Based on our analysis, we believe that Pinduoduo Inc. (NASDAQ:PDD) is a contrarian, margin-expanding investment proposition ideal for investors looking to diversify their portfolios regionally ahead of earnings. Unlike most Chinese tech stocks, Pinduoduo is a profitable company, with strong moats and operating in an industry that is not in the sights of Chinese regulators. Additionally, the People’s Bank of China (PBoC) has started to implement an accommodative monetary policy, which should provide support for high-growth tech stocks like Pinduoduo. Despite the recent drop in Chinese ADRs, we believe Pinduoduo is a good long-term investment for those willing to bear short-term risk and hold investments in China.
Solid trade gap
Pinduoduo’s feed-based shopping platform and user experience-centric business strategy are key factors contributing to the company’s business moat. In short, Pinduoduo is taking a “more social approach” to e-commerce by integrating a social feed into the shopping experience, in addition to adding games and AI-based algorithms to recommend products and services. We believe these competitive advantages have contributed to consistent MAUs (monthly active users) of 750 million users and active buyers of around 900 million. The large number of users on its platform provides Pinduoduo with an unprecedented business moat in China, and we believe that the lack of threat from new entrants will allow the company to increase its profitability and margins over the long term. term.
Finances and evaluation
We believe that Pinduoduo stock price should appreciate as its revenue increases and its profit margin expands as the company focuses on increasing profits. The company only recently became profitable and is still in the early stages of profitability. Over the past 8 reported quarters, the company has averaged a net profit margin of approximately 9%, as shown below. Over the past 4 quarters, the company has recorded a quarterly net profit margin of between 15% and 31%. We believe that in 5 years the company should comfortably be able to achieve a net profit margin of 20% as a baseline. This 20% profit margin is similar to that of a social media/technology company like Meta (META) which reported a net profit margin of around 22% in the last quarter.
If revenues continue to grow at around 5% on average over the next 5 years (slightly above GDP growth and below the quarterly revenue growth of 7% YoY recently reported), we could see Pinduoduo’s price increase to $71.11 per share at a valuation of ~25x P/E. This presents an upside of around 44% in 3 years (FY2025) under this conservative scenario (in 2020 the stock price peaked around $200 as recently as last year). Any expansion in its earnings multiple or profit margin above expectations would propel the stock to a higher price than estimated below.
Economic and geopolitical risks
It is no secret that the Chinese economy is under pressure from various macroeconomic and geopolitical circumstances. Retail sales are sluggish and property values are down. In addition to economic pressures, there are many political uncertainties in China with the upcoming National Congress of the Communist Party of China and the continued worsening of US-China relations following Nancy Pelosi’s visit to Taiwan. We are aware of these macroeconomic and geopolitical forces and how these forces can affect the long-term profitability of Pinduoduo. However, we believe Pinduoduo’s platform-based business model will fare much better than most traditional Chinese companies due to its size and high margins. Recent PBOC rate cuts and liquidity injection through repo transactions should signal an easy monetary environment which should support prices of high P/E stocks like Pinduoduo. Additionally, with initiatives that help Chinese farmers in rural areas and no history of aggravation by Chinese regulators, we see minimal risk of political circumstances materially affecting Pinduoduo’s business prospects.
We believe Pinduoduo is an excellent investment for investors seeking regional diversification and long-term shareholder value growth. Pinduoduo has strong trading moats and financial performance that will withstand most macroeconomic and geopolitical challenges, and we believe the recent PBOC rate cuts and accommodative monetary policy will provide a floor for the stock price. Additionally, based on our fairly conservative valuation model, we see that the stock may experience considerable share price growth over the next 3 years.