Article Thesis
PDD Holdings Inc. (NASDAQ:PDD) is showcasing explosive business growth at a rate of more than 100% annualized, thanks, in part, to its blockbuster Temu shopping app. And yet, PDD Holdings trades at a very undemanding valuation of just 12x this year's expected net profits. Investors should not forget about the risks of investing in PDD Holdings, but the combination of very strong business growth and a very inexpensive valuation could be of interest to investors.
PDD Holdings: An Underfollowed E-Commerce Giant
PDD Holdings Inc., based in Dublin, Ireland, and Shanghai, China, is an e-commerce company with a market capitalization of around $200 billion, making it one of the largest players in this space globally. But the company is not very well-known in the West and does not get a lot of attention from shareholders. This is likely, at least partially, due to its China ties and the fact that many investors from the US and Europe want to avoid Chinese equities due to (presumed) geopolitical and regulatory risks. But even compared to other Chinese companies such as Alibaba Group Holding Limited (BABA), which has a market capitalization of $180 billion, PDD Holdings is underfollowed.
PDD Holdings, named PinDuoDuo up to 2023, has generated massive business growth in recent years, which is why the current market capitalization seems more than justified:
We see that the company grew its revenue from a measly $73 million in 2016 to $35 billion as of the end of 2023, meaning revenues soared by around 49,000% in seven years. That is even more astonishing than Nvidia Corporation's (NVDA) compelling business growth of 1,200% over the same time frame. Of course, it has to be noted that PDD Holdings grew from a smaller base, which makes maintaining a very high relative growth rate easier. But even once PDD Holdings became a large company, its strong growth continued -- between 2022 and 2023, revenues almost doubled in a single year, from a large base of close to $20 billion, and growth accelerated further in the very recent past:
We see that revenue growth has been accelerating every quarter since the fourth quarter of 2022, showcasing that momentum is on PDD Holdings' side. The accelerating business growth is, at least partially, the result of an absolute blockbuster app that is, it should be noted, not free from controversy: Temu.
Temu was created in the US in 2022 and is thus very new, and yet, it has gained massive traction. It has been at the top of the App Store download charts in 2023 and got a lot of attention for its Super Bowl ads in early 2024. PDD Holdings does not break out the revenue percentage generated by Temu, but since the acceleration of PDD Holdings' business growth fits very well with the growing attention Temu has been receiving, it is, I believe, highly likely that Temu is a major business growth driver for PDD right now. That being said, PDD Holdings has also grown before the rise of Temu, with its more traditional (and less controversial) platforms such as PinDuoDuo, which is focused on the Chinese market and which utilizes group purchases to allow for attractive prices.
Relative to PinDuoDuo, Temu is more focused on consumers in the United States and is famous (or, some might say, notorious) for its ultra-low prices. Temu advertises that it allows consumers to "shop like billionaires" thanks to its very low prices, which are made possible by connecting consumers in the West directly with sellers (primarily) in China. But some caution that this goes hand in hand with below-average article quality, environmental concerns, low wages for the workers that produce the goods sold on Temu, and so on -- hence Temu is a somewhat controversial company that is not well-liked by everyone. But the company clearly has its fans, as millions of consumers downloaded the app and use it regularly. This is, in part, the result of gamification of the shopping process, for example via special codes and promotions that users get for logging in regularly -- some even describe the app as "addictive". Whether this is positive for consumers or humanity is up to debate, but it seems to be very positive for PDD Holdings' business, as the company keeps beating analyst expectations with its accelerating business growth.
Sometimes, when companies pursue revenue growth aggressively, margins come under pressure. This has, at times, happened at Amazon (AMZN), the largest e-commerce company in the world. Despite ongoing revenue gains, there were quarters during which Amazon generated losses. But this isn't an issue at PDD Holdings, as the company is generating highly attractive earnings growth thanks to a combination of major revenue gains and operating leverage working in its favor. PDD Holdings is not sacrificing margin in order to grow the business, showcased by the 191% earnings per share increase (on a year-over-year basis) that the company reported during the most recent quarter. In the previous quarter, year-over-year earnings per share growth was 100%.
Since PDD Holdings is a platform provider primarily, it does not have to invest in its own operations in a massive way -- which differentiates it from the likes of Amazon. This means that the vast majority of PDD Holdings' operating cash flows are not needed to pay for capital expenditures. Instead, PDD Holdings converts most of its operating cash flow to free cash flow, which has been piling up on the balance sheet, as we can see in the following chart:
PDD Holdings' cash and equivalents have soared, now standing at well north of $30 billion. Long-term debt, including the current portion, is less than $800 million, meaning the net cash position is north of $33 billion, or around 17% of the market capitalization. For comparison, Apple's (AAPL) famed net cash position is equal to around 2% of its market capitalization.
Valuation And Risks To Consider
PDD Holdings thus combines strong business growth, one of the most successful shopping apps in the world, great free cash flow conversion, and a fortress balance sheet. And yet, shares trade for just 12x forward earnings, which pencils out to an earnings yield of around 8%. The broad market trades at around 21x forward earnings, while growing at a slower pace compared to PDD Holdings. Peers such as Amazon or MercadoLibre (MELI) trade at even higher valuations of 40x and 70x net earnings.
This seems like a very low valuation, but that might be justified as there are some risks to consider. First, as a China-exposed company, PDD Holdings faces regulatory and geopolitical risks. If the Taiwan situation were to worsen, for example, investors would likely sell off Chinese equities, making PDD Holdings and other Chinese stocks risky. Alibaba has shown that Chinese regulators can levy hefty fines on Chinese tech companies.
On the other hand, PDD Holdings also faces regulatory risks in the West. In the EU, for example, companies such as Temu or Shein face headwinds, and the same can be said about Temu's position in the United States. Due to environmental issues, forced labor concerns, product quality issues, and so on, Temu might face an increasingly harsh regulatory environment. If regulators become tougher, that could slow down Temu and would thus negatively impact PDD Holdings. It thus makes some sense that PDD Holdings is not trading at an Amazon-like valuation of around 40x net profits.
Takeaway
E-commerce is a growth industry, but not every e-commerce player is growing as fast as PDD Holdings Inc. Thanks to the success of Temu, PDD Holdings is growing at a very nice pace while generating substantial cash flows. Add a fortress balance sheet, and the company looks pretty appealing from a fundamental point of view.
There are significant regulatory risks to consider, however, which is why PDD Holdings isn't for everyone. But for investors not afraid of China exposure that want a high-growth name, inexpensive PDD Holdings could be of interest. I do, however, believe that PDD Holdings should only be held in a diversified portfolio.
Is This an Income Stream Which Induces Fear?
The primary goal of the Cash Flow Kingdom Income Portfolio is to produce an overall yield in the 7% - 10% range. We accomplish this by combining several different income streams to form an attractive, steady portfolio payout. The portfolio's price can fluctuate, but the income stream remains consistent. Start your free two-week trial today!
