Growth Stocks: Pinduoduo Inc.

The restrictions and confinement in China weighed down the Asian stock markets, making many companies today cheap compared to their intrinsic value (book value of the share). In addition, after the reopening it seems to be a good option for geographical diversification of capital.

The latest results of Pinduoduo reported a good year for the first quarter of 2022. The business, excluding merchandise sales, saw revenue growth of 39% year-on-year. With over 700 million monthly active users (MAUs) on their platform, the potential for recovery.

Pinduoduo shows that despite reducing their reliance on coupons, MAUs have not been reduced. Based on a discounted cash flow analysis, the company has enormous growth potential.

Consumer Community

Pinduoduo Inc. (PDD.US) is putting out hot numbers. But we must go into detail so as not to get sidetracked with a banal interpretation.
What we need to know is that the core business is growing at a compound annual rate (CAGR) of 25%. And that Pinduoduo is generating a very robust and clean GAAP (harmonized) return. Yes, we are dealing with a Chinese company and the "China risk" will always be present. Being selective, whoever is positioned and pays attention to valuation could find an opportunity in a company like Pinduoduo.

We already know that China is easing lockdowns. And that has made battered Chinese stocks look very attractive. In fact, tracking one of the most widely followed China-themed ETFs, the KraneShares CSI China Internet ETF (KWEB.UK), we started to see a recovery.

Source: xStation5

Revenue growth rates remain strong

source: Pinduoduo earnings Q1’22

Pinduduo increased its revenue by 39% year-on-year without taking into account its merchandise sales.

Let us remember that originally, Pinduoduo had no intention of managing a sales business and did so only during Covid-19, to help merchants. Its merchandise business was discontinued several quarters ago.

By the second quarter of 2022, Pinduoduo will be easier to compare, as the merchandise business will have already been greatly reduced. Consequently, Pinduoduo could easily continue to grow at a CAGR of 30%.
 

Why Pinduoduo? Why should I care?

Pinduoduo is a mobile first e-commerce platform. For Westerners, we take Amazon (AMZN.US) as a reference and pick up what we want and deliver it as fast as possible.

What Pinduoduo does is slightly different. It is a fun and interactive experience, where certain products are promoted to their users based on value.

source: Pinduoduo earnings Q1’22

So instead of searching for the product you want, you receive the product you may not have thought of. And more importantly, there is an element of group fun. Users go to social media such as Tencent's Weixin (WeChat) and discuss the product and form a group purchase. In such a way that a prior consensus is generated before formalizing the purchase, based on the experience of previous consumers.

For the consumer, by buying together, they end up reducing the price of their purchase massively. In essence, the central value proposition for Pinduoduo customers is its value-for-price products.

source: Pinduoduo earnings Q1’22

Also, it is surprising that the MAU (monthly active users) of Pinduoduo keep growing. They were already at more than 740 million, and when the latest quarter ended, analysts saw the start of slower growth, with Pinduoduo's MAU levels marking growths below 10% or even 15% year-on-year. That would have been seriously problematic and yet the opposite happened, with MAUs rising as much as 18% YoY.

In essence, Pinduoduo does not need to rely on discount coupons for users to stay on its platform. It can be profitable and keep having a large amount of MAU at the same time. We have already seen how other listed companies like Etsy (ETSY.US) or even Twitter (TWTR.US) grow their user base, Pinduoduo has more than 700 million users!

This is the data that supports the fundamentals, a company does not have 700 million on its platform and maintain it every month, unless it provides value to them. It is not necessary to overcomplicate what is simple.

Rapidly improving profitability profile

fsource: Pinduoduo earnings Q1’22

In his last report, he showed a graph (above) that presents it in a clear way. He has a business that in the same period last year was unprofitable with about $500 million in operating profit (non-GAAP). But this time, it has raised its profitability to approximately 580 million dollars. There is absolutely no question that the company is moving in the right direction.

Pinduoduo valuation at 20x GAAP earnings price

Pinduoduo does not provide any guidance for the coming quarters, but knowing that it has 700 million active users and having shown that it can categorically monetize its users. Anyone would think that it will stay on the road.

On a follow-up basis, Pinduoduo reported non-GAAP operating profit of approximately $2.8 billion. Now let's remember, Pinduoduo is a highly seasonal business. The first quarter is always very weak, while the fourth quarter Pinduoduo generates a lot of cash flow.

Looking to the future, if we estimate that Pinduoduo increases its final profitability by 30% per year, it would mark the objective of reaching 3,600 million operating profits (non-GAAP).

In addition, the $1 billion share repurchase projects a potential $2.6 billion profit (GAAP) over the next twelve months.

This means that, very conservatively, Pinduduo is priced today at 20x forward PER (GAAP) operating profit. This is a very fair multiple for new investors coming into the stock. Since the business is growing at a 30% CAGR.

Technical analysis

From its highs at $212.6 per share Pinduoduo has come to accumulate an 89% drop in its recent lows with the war in Ukraine and the closures in China. But since then, the behavior of the stock has broken the main structure that it has maintained precisely since its highs, a bearish channel that has lasted for the last 15 months.

source: xStation5

But recently, at the end of May, the reopening of China and an exceptional earnings report (which have also been good over the last year), have allowed the resistance of the channel to be broken and a new upward movement to be initiated. In the shorter term, the Pinduoduo share is seeking to recover the highs of the beginning of the year at 71.27 dollars per share.

Conclusion

Investing in China is always very difficult and you should position this stock in your own portfolio accordingly. Chinese stocks are always very volatile and I expect it to stay that way. There is still a lot of pessimism in this action that increasingly offers a more attractive risk-reward level.

You can see from the market reaction these past few days, that since China lifted its lockdowns, investors have returned to Chinese stocks. And why shouldn't they? After all, many of these companies have been hit to the core and are down more than 50% to 75% from their highs. Consequently, paying 20x earnings (GAAP) for Pinduoduo makes sense for upside potential. If the multiple does not compress further and the business continues to grow at a CAGR of approximately 25% to 30%, the stock could return to year-high price levels.