On May 27, 2022, Pinduoduo (PDD: NASDAQ) held its Q1 2022 earnings call, posting impressive financial results and climbing more than 15% during the trading day. This is the fourth quarter that PDD has continued to generate profits since turning losses into gains in the second quarter of 2021. This article will show the key points of China’s leading e-commerce company and may restore public confidence in Chinese Concept shares.
The stable profit phase is approaching
During this quarter, PDD’s revenue reached CNY 23.8 billion, up 7% year-on-year, driven by an increase in online marketing services revenue and transaction services revenue , offset by lower 1P trial revenue. Online marketing services revenue reached CNY 18.2 billion, up 29% year-on-year, while transaction services revenue this quarter was CNY 5.6 billion, up 91% compared to the same period of 2021, which is dazzling. In terms of cost, its cost of sales decreased to CNY 7.2 billion this quarter, down 16% from the same quarter of 2021. As a result, its non-GAAP operating profit reached 3. 7 billion CNY against an operating loss of 3.2 billion CNY in the same quarter of 2021. We believe, given the current market capitalization of PDD, that it is inevitable to see slower growth. Still, that may not be a bad thing, as more sustainable project spending and more farm initiatives are the main reasons for the process over the past three quarters.
It should be noted that in the first quarter, PDD’s marketing expenditure amounted to 11.2 billion yuan, further reducing its share of total revenue to 47% (from 54% last year, although less than 112% at the peak). PDD, while reducing its marketing expenditure, significantly increased its R&D expenditure and hit an all-time high, up 20% from a year earlier at 2.7 billion yuan, by recruiting more specialized talent. We think it’s a good sign that PDD is revamping its boring marketing strategy since its inception and paying more attention to making profit through technological innovation.
Why turn to agriculture?
As we mentioned in our previous articles, since CEO Chen Lei is the main decision maker of PDD, it seems that the strategy of this e-commerce company has changed significantly from a marketing focus to a on investments in agricultural science and technology. Indeed, after a year in this position, the strategic transformation has produced the first results. Since the first profit in the second quarter of last year, PDD has made profits for four consecutive quarters and entered a phase of stable profits. We believe this is due to PDD’s long-term firm investment in agriculture, which believes that technology and talent are the keys to promoting agricultural and rural modernization. Growing profits are a reward for seizing farming-related opportunities in small towns and rural markets.
Since 2020, due to the continued impact of the epidemic and geopolitical-induced uncertainty, Chinese e-commerce companies have all turned to fierce and differentiated competition. PDD’s strategy has a strong focus on agricultural technology. On the one hand, China’s policy focus on agriculture, rural areas and farmers is shifting from poverty reduction (which is achieved in 2021) to rural revitalization. On the other hand, the priorities of e-commerce giants have shifted from the incremental model to an existing model, which means that repurchase ability will become one of the main drivers of future operations. Agricultural products, as a type of high-frequency consumption, contribute to a large number of DP sales. However, agricultural scientific research is a long process of investment, and it may take 10 years or more to break through and move into mass production. Investing in agricultural science and technology essentially means sacrificing short-term profits and pursuing long-term sustainable development.
However, we believe that this market, although extremely difficult, has great potential. Currently, in terms of international trade, China’s high value-added agricultural products are still dependent on imports. According to data from the Ministry of Agriculture, China’s agricultural imports are essentially double the exports. This trade deficit is not due to the fact that Chinese agriculture cannot be self-sufficient, but to the lack of high value-added agricultural products. For example, high value-added agricultural products such as edible oilseeds, cereals, wheat, corn and soybeans are the categories with a large import balance. At the policy level, the national agricultural and rural informatization development plan for the “14th Five-Year Plan” requires that the national online retail sales of agricultural products reach 800 billion yuan by 2025, which is quite done in accordance with the provision of the PDD strategies. As far as we all know, political leanings are a key consideration when investing in emerging markets with unique political environments. Especially for Internet companies since the 20th century, Ant Group’s IPO attempt is a negative example. A very important fact is that due to the political peculiarity, the market of small towns and countryside is one of the markets that China pays special attention to. An important piece of evidence is that, earlier in 2021, Pinduoduo was among three tech companies praised for their contributions to China’s poverty reduction efforts.
Uncovered potentials and efforts behind profit
Since the first quarter of last year, PDD has stopped disclosing single-quarter GMV, and the growth rate of annual active buyers and average monthly activity has gradually fallen back to single digits. We believe this is a good strategy because with the rise of the platform and the disappearance of the Internet’s demographic dividend, it is difficult for PDD to continue to maintain broadband GMV growth. In other words, the valuation premium brought by rapid growth is unsustainable. PDD changed its strategy at the right time and achieved initial success.
As mentioned earlier, PDD commission revenue in the first quarter nearly doubled, which we believe is primarily due to commission revenue from more product sales. At present, it is undeniable that the logistics processes of agricultural products still need to be improved, and the distribution of resources is still very unequal between regions. This is where PDD saw the opportunity, ameliorating this problem and taking advantage of it. At the same time, in terms of agricultural infrastructure, PDD adopts route planning technology and network solutions. The company initially created an efficient agricultural product logistics system, directly connecting more than 1,000 agricultural production areas and encouraging more than 16 million farmers to participate in the digital economy.
Additionally, PDD launched a CNY 10 billion agricultural initiative in August 2021 to support agricultural modernization and rural revitalization. As of March 31, 2022, nearly 40,000 quality agricultural products have been launched on this channel. In addition, PDD has launched or helped several influential events, including the 2020 International Smart Agriculture Competition, the 2021 Global Agriinno Challenge and China’s First Agricultural Robot Innovation Competition, trying to break the traditional restrictions and promote the development of smart agriculture. In addition, PDD has also increased its investments in infrastructure such as agricultural product transportation, logistics and warehousing in recent quarters. All we can think of are factors that favor the DP to achieve strong growth in this segment in recent quarters.
Long-term bullish, risks attract attention
Although suffering from regulatory constraints, a falling market and tightening Sino-US relations, PDD should still be given some guidance as many investors are restoring confidence in Concepts’ Chinese stocks. We used the EV/income and P/B ratio to value the company. Considering that the company was able to transform losses into profits and that its competitors have much lower ratios, we decided to use the adjusted historical average method. From the chart, it is evident that the ratio is at a low level, which we believe is mainly caused by regulatory changes in China recently. Based on its current financial performance and current business environment, momentum and competitive landscape, we have calculated that 7.5x EV/revenue and 8.7x P/BV is an appropriate valuation for PDD over 12 months , which corresponds to a target price of 91.48 USD. .
We are still firmly bullish on PDD, at least from the perspective of it as a value investment. One day in the future, we may finally notice the opportunities, values and changes in the Chinese agricultural industry benefiting the whole Chinese society, brought about by PDD’s agricultural digitalization strategy. However, under such a strategy, since it is difficult to generate sustained high growth and high initial investment, the DP will be more vulnerable to market fluctuations and international trade frictions in the short term, and the price may not not be satisfactory. Medium and short-term investors should pay more attention to this. Additionally, investors should also keep an eye out for changes to the company’s SEC regulations, which we believe could be the biggest threat to this investment.