Profits Soar At Pinduoduo As Shoppers Chase Online Bargains

Key Takeaways:

• Pinduoduo beat market expectations by boosting revenue and profit in the third quarter, powering a surge in its share price
• The company’s overseas expansion, although in its early stages, has made a positive impression on investors

By Lau Ming

With consumer confidence shaken by Covid and economic worries, even some of China’s biggest e-commerce firms have struggled to attract more business in recent months. That is, except for Pinduoduo Inc. PDD, a thriving online marketplace for affordable goods and farm produce.

Price-conscious consumers with limited budgets have been hunting for bargains on the Pinduoduo platform, helping the company to post bumper quarterly earnings despite the challenging environment, and putting its better known rivals in the shade.

The third-quarter earnings beat market expectations, triggering a multi-day share price rally, as investors realized that economic uncertainty could be sending more online shoppers towards Pinduoduo’s marketplace – a trend known in the retail industry as “consumption downgrade”.

Responding to the shifting retail dynamics, the company has been working closely with merchants to offer a greater volume and variety of affordable branded products, providing more choices for consumers with tight finances.

In addition, the company invested in upgrading its technology to better align its products with consumer demand, which encouraged merchants to step up their online promotions. This set off a virtuous cycle in which the platform offers more brands, spurring more demand and so on. The company has clearly reaped the rewards in its latest earnings report.

The third-quarter report released last Monday showed revenue jumped 65% year on year to 35.5 billion yuan ($5.1 billion), a record high despite the challenging market. The revenues came in well above market expectations of 30.7 billion yuan and outpaced growth of just 3% and 11% at e-commerce giants Alibaba BABA and JD.com JD in the same period.

Pinduoduo’s platform offers a range of competitively priced items including consumer goods, beauty products and agricultural produce. By business, Pinduoduo’s revenue from transaction services stood out, jumping 102% to 7 billion yuan during the period, mainly due to increased merchant activity. Marketing revenues from providing platform services to merchants also maintained high growth, rising 58% from the year-earlier quarter to 28.4 billion yuan.

Promoting agricultural produce

Pinduoduo started out as an online marketplace for fresh farm produce and is keenly aware of the vast scale of the agricultural market, as well as the many challenges in production, logistics and sales. Therefore, it is important for Pinduoduo to help farmers and other suppliers achieve a digital transformation to fully reap the benefits of the agricultural trade.

Last August, the company launched a campaign to promote agricultural technology, which it dubbed the “10 billion yuan agricultural initiatives”. It spent 1 billion yuan this September on hosting live events in a nationwide harvest festival, aiming to provide a live-streaming platform specifically for farm produce. It has since continued to nurture e-commerce partnerships to promote agricultural products across the country, succeeding in boosting consumption of the targeted goods.

But the company’s agri-tech campaign has not come cheap. R&D expenses rose 11% to 2.69 billion yuan in the third quarter from the year-earlier period. The rising R&D spending outpaced a 1% increase at Alibaba and a 2.5% jump at JD. However, Pinduoduo’s managers said they would continue to ramp up R&D investment to drive innovation and harness technology to create long-term value.

Meanwhile, Pinduoduo’s total operating expenses also jumped 38% year on year to 17.65 billion yuan in the third quarter. But thanks to the revenue boost, plus incidental factors such as delayed investment in individual projects, the ratio of expenses to total revenue still dropped to 49.7% from 59.6% in the same period last year. As the scale effect also kicked in, the company’s net profit surged 546% to 10.59 billion yuan, marking a sixth straight quarter of profits. The company has thus broken out of a previous vicious cycle of big losses to generate fast growth.

Investors are clearly happy about its performance. On the day of the earnings report, Pinduoduo’s shares rallied 12.6% and kept climbing over the next five trading days, ending at a one-year high of $87.80 on Monday, a 33.5% jump since the figures came out.

However, Pinduoduo’s managers sounded a note of caution in the earnings call, warning that such a strong profit surge would be hard to sustain over the longer term. Delays and deferred investment on projects, including agriculture-related initiatives, had inflated profit levels in the third quarter, they said. Still, the company aims to keep promoting agricultural technology and supply-side upgrades to help maintain fast growth in revenues.

JP Morgan believes that Pinduoduo has made a breakthrough in consumer and brand awareness that will provide benefits for the next two to three quarters, even as average revenue per user (ARPU) remains low. In addition, Pinduoduo stands to gain from the trend of “consumption downgrade” in the coming quarters as economic weakness in the wake of the Covid pandemic enhances the appeal of its low-priced products..

Overseas expansion off to a good start

Pinduoduo has taken its low-price formula overseas, launching a cross-border e-commerce platform for the U.S. market providing small goods such as key chains and storage boxes priced at less than $1. A month after its launch, the Temu platform became one of the top 10 U.S. iPhone and Android e-commerce Apps by download rankings, catching the attention of the market.

Temu’s app downloads in the U.S. market reached 5.49 million as of Nov. 26, according to figures cited in research from investment bank CICC. The bank tipped Temu as a potential dark-horse success in the North American market, as inflation fuels rising demand for affordable products. The company can leverage its access to China’s efficient supply chain and benefit from falling costs of cross-border logistics and overseas marketing, CICC said.

Pinduoduo’s economic resilience and the growth potential for its agricultural business are reflected in its valuation numbers. According to Bloomberg brokerage forecasts, the forward price-to-earnings (P/E) ratios of e-commerce giants Alibaba, JD.com and Vipshop Holdings Ltd. VIPS are 11.9 times, 24.5 times and 8.7 times respectively, all below Pinduoduo’s 27.9 times.

The outlook for investment returns is bright, according to Citi. The bank sees upside potential for the stock given Pinduoduo’s better than expected profit performance for several quarters, coupled with its potential success in international markets, which could translate into handsome returns for risk-tolerant investors. Therefore, Citi has maintained a buy rating on Pinduoduo and lifted its price target by 40% to $111 from $79, making it one of the bank’s top investment picks for the first half of next year.