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After observing the market‘s up-beat reaction to Pinduoduo‘s (NASDAQ:PDD) Q1 2022 earnings, I believe investors might have reason to believe that the stock‘s 15-month drawdown (-75% from ATH) could be coming to an end. Personally, I am bullish on Pinduoduo‘s pioneering business model and ongoing initiatives in agriculture technology, and thus I initiate my coverage on the stock with a Buy rating. I support my recommendation with a residual earnings framework based on analyst EPS consensus and set a base-case price target of $62.99/share.
Pinduoduo is a Chinese e-commerce giant. The company operates a digital market-place that connects buyers and sellers of relatively low-cost (or value-for-money) merchandise. Pinduoduo was one of the first e-commerce players to strongly focus on the social aspect of shopping, inviting customers to an interactive shopping experience based on social discussions, games and team purchases.
Most recently Pinduoduo has increasingly grown into a leading player for the agriculture sector as the company is aiming to directly connect farmers and consumers. Notably, Pinduoduo is investing heavily to digitize the farming industry in China. In November 2021, the company announced a 10 billion RMB ($1.6 billion) funding package to support digital inclusion of the Chinese agriculture industry, which will ultimately benefit Pinduoduo‘s business. As of December 2021, the Pinduoduo platform serves 16 million farmers and 788 million active buyers. That said, Pinduoduo enjoys a strong self-reinforcing network effect as more customers attract more farmers and vice versa.
The company monetizes it‘s business primarily through advertising services, which account for approximately 90% of revenues and transaction services, which are approximately 10% of revenues. Pinduoduo first sold stock to the public in July 2018.
As an innovative technology-focused company in China, Pinduoduo has enjoyed super-charged growth rates in the past. From 2018 to 2021, the company grew revenues from $1.98 billion to $14.57 billion, representing a 3-year CAGR of approximately 95%. Also, profitability increased over the same period. While the business recorded losses until late 2020, in 2021 Pinduoduo managed to achieve a net-income of $1.2 billion (8.3% margin), or $0.85/share. Cash from operation was more than triple net-income: $4.46 billion. Pinduoduo ended the year 2021 with $14.6 billion of cash, equivalents and investments and only $2 billion of debt.
After PDD surprised analysts with a strong Q1 2022, the stock surged >15%. Apparently, PDD‘S value-for-money value proposition and focus on fresh agriculture products proves quite resilient amidst macro-economic slowdown. Here are the highlights:
Total revenues in the quarter were RMB23,793.7 million (US$ 3,753.4 million), an increase of 7% from RMB22,167.1 million in the same quarter of 2021.
Average monthly active users in the quarter was 751.3 million, an increase of 4% from 724.6 million in the same quarter of 2021.
Active buyers in the twelve-month period ended March 31, 2022 was 881.9 million, an increase of 7% from 823.8 million in the twelve-month period ended March 31, 2021.
Operating profit in the quarter was RMB2,154.4 million (US$339.8 million), compared with operating loss of RMB4,147.0 million in the same quarter of 2021.
Net income attributable to ordinary shareholders in the quarter was RMB2,599.5 million (US$410.1 million), compared with net loss of RMB2,905.4 million in the same quarter of 2021.
Analysts expect PDD‘s revenue and earnings to grow significantly until at least 2025. Consensus estimates as available on the Bloomberg Terminal indicate revenues for 2022, 2023, 2024 and 2025 of $16.5 billion, $20.6 billion, $24.3 billion and $28.6 billion, representing a 4-year CAGR of 15%. Respectively, EPS are estimated at $1.57, $2.22, $3.07 and $4.78.
If analyst consensus is right about PDD’s business forecast, what could be a fair per-share value for PDD? To answer the question, I have constructed a Residual Earnings framework based on the EPS analyst consensus forecast until 2025, a WACC of 10% and a TV growth rate equal to one percentage point above nominal GDP growth (4.5%). And based on my assumptions, the calculation returns a fair share price of $62.99/share, implying an undervaluation of approximately 30%.
Investors might have different assumptions with regards to PDD’s required return and terminal business growth. Thus, I also enclose a sensitivity table to test varying assumptions. For reference, red-cells imply an overvaluation as compared to the current market price, and green-cells imply an undervaluation.
Analyst consensus; author’s calculation
Analyst consensus; author’s calculation
Investors should be aware of the following downside risks that might cause PDD stock to materially deviate from my base-case target price of $62.99/share:
First, the economy in China is currently pressured by multiple headwinds including inflation, real-estate crisis and COVID-19 lockdowns. If the Chinese economy would slow more than what is expected and priced in, investors should adjust expectations for PDD’s short/mid-term business monetization accordingly.
Second, China’s internet/tech companies are strongly exposed to regulatory risk. That said, investors should monitor the regulatory environment very closely.
Third, much of PDD’s share price volatility is currently driven by investor sentiment towards Chinese ADRs and risk assets. Thus, Pinduoduo stock price might show strong price volatility even though the company’s business fundamentals remain unchanged.
Finally, investors are well advised to not underestimate competitive pressures. Pinduoduo is directly competing with Alibaba (BABA) and JD.com (JD), who are two of the world’s biggest and most successful e-commerce companies with substantial user-base, scale and financial power.
Fundamentals indicate that Pinduoduo stock is undervalued, especially given the company‘s 5-year growth outlook of >20% CAGR. Personally, based on a residual earnings framework valuation, I set a base-case target price of $62.99/share and assign a Buy recommendation. However, investors should note that investing in Pinduoduo might come with elevated risk-exposure as the company is less established than mega-cap peers Alibaba and JD.com. Going forward, Pinduoduo‘s agriculture technology push might be an interesting growth vertical to watch and might add to the company‘s unique value proposition.
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: not financial advise