A recession and global pandemic were terrible for the world in 2020; however, it was also probably an ideal scenario for both discount retailers and e-commerce companies. So when you fuse both of those elements together in a single business model, and mix it with one of the highest-growth countries in the world, you'll probably get impressive returns.
That's exactly what happened this year to Chinese e-commerce upstart Pinduoduo (PDD -0.37%), which has nearly quadrupled through Dec. 18.
PDD Year to Date Total Returns (Daily) data by YCharts
Pinduoduo, founded only five years ago, has already racked up an incredible 731 million active buyers. Chinese consumers have flocked to its innovative discount model, whereby consumers can join groups buy to products in bulk and thereby receive big discounts.
With its current eye-popping growth, there's reason to think Pinduoduo's stock could continue climbing into the future. Nevertheless, with an expensive valuation and a bold new initiative that will likely require a lot of spending, a big drawdown could be in the cards as well. Here's how investors should be playing Pinduoduo in 2021.
Image source: Getty Images.
Pinduoduo's accelerating growth
First, it's important to understand Pindudoduo's type of e-commerce business model. It's mostly third-party, meaning that Pinduoduo doesn't actually take possession of inventory or delivery. Additionally, Pinduoduo makes very little revenue from transaction fees, or the cut of the sale between buyer and consumer. Instead, Pinduoduo makes over 90% of its revenue from online marketing services it offers to its merchants. In other words, high-margin digital advertising.
While Pinduoduo has traditionally racked up big losses as it invests heavily in growth, its gross margin last quarter was actually 77%, a high, software-like gross margin. That should give investors confidence that once the company reaches scale, it could be a very profitable business. In fact, last quarter, Pinduoduo was actually profitable on an adjusted (non-GAAP) basis for the first time.
However, in 2021, Pinduoduo is looking to accelerate a large and complex new initiative in agriculture, so that could -- emphasis on the word could -- send adjusted profits back into the red.
Duo Duo Maicai
Last quarter, Pinduoduo launched Duo Duo Maicai, its new platform that aims to revolutionize the sale of agricultural products in China.
The move is a bold one, as Pinduoduo aims to be the first mover in digitizing China's agriculture industry. It's also likely a smart move. Pinduoduo is a late-entrant as the third large e-commerce player in China behind early movers Alibaba (BABA 2.92%) and JD.com (JD 2.61%). Alibaba is quite strong in a diverse array of basic goods and apparel, while JD has its roots in more high-end goods like electronics and appliances. However, if Pinduoduo capitalizes on the agricultural opportunity, it could open up a large market for the company. That will likely be necessary to justify Pinduoduo's $185 billion market cap.
During Covid, Pinduoduo's fresh food sales surged. While the company found it was able to transport certain goods like apples and potatoes through existing logistics infrastructure, that infrastructure wasn't sufficient to support more perishable foods like leafy vegetables.
Therefore, Pinduoduo is embarking on a new initiative to build out the infrastructure to support more perishable items, sourcing goods from local vendors and shortening delivery schedules. When asked on the conference call with analysts whether that would require Pinduoduo to spend more on its own infrastructure, management noted that it is working with its third-party partners to develop this ecosystem but would also probably build out some of its own infrastructure if it thought it was the appropriate thing to do.
What this means looking ahead to 2021
It looks like Pinduoduo is comfortable learning as it goes in this new field. If the buildout of this platform is capital-intensive, it could send Pinduoduo's spending higher and profits back down into the loss category. After reporting its first-ever quarter of adjusted net income, Pinduoduo's stock shot up to recent highs. Therefore, if profit margins decline on the Duo Duo Macai rollout, it could lead to a sell-off, especially after Pinduoduo's massive run this year and lofty 26 times price-to-sales-ratio.
Yet even if losses mount, should top-line growth remain high enough, the stock could just as easily head higher. Management predicted it would sell RMB250 billion of agricultural products this year, almost double the figure from last year, and above the company's current 73% GMV growth. Much of China's economy has already been digitized, but agriculture is one of the last to do so. Therefore, the opportunity could be large.
All in all, I tend to agree with VP of Strategy David Liu's description of the agricultural efforts: "They are not the easiest, but they certainly are the right things to do. We believe that our hard work will pay off in the long run."
As such, I still think Pinduoduo is headed higher over the long run, but may be subject to some volatility next year. For those investors (like me!) who missed out on buying the dips this year, you should monitor what happens with Pinduoduo's stock. Any big drawdowns could be good opportunities to pick up shares of this hypergrowth stock at the beginning of an exciting new chapter.
