PDD’s $55 billion stockpile collapse sends a warning to the Chinese economy

(Bloomberg) — One of the last remaining bright spots for Chinese consumption is fading fast as the nation’s economic malaise hurts demand for even the most affordable goods.

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In the latest warning to global markets about the health of the Chinese economy, Temu owner PDD Holdings Inc. surprised investors Monday with an unusually bleak outlook. The e-commerce firm, which has become a go-to market for low-priced goods that have helped propel sales and profits during China’s economic downturn, also reported revenue that missed estimates. During a post-earnings briefing, CEO Chen Lei mentioned at least eight times that revenue and profits must “inevitably” fall as economic growth slows.

“We have many new challenges ahead, from changing consumer demand, intensifying competition and uncertainties in the global environment,” Chen, also one of PDD’s first hires, told analysts.

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The CEO and his lieutenants were careful to emphasize that they remained confident in long-term Chinese consumption — a high priority for Beijing in rebalancing the No. 1 economy. 2 in the world. But the damage was done. PDD shares fell 29% in their biggest drop on record, wiping $55 billion off their market value. Its closest rivals Alibaba Group Holding Ltd. and JD.com Inc. followed suit, falling about 5% in Hong Kong.

PDD’s warning stunned investors as the company has long been seen as the main beneficiary of a Chinese “consumer downgrade” – its strategy of low prices for Pinduoduo domestically and Temu abroad was intended to attract cost-conscious buyers in a moment of unprecedented economic volatility.

The disappointing results were the latest in a series of red flags about the Chinese economy. This week, popular fast-food chain Din Tai Fung – long one of the most popular restaurant brands across the country – revealed it was closing more than a dozen stores. Last month, Starbucks Corp. revealed a 14% decline in China revenue in the June quarter.

“The big issue is consumer weakness in China,” said Joshua Crabb, head of Asia Pacific equities at Robeco Hong Kong Ltd. “Competition and a weak consumer will definitely be negative.”

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While Starbucks and Din Tai Fung have long struggled with volatile sentiment, PDD’s warnings were particularly surprising given that they encapsulated years of cash-strapped Chinese consumers rejecting luxury brands for alternatives inferior quality.

Founded by former Google engineer Colin Huang in 2014, the company has in recent years combined low prices with aggressive rural expansion and game-like elements on its platform to gain market share from Alibaba and JD. He used this formula in the global e-commerce bargain app Temu, which he launched during the 2023 Super Bowl. That app became a Shein-like shopping phenomenon, for a time becoming one of the most downloaded US applications.

That led to a remarkable six-fold gain in market value post-Covid 2022, crowning Huang China’s richest person this month. But he only held the mantle for 18 days, until Monday’s sale.

China’s less affluent consumers outside the glittering megacities have driven much of PDD’s success. Now they are a great source of uncertainty.

Consumption, the main driver of the economy, has weakened this year after a rebound in post-Covid spending last year. Amid widespread job and wage cuts, as well as falling property prices, Chinese consumers have become more cautious about spending, leading to intense price wars in sectors such as cars.

Retail sales expanded just over 3% in the first seven months of 2024, much worse than the more than 8% growth seen in the pre-pandemic period. Residents’ confidence in future incomes fell to their worst level since the end of 2022, one of the most intense periods of lockdown due to Covid-19, according to a central bank survey in the second quarter.

Nearly half of residents surveyed said employment is “bleak and difficult,” the highest proportion since the end of 2022. Nearly two-thirds of those surveyed said they are willing to save more, nearing an all-time high last year.

Lei signaled that there has been a fundamental shift in consumer behavior, a shift away from the bargain products that have generated turbo revenue since its inception.

“Consumers are making more careful decisions to balance quality and value,” he said on the earnings call. “In response, we’ve partnered with high-quality brands and manufacturers to create custom products that meet these diverse demands.”

For some investors, PDD executives were just trying to limit their wild expectations. After all, it might be unreasonable to expect the company to keep posting 50%-plus growth, as it has in all but a quarter of the record. Wall Street was betting on PDD to nearly double revenue in the June quarter. Instead, it increased by 86%. On Monday, executives said they would make big investments to capitalize on future opportunities.

The PDD result “implies poor consumption and intense competition. However, management’s comments on declining long-term profitability are too conservative in our view,” wrote Morgan Stanley analysts Eddy Wang and Kathy Zhu.

What Bloomberg Intelligence says

PDD’s Aug. 26 indication of lower profitability as the company ramps up spending to meet increased global competition suggests a decline in 2H earnings consensus, which projected higher margins in 2025. This, along with PDD’s first revenue miss in 10 quarters for the three months ended. June, appears to dampen growth prospects for the next 12 months.

• Catherine Lim and Trini Tan, analysts

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In the long term, much depends on the labor market and how Beijing runs the economy.

Authorities have tried to ensure there are enough jobs even as the economy has slowed by asking state-owned enterprises to expand recruitment and training.

But officials have not offered more direct aid to consumers, although many economists have called for a cash subsidy or consumer voucher at least for low-income groups. They have also refrained from taking steps to support wage growth, which is essential to encourage more spending. Regulatory crackdowns in several industries, from private tutoring to finance, in recent years have also worsened the job market.

For now, many investors are still counting on PDD to at least outshine its peers in a turbulent economy.

“We believe PDD is the only Chinese e-commerce player to outperform industry growth,” Morgan Stanley analysts wrote.

–With assistance from Yujing Liu, Catherine Ngai and Dong Lyu.

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