China has the second largest economy in the world and the world's largest population. The country is often seen as a place investors can get access to high growth stocks at lower valuations than the West. Of course, there are major risks for U.S. investors when it comes to investing in Chinese companies due to the political tensions between these two countries. However, the U.S. and Chinese economies continue to rely heavily on each other. Thus, in this article, let's take a look at two Chinese stocks that have been growing their revenue rapidly and appear to have further high growth potential going forward.
1. Pinduoduo
PDD Holdings (PDD, Financial), or Pinduoduo, is a Chinese e-commerce company that is truly innovative. The company’s unique selling point is its social e-commerce feature. This enables a consumer to purchase products in bulk as “teams” with friends and thus generate discounts for each other. This is immensely powerful as it generates organic word of mouth growth and engagement of the platform. In addition, the suppliers can also leverage the platform instead of traditional distribution methods in order to save money on their side. That's why over 16 million farming businesses have signed up with Pinduoduo to benefit from bulk purchases of their goods.
Although social media companies such as Meta (META) have integrated some elements of social selling such as Facebook's “Shops” feature, they haven’t created anything similar to Pinduoduo. The largest e-commerce company in the U.S., Amazon (AMZN), has also not created any similar features for its customers. Therefore, this is a testament to the truly innovative nature of Pinduoduo.
It's no surprise the platform has racked up ~900 million users and is now aggressively expanding into the West with a new platform called Temu. Temu was launched in September 2022, and has since taken the e-commerce world by storm. The app has become the number one app in the IOS App Store and has been growing its sales at a double digit growth rate.
Upon researching this platform, I discovered its website is very similar to most other e-commerce platforms. The company offers the ability to purchase goods across a variety of categories from fast fashion to electronics and home decor. Its products are interesting in that many of them you don’t realise you need until you see them. Examples of best selling items include Lenovo (HKSE:00992) ear phones, which look similar to Apple (AAPL) airpods, yet cost just $10 each. It is missing the bulk farm goods of Pinduoduo, but that's not surprising considering the U.S. is unlikely to entrust its produce distribution to a Chinese company.
The unique thing about the platform is its rock bottom prices, as the website connects buyers directly to sellers in China. This is similar to Alibaba’s (BABA) B2B website, which is for the bulk purchasing of goods. However, Temu has effectively transformed this into a B2C version. For example, a pebble styled bathroom matt costs ~$12 on Amazon but just $4 on Temu. This is a significant discount made possible by aggregating buyers and cutting out the middle men.
In addition, if the company introduces a “social selling” element, it could take the West by storm. It has already announced expansion plans into Canada and Australia, with the rest of the world to follow.
Growing financials
Pinduoduo reported solid financial results for the fourth quarter of 2022. Its revenue was $5.7 billion, which increased by ~37% year over year. This was a solid result despite technically missing analyst forecasts by over $110 million. The good news is the miss looks to have been mainly driven by foreign exchange rate headwinds.
Moving on to margins, the company reported a gross margin of 75.9% for the quarter, which is higher than its 66.24% margin reported in the year-ago quarter. Its operating margin was a solid 23.29%, which was significantly better than the 7.34% reported a year ago. Operating income was $4.4 billion, which increased by 11.23% year over year. These were solid earnings results given the company actually reported a 57% increase in its operating expenses to $3.16 billion. The only silver lining is the vast majority (81%, or $2.57 billion) of this was driven by sales and marketing expenses, which I don’t think is necessarily bad as the company expands aggressively.
Pinduoduo also has a solid balance sheet with $21.7 billion in cash, cash equivalents and marketable securities versus total debt level of ~$2.4 billion.
Valuation
Pinduoduo trades at a price-sales ratio of 5.27, which is 54% cheaper than its five-year average.
The GF Value chart indicates a fair value of $156 per share and thus the stock is “significantly undervalued” at the time of writing.
2. Contemporary Amperex Technology Co Ltd
Contemporary Amperex Technology Co Ltd (SZSE:300750, Financial), better known as CATL, is the world's largest maker of electric vehicle batteries. The company supplies approximately half (47%) of lithium-ion batteries to major electric automakers such as Tesla (TSLA, Financial), NIO (NIO, Financial), XPeng (XPEV, Financial) and more.
The electric vehicle market is forecast to be worth $457.6 billion in 2023 and grow at a rapid 17% compounded annual growth rate, according to estimates from Statista. Therefore, I expect the CATL to benefit from this industry growth trend while the automakers battle it out for market share.
This type of investment reminds me of the phrase, “when there is a gold rush, sell shovels." This refers to the fact that the majority of the speculators in the gold rush of 1848 didn’t make huge fortunes, but those selling the tools such as shovels and jeans made a killing.
The company is also continually innovating with its products and has recently developed Lithium Iron Phosphate (LFP) and Sodium Ion batteries, which offer improved performance characteristics.
Strong financials
Given CATL trades only on the Shenzhen stock exchange, the business reports its financial results only in Mandarin Chinese. I have spent some time looking through and translating its financial results to English, and the results are fantastic, with the company reporting 328 billion Chinese yuan ($48 billion) in revenue for 2022, up an incredible 152% year over year.
Its operating profit also ballooned to $5.3 billion (ÂĄ36 billion), which increased by a rapid 85.8% year over year. This was despite its operating margin actually declining from 15.2% in 2021 to 11.2% in 2022.
Its earnings per share also increased by a rapid 87.87% year over year to $1.87 (ÂĄ12.0) per share.
CATL also reported a fantastic average return on net assets of 24.67%. Moving forward, China-based analysts have forecast 31% revenue growth for the company in 2023, followed by 23% growth in 2024, which is solid and fairly conservative given prior growth rates.
Valuation
CATL trades at a price-earnings ratio of 30.5, which isn’t exactly cheap given the current market conditions. However, as this is a growth stock, a sales based valuation may be more appropriate. In this case, the stock trades at an enterprise-value-to-sales ratio of 2.65, which is cheaper than the 10.2 ratio it traded at in 2021 and the 15.5 ratio reported in 2022. Its price-sales ratio is 2.89, which is lower than historic levels. Its price-book ratio has also gotten cheaper, declining to 5.87.
Final thoughts
Both Pinduoduo and CATL are two tremendous high growth companies based in China. I believe CATL is poised to benefit from the continued growth in the EV industry, as is effectively the backbone of the EV revolution. Pinduoduo has also been executing immensely well, and the introduction of e-commerce platform Temu in the West could disrupt major players such as Amazon. Both stocks look to be trading at cheap to reasonable valuations at the time of writing given their growth prospects, but be aware both have the country risk for U.S.-based investors.
