PDD Holdings stock is down now, but could 10x

PDDhis (PDD 2.33%) the stock closed at a record high of $202.82 on February 17, 2021. This represented a 10-plus gain from its IPO price of $19 on July 26, 2018. Bulls were impressed by the explosive growth rates of the Chinese leader of e-commerce and the temporary buying frenzy of hyper-growth stocks boosted its gains.

But today, PDD is trading around $95. It lost more than half its value as its growth cooled and rising rates compressed its valuations. Rising tensions between the US and China have also steered many US investors away from Chinese stocks. However, I think PDD still has a chance to deliver another 10-sack win in the next decade.

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How PDD differs from Alibaba and JD

PDD was founded only nine years ago, but has rapidly expanded to become the third largest e-commerce company in China after Alibaba (GRANDMA -1.29%) and JD.com (JD 0.23%). The initial plane of PDD growth was driven by China’s lower-income buyers in its lower-tier cities. It generally sold products cheaper than Alibaba and JD and encouraged its shoppers to team up on social media to get deep discounts.

PDD later launched a farm-to-table platform that allowed farmers in China to sell their fresh produce directly to consumers at lower prices. This strategy has disrupted traditional retailers and turned PDD into the largest online agricultural platform in China. Alibaba and JD only operate traditional brick and mortar supermarkets.

In 2022, PDD expanded overseas with Temu, a cross-border marketplace that connected its Chinese merchants with overseas buyers. It is now one of the most popular e-commerce apps in the world, with over 167 million monthly active users (MAUs) worldwide, and 50 million of those MAUs are in the United States. Alibaba operates a similar cross-border marketplace called AliExpress, but JD’s cross-border marketplace only connects overseas sellers and Chinese buyers.

PDD initially sold its products through primary and third-party channels such as JD. But in 2021, it phased out its lower-margin primary market and expanded its higher-margin third-party market. This makes it more similar to Alibaba, which only operates third-party marketplaces in China and other countries.

Ultimately, China’s antitrust regulators haven’t pilloried PDD in the same way they cracked down on Alibaba. Instead, PDD likely benefited from those tighter restrictions against Alibaba — which include a ban on its exclusive deals with merchants, closer scrutiny of its algorithm-based promotions and tougher restrictions on its future investments.

Why did the bulls withdraw from PDD?

From 2018 to 2023, PDD revenue grew at a compound annual growth rate (CAGR) of 80%. It also became profitable in 2021 after shutting down its own market, and its net income grew at a CAGR of 178% from 2021 to 2023.

These growth rates have made China the fastest growing e-commerce leader. Alibaba’s revenue only grew at a 20% CAGR from fiscal 2019 to fiscal 2024, which ended in March. JD’s revenue grew at a CAGR of 19% from 2018 to 2023.

PDD’s growth rates have been explosive, but some cautious comments during its second-quarter conference call on Aug. 27 weighed on its stock. CEO Lei Chen said PDD “sees many new challenges ahead, from changing consumer demand, intensifying competition and uncertainties in the global environment.” To counter these challenges, Chen warned that PDD would need to “enter a new phase of high-quality development” with “increased investment” that would erode its profits.

This warning rattled the bulls, but many other e-commerce expansion leaders, including Amazon (AMZN -0.86%) and MercadoLibre (MELI -0.79%) — issued similar warnings before as they expanded their businesses. However, those companies continued to flourish once their investments flourished and their profits increased again.

PDD seems undervalued relative to its growth potential

For now, analysts still expect PDD’s revenue to grow at a CAGR of 36% from 2023 to 2026 as EPS grows at a CAGR of 39%. We should take these estimates with a grain of salt, but they’re excellent for a stock that trades at just 7 times next year’s earnings. Alibaba and JD trade at 14 and 8 times forward earnings, respectively.

Assuming PDD meets these expectations, grows its EPS at a slightly slower CAGR of 20% through 2034, and trades at a higher but still reasonable multiple of 20, its share price would rise nearly tenfold to around 930 USD until the last year.

But to reach that target, PDD should widen its moat against Alibaba and JD in China, continue to expand Temu overseas and start new growth engines. US-China tensions should also ease before most investors pay higher valuations for Chinese stocks again. In other words, PDD could remain out of favor as it faces near-term macro and competitive headwinds. But in the long term, I think it’s still a potential multibagger growth stock.