PDD Holdings(NASDAQ: PDD) has been the best-performing Chinese tech company in the last 12 months -- until lately. Despite reporting solid quarterly earnings, stock in Pinduoduo's parent company plunged by more than 30% as investors sold it amid the company's pessimistic guidance on its prospects.
Still, contrarian investors and PDD Holdings bulls are taking this sell-off to buy the stock on the cheap. But before they rush into loading up on the stock, investors should consider these two headwinds the e-commerce company faces.
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1. Temu's success is not a sure thing yet
Pinduoduo, an up-and-coming e-commerce platform in China, has shocked its competitors after growing at breathtaking speed to become one of China's top three e-commerce players. Armed with its strategy of selling products at rock-bottom prices, the e-commerce platform built a vast business that reached hundreds of millions of consumers in China.
Just when everyone thought that the company had almost reached its ceiling on growth, PDD Holdings surprised investors again after launching its cross-border e-commerce platform Temu two years ago to serve overseas consumers. Like its sister company, Temu has been growing so fast that investors have begun to have rosy expectations of this business, such as challenging Amazon's dominance.
Investor's high expectation of Temu is not without reason. The cross-border e-commerce market size is huge (estimated at $785 billion ) and growing. With its experience serving consumers in China and its massive supply chain resources, PDD Holdings is well positioned to become a substantial player in this industry.
Still, while the prospects look rosy, there are huge hurdles that Temu must overcome to build a legitimate cross-border e-commerce business, let alone challenge Amazon. Issues like low-quality products, slow delivery, a poor reputation, and regulatory and trade barriers are just a few examples of the issues that Temu must solve in the coming years. It will take plenty of financial resources, world-class execution, and a lot of patience and time to build a meaningful, sustainable business.
Besides, since retail is generally a local business, Temu must recruit local merchants and diversify its product sourcing in the long run rather than relying on its Chinese suppliers. Doing so will help it further enhance product selection, reduce delivery time, and, at the same time, improve user experience, since local sellers have a better understanding of consumers and can respond faster to consumers' needs.
Needless to say, there are plenty of risks and uncertainties as Temu tries to build a lasting business in foreign territories. Unless it can live up to its mission of providing quality goods at attractive prices, Temu could end up like its predecessor, Wish.
2. PDD Holdings will likely face more challenges in growing its core business in China
Temu might have generated a lot of excitement, but investors should remember that PDD Holdings makes almost all its profits (and the majority of its revenue) from its Chinese business. So this local business must continue growing and thriving to create long-term shareholder value.
Unfortunately, PDD Holdings is increasingly facing headwinds in its efforts to grow its Chinese business. One factor is that the Chinese e-commerce industry is increasingly competitive as major players like Alibaba and JD.com aim to either sustain or grow their businesses. So while PDD Holdings has been quite successful historically with its innovative strategies like low prices, fun shopping experiences, and intelligent marketing tactics – such as its 10 billion yuan subsidies program -- incumbents have been copying and implementing them.
For instance, Alibaba has been focusing on gaining customer mindshare with low prices and better services. This partially explains the giant's improving gross merchandise value (GMV) growth rate in the latest quarter -- online orders grew by double digits, and GMV increased by high single digits.
Internally, PDD Holdings has captured most of the low-hanging fruit by growing its user base, adding new product categories, and providing subsidies to encourage customer purchases. Thus, future growth must come from enhancing user engagement and increasing user wallet share. Better services, better product recommendations and matching services, and more efficient supply chain management are some areas of improvement.
To this end, PDD Holdings has committed to the development of its ecosystem, supporting high-quality merchants to continuously provide an ever-growing supply of high-quality goods at attractive prices to consumers. For example, the tech company has committed to spending 10 billion yuan to subsidize merchants through lower fees.
In other words, while there is still room for PDD Holdings to grow in China, future growth is unlikely to be as easy to come by. Keeping the growth machine spinning will require enormous effort, significant investment, and plenty of patience.
Therefore, investors will need to recalibrate their expectations.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Lawrence Nga has positions in Alibaba Group and PDD Holdings. The Motley Fool has positions in and recommends Amazon and JD.com. The Motley Fool recommends Alibaba Group. The Motley Fool has a disclosure policy.
