U.S.-listed Chinese stocks have been volatile for years as government intervention from both the U.S and China has caused immense tensions. Following progress between the two countries on resolving regulatory issues, on Dec. 28, investors finally got some solid positive news in this saga. U.S.-listed Chinese companies Pinduoduo (PDD, Financial) and Full Truck Alliance (YMM, Financial) announced that they are putting plans on hold to list on the Hong Kong stock exchange, according to a report by Reuters.
This is positive news as it signals that certain Chinese companies now don’t feel the need to “hedge their bets” by listing in Hong Kong in case they get kicked off the New York stock exchange. The fear looks to be easing in this regard. Both Pinduoduo and Full Truck Alliance popped by ~2% on the news. Alibaba stock also was up by ~2% although the company is already listed in Hong Kong and thus not directly impacted by this news.
The news comes after the Public Company Accounting Oversight Board (PCAOB) reported that it had received full access to the accounts of approximately 200 U.S.-listed Chinese companies for the first time ever. This was after over 30 PCAOB staff members traveled to Hong Kong in September to conduct site inspections on what was deemed to be more neutral territory. The team investigated two major accounting firms, KPMG Huazhen LLP in mainland China and PricewaterhouseCoopers in Hong Kong, with eight engagements between these two firms.
The PCAOB team conducted interviews and took various testimonies over a two-month period. The goal of this analysis was to perform a “through inspection and investigation” to root out “potential problems” and hold companies “accountable to fix them."
It should be noted that this inspection should not be viewed as a “clean bill of health” for U.S.-listed Chinese stocks. Final inspection reports are expected to be released someime in 2023, and a regular inspection process is expected to be implemented.
For American investors in Chinese stocks, the uncertainty isn’t over yet, but this is a step in the right direction. In light of this, let's take a closer look at Pinduoduo to see whether it could be a value opportunity at current levels; let’s dive in.
About Pinduoduo
Pinduoduo (PDD, Financial) is a Chinese e-commerce company which pioneered the concept of social or “team” commerce. The company enables customers to form “teams” in order to get bulk discounts on products from suppliers. I believe this concept is immensely innovative and I am surprised we have not seen an American company such as Amazon (AMZN, Financial) try to do something similar.
Pinduoduo also runs an e-commerce marketplace for U.S consumers, which offers imports of many unique and differentiated products directly from China.
Growing financials
Pinduoduo generated strong financial results in the third quarter of 2022. Revenue was 35.5 billion renminbi ($4.99 billion), which rose by an outstanding 65% year over year. Its online marketing services drove the majority (80%) of revenue and increased by a fantastic 58% year over year to $3.9 billion.
Its transaction services business also reported strong growth, increasing revenue by a staggering 102% year over year.
The only negative was the compay’s “Merchandise sales” declined by 31% year over year to $7.9 billion. This looks to have mainly been driven by a series of strict Covid lockdowns in China and tepid consumer demand.
In the third quarter of 2022, the company reported solid operating income of $1.47 billion, which increased by over 300% from the $332 million reported in same quarter last year.
This growth in profitability was a positive sign, given its operating expenses increased by 38% year over year to $2.48 billion. This was mainly driven by a 40% increase in sales and marketing expenses to $1.98 billion. Overall I don’t deem this to be a bad sign, as investing into sales and marketing is necessary for growth, assuming the company is obtaining a strong return on such investments.
A positive of Pinduoduo’s business model is, as its social commerce platform uses teams of customers, it has natural word of mouth virality built into it. For example, one consumer will likely call up another an ask them to join a team, so they can both get a discount. Pinduoduo has this philosophy embedded into its brand with the tagline “together, more savings, more fun." Most things are better and more fun with friends, even shopping.
The company has a robust balance sheet with cash, cash equivalents and marketable securities of $19.4 billion versus pproximately $1.6 billion in “convertible” long-term debt, which is manageable.
Advanced valuation
I have plugged the financials of Pinduoduo into my advanced discounted cash flow model. I have forecasted 40% revenue growth for next year, which is fairly conservative given prior growth rates of over 60%. In years two through five, I have forecasted just 30% revenue growth per year, as the company is growing from a larger base.
I have capitalized research and development (R&D) expenses, which has lifted the operating margin. In addition, I have forecasted the company can increase its margin by approximately 2% over the next eight years, which is fairly reasonable.
The output of the valuation model is a fair value of $274 per share. The stock is trading at ~$84 per share at the time of writing and thus is approximately 70% undervalued, which is significant.
The stock also trades at a price-sales ratio of 6.26, which is 46% cheaper than its five-year average. The GF Value chart indicates a fair value of $140 per share and rates the stock as significantly undervalued.
In the third quarter of 2022, growth stock investing firm Baillie Gifford (Trades, Portfolio) and Ray Dalio (Trades, Portfolio)'s Bridgewater bought shares of the stock, based on their 13F filings. During the third quarter, the stock traded an average price of $58 per share. This is around 40% cheaper than where the stock trades at the time of writing.
Investors should be aware that 13F reports do not provide a complete picture of a guru’s holdings. They include only a snapshot of long equity positions in U.S.-listed stocks and American depository receipts as of the quarter’s end. They do not include short positions, non-ADR international holdings or other types of securities. However, even this limited filing can provide valuable information.
Final thoughts
Pinduoduo is a fantastic company and a truly innovative player in the world of Chinese e-commerce. The recent news about its Hong Kong listing implies positive implications for its position on the New York stock exchange. In addition, the company has continued to produce strong financial results and guru investors have been buying. Based on my analysis, the stock looks undervalued intrinsically and relative to historic multiples.
