PDD’s $55 billion stock crash sends warning on Chinese economy

(Bloomberg) — One of the last remaining bright spots in Chinese consumption is fading fast, as the country’s economic malaise saps demand for even the most accessible goods.

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In the latest warning to global markets about the health of China’s economy, Temu owner PDD Holdings (PDD) Inc. surprised investors on Monday with an unusually bleak outlook. The e-commerce company, which has become a market darling for its low-priced goods that helped drive sales and profits during China’s economic downturn, reported revenue below estimates. During a post-earnings briefing, Chief Executive Chen Lei mentioned at least eight times that revenue and profits would “inevitably” decline as economic growth slows.

“We are facing many new challenges ahead, from changing consumer demand, intensifying competition, and uncertainties in the global environment,” Chen, who is also a longtime employee at BDD, told analysts.

The chief executive and his aides were keen to stress their confidence in Chinese consumption over the longer term — a top priority for Beijing as it rebalances the world’s second-largest economy. But the damage was done. PDD shares plunged 29% in their biggest drop on record, wiping $55 billion off their market value. Closer rivals Alibaba Group Holding Ltd. and JD.com Inc. (JD, 9618.HK) followed suit, falling about 5% in Hong Kong.

PDD’s warning surprised investors because the company has long been seen as a major beneficiary of China’s “consumer downgrade” — its strategy of lowering Pinduoduo’s pricing domestically and Temu’s overseas was aimed at attracting cost-conscious shoppers at a time of unprecedented economic volatility.

The disappointing results were the latest in a series of red flags around the Chinese economy. This week, popular fast-food chain Din Tai Fung — long one of the country’s most popular restaurant brands — revealed it was closing more than a dozen outlets. Last month, Starbucks (SBUX) reported a 14% drop in Chinese revenue in the quarter ended in June.

“The big issue is consumer weakness in China,” said Joshua Crabb, head of Asia Pacific equities at Robeco Hong Kong Ltd. “The comparison between competition and consumer weakness is certainly negative.”

While Starbucks and Din Tai Fung have long struggled with volatile sentiment, Din Tai Fung’s warnings were particularly surprising given that it has for years embodied how cash-strapped Chinese consumers have rejected luxury brands in favor of less expensive alternatives.

Founded by former Google engineer Colin Huang in 2014, the company has in recent years combined low prices, aggressive rural expansion and game-like elements on its platform to grab market share from Alibaba and JD. It has leveraged that formula with its global e-commerce deals app Teemo, which it launched during the Super Bowl in 2023. The app has become a shopping phenomenon akin to Shein’s, and for a time was one of the most downloaded apps in the United States.

That has sent the market’s value soaring six-fold from its post-Covid lows in 2022, making Huang China’s richest person this month. But he held the position for just 18 days, until Monday’s selloff.

China’s less affluent consumers outside of the flashy megacities were the main driver of PDD’s success. Now they’re a major source of uncertainty.

Consumption, the main driver of the economy, has weakened this year after spending rebounded after the post-Covid-19 reopening last year. Against the backdrop of widespread job and salary cuts as well as falling property prices, Chinese consumers have become more cautious in their spending, leading to intense price wars in sectors such as cars.

Retail sales expanded by just over 3% in the first seven months of 2024, well above the more than 8% growth seen in pre-pandemic times. And confidence in future incomes fell to its worst level since the end of 2022, one of the most intense periods of Covid-19 lockdowns, according to a central bank survey in the second quarter.

Nearly half of those surveyed said employment was “tough and difficult,” the highest percentage since the end of 2022. Nearly two-thirds of those surveyed said they were willing to save more, close to an all-time high recorded last year.

He pointed out to me that there is a fundamental shift in consumer behavior, a move away from cheap products that have been driving revenue growth since the company was founded.

“Consumers are making more thoughtful decisions to balance quality and value,” he said on the earnings call. “In response, we’ve partnered with quality brands and manufacturers to create customized products that meet these diverse demands.”

For some investors, PDD executives were trying to contain the wild expectations. After all, it may be unreasonable to expect the company to continue to grow at double-digit rates, as it has in every quarter but one. Wall Street had been betting that PDD would nearly double its revenue in the fourth quarter. Instead, it surged 86%. And on Monday, executives said they would make big investments to capitalize on future opportunities.

“PDD’s result points to weak consumption and intense competition,” wrote Morgan Stanley analysts Eddie Wang and Kathy Zhu. “However, management’s comments on declining long-term profitability are too conservative, in our view.”

What does Bloomberg News say?

PDD’s August 26 report signaled a decline in profitability as the company ramps up spending to meet rising global competition, adding to the downside of the second-half earnings consensus, which had forecast higher margins through 2025. That, coupled with PDD’s first revenue failure in 10 quarters in the three months ended June, looks set to dampen growth expectations for the next 12 months.

In the long run, much depends on the labor market and how Beijing steers the economy.

Authorities have sought to ensure there are enough jobs even as the economy slows, calling on state-owned companies to expand recruitment and vocational training.

But officials have not offered more direct help to consumers, even though many economists have called for at least cash handouts or vouchers for low-income groups. They have also refrained from measures to boost wage growth, which is needed to encourage more spending. And aggressive regulatory crackdowns on a range of industries from tutoring to finance over the past few years have worsened the labor market.

For now, many investors are still counting on PDD to outperform its peers at least in a turbulent economy.

“We believe PDD is the only Chinese e-commerce company that will outpace industry growth,” Morgan Stanley analysts wrote.

—With assistance from Yujing Liu, Catherine Ngai, and Dong Liu.

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