Wanted to share my due diligence on a stock that is in my portfolio, PinDuoDuo Holdings. I caught a hold of this stock when I was researching BABA, and found out that PDD was not only profitable but was growing 50% + YOY and was also profitable. This got me deep-diving into the stock. I started accumulating after it rebounded at the bottom around $65 and recently added more to the position given the recent correction.
Business Operations
PDD is an E-commerce business located in China. Their main competitors consist of major players as such Alibaba & Jd.com but have been snatching a tremendous amount of market share. There are a few key reasons why PDD has been striving so well.
- With the current recession in China, everybody has been trying to save more and spend less and PDD does exactly just that. They gamify the buying experience for the users, encouraging families and friends to join in on a “group-buy” to get it for a cheaper price. The reason they are able to charge at such competitive prices is they handle directly with the supplier/manufacturer to deliver the goods and attain special prices. PDD handles every single process of the logistics, cutting out unnecessary middlemen. Alibaba also does this with their “Cainiao” logistics company but I think it is less integrated than PDD’s process. This is very clear from the gross margin difference of around 60-75% compared to Alibaba’s 35-40% and also a much higher return on invested capital at 25% and compared to 10%.
- They focus heavily on their agriculture program. Farmers do not have the best connections/resources, therefore they usually make very thin margins. With PDD they directly engage with the farmers to cut out any unnecessary middleman. They spent 10 billion RMB to create an agriculture program to help address some of the agricultural needs in the country. Once new farmers hit the market, they can receive digital training to become a seller on the platform. This would be a further tailwind for growth in the future. As far as I know, PDD is the only player in the market with this initiative.
Valuation (PDD)
PDD is extremely cheap for a company that is growing this fast. In Q32023 PDD generated RMB 68.840 Billion with a net income of RMB 15.537 Billion. The same time the previous year they generated RMB 35.504 Billion with a net income of RMB 10.589. That is a revenue growth of 94% & earnings growth of 46%! Best part is that they barely dilute the stock which means shareholders retain nearly all of those earnings.
Here's my DCF Assumption:
FCF Growth Year 1 to 3: 30% CAGR, Year 4 to 6: 22% CAGR, Year 7-10: 18% CAGR
Outstanding Shares(Projected): 1,631,000,000
Discount Rate: 16%
Intrinsic Value: $132.64/Share
Now you might say that the discount to the current share price today ($110) does not feel like it gives enough of a margin of safety, however do keep note that I am heavily sandbagging the future growth of this company(they are expected to grow 80% next year) and this already with an extreme discount rate. If you would apply an industry standard of 10% discount rate the intrinsic value of the stock would be $289/Share! Of course, there is a reason why I heavily sandbagged the stock which I will explain in the next section.
Risks of Chinese Equities
With the recession happening in China, everything including stocks, and properties have been on a fire sale and getting cheaper for the past 2 years. Even though the fundamentals of the stock are good it can get cheaper for no good reason. Look at JD, it is trading below book value even though cashflow growth is still there, yielding an insane 25% free cash flow. Now investing in PDD might still be viable because despite the recession, it is still growing very fast and is very profitable, so it is somewhat negated this side of the risk slightly.
Another risk that I have to mention is the VIE structure. When you invest in PDD, you technically do not own shares of the company. You own an entity with a holding company that has made a contract for PDD to distribute profits to that holding company you do not technically own shares of the company. The reason for the is because of the restrictions the CCP has imposed on foreign investments so this is a loophole for international investors. The only reason why PDD is still operating this way is because the CCP closes an eye on these VIE entities. At any moment they could implement a new regulation and completely render the shares worthless.
Even with the risks I have mentioned, the tech crackdown had already been over for 2 years and the CCP has been inviting people to invest again in China, therefore the risk of the VIE structure falling apart is quite low IMHO.
Other things to take note off
– 36.8% Institutional Ownership
– 33.6% Insider Ownership (That’s good)
– 29% Return on Invested Capital TTM
– Net Debt is zero
Conclusion
Even though the geopolitical risks are there, I think the prospect of the business can continue to thrive even in a recession. With strong growth and profitability, my hope is that PDD can continue to gain market share from its competitors and become a trillion dollar stock in the future. Cheers.
