PDD Holdings Inc. (NASDAQ:PDD), a Chinese conglomerate with several online business interests, is among the best-performing Chinese ADRs in the market after rising 137.5% in the last 12 months. I believe this rally has more legs, as evident by the market reaction to the strong first-quarter financial performance of the company. PDD stock rose by as much as 7.5% on May 22 after the company reported a 202% surge in quarterly adjusted net income. I am bullish on PDD, as I believe the company will benefit from improved monetization levels in the future, leading to robust earnings growth.
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PDD Is Gaining Market Share
PDD’s crown jewel, Pinduoduo, is aggressively gaining market share in China’s e-commerce sector. Since its founding in 2015, Pinduoduo’s share of the e-commerce market has risen to over 13%, according to the International Trade Administration. There are a couple of key components to Pinduoduo’s success.
First, the company actively targets communities in China, especially in rural areas, that have been historically underserved by established retail giants such as Alibaba Group Holding (NYSE:BABA) and JD.com (NASDAQ:JD). Second, Pinduoduo’s group buying feature has become wildly successful. The company has established itself as a social commerce platform that secures discounts from suppliers when groups of consumers form a team to purchase a larger quantity from a supplier.
Pinduoduo’s ability to take market share from established players is a testament to the competitive advantages enjoyed by the platform as a result of its unique team buying feature and its strategic decision to target the underserved community through low pricing.
Temu Is a Blockbuster
PDD’s recent growth driver has been Temu, its international retail arm. Temu, since its limited launch in 2022 covering North America, Australia, and New Zealand, has now grown into a global brand with a major footprint in Europe and the Middle East.
With 338 million downloads, the Temu mobile application became the most downloaded shopping app in 2023. Shein, Temu’s arch-rival, came in second with 262 million downloads. As evident from this statistic, Temu is crushing the competition today, enabling PDD to replicate Pinduoduo’s success formula on a global scale.
Temu is using aggressive marketing strategies to penetrate target markets, which is in line with how Pinduoduo grabbed market share in China. The company spent almost $2 billion on advertising through digital channels in 2023 and also purchased airtime during the Super Bowl. PDD also spent more than $15 million in giveaways during the Super Bowl event. These massive advertising costs are eating into Temu’s profitability today, but brand awareness will help the platform turn profitable in the long term.
According to Goldman Sachs (NYSE:GS) analysts, Temu spent $5 in marketing to acquire orders worth $39 in the U.S. in 2023, an improvement from $16 spent on winning similar levels of sales in the previous year.
The Increasing Focus on Profitability
PDD continues to focus on investing for growth. This was confirmed by Co-CEO Chen Lei during the Q1 earnings call on Wednesday. However, in recent times, the company has introduced several initiatives to grow profitability as well.
First, PDD is investing in its supply chain to achieve operating efficiencies with the objective of realizing lower fulfillment fees and processing fees in the long run. As the business scales further, these savings could fuel a margin expansion, resulting in higher operating income.
Second, the company is promoting sellers to prioritize high-quality products to reduce customer returns and improve customer satisfaction, which is expected to lead to higher customer lifetime value. Eventually, this may lead to higher monetization levels on the Pinduoduo platform, enabling earnings growth.
Third, PDD is investing in technology, including AI, to improve platform efficiency and also automate certain business functions. These investments, although a drag on operating margins in the short term, will prove to be value-accretive in the long run. The use of AI, in particular, may lead to substantial cost savings in the future, boosting profit margins.
The stellar revenue growth in recent times, coupled with the aforementioned strategies, has boosted PDD’s net income. In Q1, its operating profit increased 275% year-over-year to $3.59 billion, and net income also increased by a staggering 246% to $3.87 billion (202% growth on an adjusted basis). This came on the back of a 131% year-over-year increase in revenue to $12 billion.
Is PDD a Buy, According to Analysts?
The sentiment toward Chinese stocks is improving among analysts amid the resurgence of Chinese stocks this year. After digesting the 31% surge in iShares MSCI China Index (NASDAQ:MCHI) since January 22, Goldman Sachs analysts now believe there is more upside to Chinese stocks if earnings growth remains stellar, which is likely to be the case in the foreseeable future. PDD stock, therefore, is likely to see more gains alongside other Chinese tech stocks.
On May 17, UBS (NYSE:UBS) analyst Kenneth Fong raised the price target for PDD from $217 to $248 and wrote in a note that the market is overly bearish on Temu’s geopolitical risks. The analyst also claimed that investors are overlooking Temu’s attractiveness to underserved communities in overseas markets.
Overall, based on the ratings of 13 analysts, PDD has a Strong Buy rating. The average PDD stock price target is $193.95, which implies upside potential of 31.9% from the current market price.
The Takeaway: PDD Has More Room to Grow
Aided by Temu’s aggressive expansion into new geographic regions, PDD has more room to grow. The company’s focus on profitability will likely boost EPS growth in the coming quarters, leading to higher stock prices in the foreseeable future. PDD’s continued market share gains in China may help the company attract premium valuation multiples as well. Based on these factors, PDD seems like an attractive bet today.
