Pinduoduo (PDD -4.39%) was once a red-hot growth stock. The Chinese e-commerce company went public at $19 per American depository share (ADS) in 2018, and its stock eventually hit an all-time high of $202.82 last February.
But Pinduoduo's stock today trades at about $40. China's crackdown on its top tech companies, including Pinduoduo's larger rival Alibaba (BABA -3.54%), curbed the market's enthusiasm for Chinese tech stocks. Its growth also decelerated as it faced a post-lockdown slowdown, competitive pressure, and tougher macroeconomic headwinds in China. To make matters worse, rising interest rates sparked a broad rotation from growth to value stocks.
That sell-off was brutal, but Pinduoduo now looks more like a value play at 19 times forward earnings and three times this year's sales. Four new green flags could also bring the bulls back to this beaten-down stock soon.
1. It's turning profitable
The bears once claimed Pinduoduo would never turn a profit because it relied too heavily on low-margin group purchases of cheap products.
But in 2021, it posted an operating profit of 6.9 billion yuan ($1.1 billion), compared to an operating loss of 9.4 billion yuan in 2020. It also posted a net profit of 7.8 billion yuan ($1.2 billion), compared to a net loss of 7.2 billion yuan a year earlier. It attributed those massive bottom-line improvements to tighter cost controls, which boosted its operating margins even as its gross margin dropped from 67.6% in 2020 to 62.9% in 2021.
In 2022, analysts expect Pinduoduo's operating margin to expand from 12.4% in 2021 to 15.2% and for its net income to surge by 57%. That rosy outlook indicates that economies of scale are finally kicking in for its massive marketplace of 868.7 million annual active buyers.
2. It's almost fulfilled its 10 billion yuan pledge
Last year the Chinese government launched a "common prosperity" drive that strongly encouraged companies to fund state-backed projects to reduce income inequality and improve the country's rural infrastructure.
In the second quarter of 2021, Pinduoduo launched a 10 billion yuan ($1.6 billion) agricultural initiative to support those plans. It pledged to allocate all of its near-term profits -- up to a cumulative total of 10 billion yuan -- to fund the modernization and expansion of China's agricultural sector.
That plan initially rattled investors, since it would throttle the company's cash flows and limit its ability to invest in new projects. However, investing in China's agricultural sector should also make it easier for Pinduoduo to expand its own agricultural business -- which delivers "farm to table" produce directly from farmers to consumers -- over the long term.
Pinduoduo's rising profits indicate it will likely fulfill its ambitious pledge in the first half of 2022. Crossing that threshold should allay concerns about its big commitment and free up more cash for its future initiatives.
3. China's zero-COVID policy
China recently locked down several major cities, including Shanghai, in response to a resurgence in COVID-19 cases across the country. Unlike many other countries, China enforces a "zero-COVID" policy that requires strict lockdowns and mass testing until an outbreak ends.
Those draconian measures have sparked food shortages across several cities and caused shoppers to rely more heavily on online grocery delivery platforms like Pinduoduo, Alibaba's Ele.me, and Meituan. All those platforms are now reportedly operating at full capacity and struggling to meet the skyrocketing demand for fresh produce and other foods.
As the largest online marketplace for agricultural products in China, Pinduoduo will likely be a major beneficiary of these new lockdowns. These tailwinds will be temporary, but the crisis could enable Pinduoduo to lock in more consumers and permanently alter their shopping habits.
4. A possible compromise between the U.S. and China
Lastly, another major headwind for Pinduoduo has been a threat by the U.S. Securities and Exchange Commission (SEC) to delist shares of Chinese companies that didn't fully open their books to American auditors for three consecutive years. Those rules went into effect in late 2020.
But earlier this month, the China Securities Regulatory Commission (CSRC) started to draft new guidelines to prevent its stocks from being delisted. Those new rules haven't been finalized yet, but they'll likely enable most Chinese companies to fully comply with the SEC's tighter auditing rules. Once that happens, investors might be willing to pay a much higher premium for Pinduoduo's stock again.
Is Pinduoduo's stock worth buying?
Analysts expect Pinduoduo's revenue and earnings to grow 18% and 20%, respectively, this year. That represents a significant deceleration from its 58% revenue growth in 2021, but its expanding operating margins and rising profits indicate its long-term growth is sustainable. It should also remain China's third-largest e-commerce player after Alibaba and JD.com (JD -5.41%) for the foreseeable future.
I'm still not bullish on Chinese stocks, but I think Pinduoduo could be worth buying again once all the regulatory headwinds fade away.