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Pinduoduo plunged nearly 30% overnight, its biggest drop since its IPO. Lower-than-expected performance and warnings from company executives dampened market confidence, but Goldman Sachs strongly supported Pinduoduo.

Overnight, Pinduoduo released its second-quarter results, with revenue increasing 86% year-on-year, just one step away from breaking the 100 billion mark, slightly lower than market expectations; but at the same time, it achieved the sixth consecutive quarter of adjusted operating profit exceeding expectations, reaching 35 billion, a year-on-year increase of 139%.

In its latest report, Goldman Sachs gave Pinduoduo a buy rating, with a 12-month base price target of $184:

Pinduoduo's stock price has performed poorly this year, with a current price-to-earnings ratio of less than 10 times, which has reflected investors' concerns about intensified domestic competition and Temu's geopolitical situation.

Meanwhile, Pinduoduo's faster GMV growth and better-than-expected transaction service revenue mean that Temu's growth momentum continues. Pinduoduo remains one of the fastest-growing Chinese Internet companies in the second quarter so far, and its strategy/investment will drive future growth.

We have a Buy rating on Pinduoduo based on its ad tech capabilities (ROI-based marketing tool) and cost-competitive suppliers/merchants/supply chain in China, plus a favorable risk-reward profile, with a 12-month base price target of $184, 84% upside from current market cap, which does not include a valuation for Temu.

Regarding the overnight plunge, Goldman Sachs believes that this sharp negative reaction may be due to three aspects:

1. Investor expectations were high before the earnings report was released. As the market expected strong results, Pingduoduo's stock price has risen by about 20% since the end of July, while the KWEB (KraneShares China Overseas Internet ETF) index has fallen by 4% during the same period;

2. Online marketing service growth showed signs of normalization for the first time, with year-on-year growth slowing to 29%, which was lower than market expectations. However, we believe that Pinduoduo's performance is still significantly better than Alibaba's 1% growth in customer management revenue and the median growth of Kuaishou's e-commerce advertising.

3. Management's comments scared the market. Pinduoduo's management pointed out in a conference call that due to intensified competition/and possible decline in long-term profitability to promote high-quality development, future revenue growth is expected to slow down and sacrifice short-term profits; Pinduoduo plans to spend 10 billion yuan in the next 12 months to support high-quality merchants; as the overall market is still in the investment stage, Pinduoduo will not repurchase or distribute dividends in the next few years.

In addition, Goldman Sachs pointed out that Pinduoduo's performance highlights also include Temu's strong GMV reaching US$11 billion, and transaction commission income increased by 234% year-on-year. Due to the reduction of subsidy levels in mature markets (such as the United States) and strict control of procurement prices, profit margins have improved quarter by quarter. Adjusted EBIT (earnings before interest and taxes) also exceeded expectations, which may be attributed to the improvement of domestic profitability and Temu unit profitability.

However, Goldman Sachs also issued a downward warning on stock prices:

(1) Online marketing revenues may be lower than expected due to lower e-commerce ROI/increased sales-based advertising inventory and narrowing GMV growth gap with the industry; (2) Geopolitical headwinds may be greater than expected when entering Europe and other developed markets with strong spending power; (3) Competition may be more intense than expected if Alibaba's new low-priced advertising initiatives are successful and Douyin's shelf-based low-priced merchandise expands faster than expected; (4) Reinvestment to maintain growth may pose a downside risk to core profit margins; and (5) The lack of segmental disclosure on business performance and profitability may make it difficult to analyze/estimate domestic and international (Temu) performance and profitability.