a product rating system, closed many stores and blocked offers that do not meet quality standards. I believe this is an extremely important approach by the board and shows a willingness to sacrifice short-term profits to improve the long-term brand.

Another element that stands out about PDD is that it improves user engagement through gamification. Much like Duolingo (DUOL, Financial) incentivizes language learning through rewards and games, Pinduoduo has implemented a daily check-in system that rewards users for logging into the app regularly. It also has mini games that users can play in the app to earn rewards and discounts, as well as membership cards for additional incentives like early access to sales and invitations to special events. The sense of community and habit formation is certainly good for the company’s growth prospects.

Financial analysis and valuations

PDD Holdings’ GF Score is just 80 out of 100, which is primarily a result of its short run of profitability (three of the last 10 years) and weak momentum, with the stock down over 36% year-over-year. However, the GF Value line suggests the stock is significantly undervalued, which I believe is accurate given its strong future growth estimates and historical investor sentiment toward the company.

The current price-to-earnings ratio is 10, which is a significant drop from the 10-year median of nearly 24. Furthermore, the price-to-sales ratio, while high at 2.83 compared to the sector median of 0.65, is still a significant reduction from the 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 well below my own 10-year median of 19.37.

There is a lot of bearish sentiment around Chinese stocks in the stock market, but this has opened up significant undervaluation. As such, prices may soon start to rise. PDD is a notable exception among Alibaba, JD.com, and Tencent, as its price has risen much more in the past three years.

For example, PDD has incredible revenue growth that far outshines its competitors. Over the past three years, it has achieved revenue growth of 281.23%. Second place is far below that, occupied by JD.com with revenue growth of 33.20%.

The company also achieved the highest three-year free cash flow per share growth among the companies on my list, with Alibaba seeing its stock decline significantly during that period.

In my opinion, such strong growth and a smart, cost-competitive business model are reasons to be bullish on PDD compared to its peers. This is especially true since the company has the second lowest price-to-free cash flow ratio, with only the deeply undervalued JD.com below it. As such, I believe the market was definitely inefficient here, and PDD is definitely worth buying.

However, PDD Holdings has also shown a slowdown in revenue growth compared to its historical data, with three-year revenue growth of 46% compared to the 10-year median of 59%. Its forward estimated growth rate for total revenue over the next three to five years is also lower at 35%. Therefore, I believe there is potential for periods of volatility and a decline in the price-to-sales ratio as the company’s growth rates continue to decline from the peak growth we saw in 2023-2024. Nevertheless, the recent indication of a slowdown in growth by analysts is one reason why the stock is likely to be significantly undervalued now, as market sentiment has temporarily cooled, opening up a buying opportunity.

Risk analysis

Despite the company having a strong gaming system that is supposed to increase user engagement, I think it could face more scrutiny from the Chinese government in the future. This comes at a time when the government is cracking down on both big tech companies and game developers in the country. Pinduoduo has already faced scrutiny for selling counterfeits and is hit with ongoing monopoly control. Additionally, we recently saw minors being limited to three hours of gaming per week, and I think we could see further scrutiny of the company’s operations in the near future, especially in relation to its gamification and user engagement tactics. This is a reason to be cautious given the high growth that is currently being projected for the company.

In addition, emerging platforms in China such as Douyin (known internationally as TikTok) and Kuaishou (KUASF, Financial) are changing the e-commerce landscape. Douyin stands out in particular for its use of short-form video content to create e-commerce experiences; this directly competes with Pinduoduo in entertainment shopping, and Douyin has enjoyed increasing popularity among younger audiences, gaining market share. Additionally, both Douyin and Kuaishou have leveraged influencers and key opinion leaders to promote products, another significant strategy that threatens PDD’s core user base. Both competitors also offer competitive pricing, sometimes even undercutting parent company Pinduoduo.

The geopolitical climate has also made foreign investors more cautious about investing in China, reflected in a decline in foreign direct investment into China from 2022, putting downward pressure on Chinese stock valuations. The country is also grappling with slowing economic growth, weighed down by an aging population, lower investment rates, and higher labor costs. In addition, concerns are growing about Xi Jinping’s more socialist integration policies, which differ from Deng Xiaoping’s heavier capitalist integrations, which could put pressure on PDD growth rates in the long term.

Application

Despite the risks involved in investing in China right now, PDD Holdings’ valuation looks extremely attractive. I believe the investment will grow quite rapidly over the next few years, based on analyst estimates of future earnings and revenue growth rates. Additionally, the low price to free cash flow ratio and significantly higher free cash flow growth over the past three years compared to its peers certainly make the stock a favorable investment.

The company continues to be a leader in price-competitive e-commerce in China, and tactics like gamification to drive user engagement prove that the company can continue to drive growth and compete with new players.

Disclosures

I do not have any positions in the stocks listed above and have no plans to purchase new positions in the stocks listed above in the next 72 hours.