PDD's $55 billion stock crash sends warning to Chinese economy

(Bloomberg) — One of the last bright spots for Chinese consumption is fading rapidly as the country's economic crisis leads to declining demand for even the lightest goods.

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In the latest warning to global markets about the health of China's economy, Temu owner PDD Holdings Inc. surprised investors on Monday with an unusually gloomy forecast. The e-commerce company, which became a market darling with its low-priced goods that helped boost sales and profits during China's economic downturn, also reported revenue that was below estimates. During a press conference after the results were released, CEO Chen Lei mentioned at least eight times that sales and profits would “inevitably” decline if economic growth slows.

“We face many new challenges, from changing consumer demand to increasing competition and uncertainties in the global environment,” Chen, also one of PDD's first employees, told analysts.

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The CEO and his staff made it clear that they continued to have confidence in Chinese consumption in the long term – a high priority for Beijing in the reorientation of the world's second-largest economy. But the damage was done. PDD shares plunged 29 percent – the biggest drop ever – and wiped out $55 billion in market value. Its biggest competitors Alibaba Group Holding Ltd. and JD.com Inc. followed suit, losing around 5 percent in Hong Kong.

PDD's warning shocked investors as the company has long been seen as a key beneficiary of a downgrade in Chinese consumer sentiments – its low-pricing strategy for Pinduoduo at home and Temu abroad aimed at appealing to price-conscious shoppers at a time of unprecedented economic volatility.

The disappointing results were the latest in a series of warning signs for the Chinese economy. This week, popular fast-food chain Din Tai Fung — long one of the most popular restaurant brands in the country — announced it would close more than a dozen stores. Last month, Starbucks Corp. said sales in China fell 14 percent in the June quarter.

“The big problem is the weakness of the Chinese consumer market,” says Joshua Crabb, head of Asia-Pacific equity markets at Robeco Hong Kong Ltd. “The impact on competition and a weak consumer market will certainly have a negative impact.”

The story continues

Starbucks and Din Tai Fung have long struggled with sentiment volatility, but the PDD's warnings were particularly surprising, as they highlighted how cash-strapped Chinese consumers have been rejecting luxury brands in favor of cheaper alternatives for years.

Founded in 2014 by former Google engineer Colin Huang, the company has combined low prices with aggressive rural expansion and game-like elements on its platform to grab market share from Alibaba and JD in recent years. It has parlayed that formula into global e-commerce bargain app Temu, which it launched during the Super Bowl in 2023. That app has become a shopping phenomenon similar to Shein and was at one point one of the most downloaded U.S. apps.

That led to a remarkable six-fold increase in market value since the post-Covid lows of 2022 and made Huang the richest man in China this month. But he held the title for only 18 days, until Monday's sell-off.

China's less affluent consumers outside of its glitzy megacities were largely responsible for PDD's success. Now they are a major source of uncertainty.

Consumption, a key driver of the economy, weakened this year after spending rebounded last year following the post-Covid reopening. Amid widespread job and salary cuts and falling property prices, Chinese consumers have become more cautious about spending, leading to fierce price wars in sectors such as autos.

Retail sales rose by just over 3% in the first seven months of 2024, far worse than the over 8% growth recorded in pre-pandemic times. Citizens' confidence in future incomes has fallen to its worst level since late 2022, one of the most intense periods of Covid lockdowns, according to a central bank survey conducted in the second quarter.

Nearly half of residents surveyed said the job situation was “bleak and difficult” – the highest proportion since the end of 2022. Nearly two-thirds of respondents said they were willing to save more – a figure close to the all-time high recorded last year.

Lei suggested there was a fundamental shift in consumer behavior, a move away from low-cost products that had boosted sales since the company was founded.

“Consumers are making more conscious choices to balance quality and value,” he said on the conference call. “In response, we have partnered with high-quality brands and manufacturers to develop customized products that meet these diverse needs.”

Some investors said PDD executives were simply trying to temper over-expectations. After all, it may be unreasonable to expect the company to grow by more than 50 percent, as it has done in all but one quarter. Wall Street had bet that PDD would nearly double its revenue in the June quarter. Instead, it grew 86 percent. On Monday, executives said they would make major investments to capitalize on future opportunities.

PDD's earnings “imply weak consumption and intense competition. However, management's comments on declining long-term profitability are too conservative in our view,” wrote Morgan Stanley analysts Eddy Wang and Kathy Zhu.

What Bloomberg Intelligence says

PDD's Aug. 26 disclosure that profitability is falling as the company increases spending to meet increasing global competition indicates a downward trend from its second-half earnings guidance, which had forecast higher margins through 2025. This, along with PDD's first revenue decline in 10 quarters for the three months to June, is likely to dampen growth prospects for the next 12 months.

• Catherine Lim and Trini Tan, analysts

• The study can be found here.

In the long term, much depends on the development of the labor market and how Beijing manages the economy.

The authorities are trying to create enough jobs even as the economy slows down by asking state-owned companies to hire more new employees and intensify their vocational training.

But the government has failed to provide more direct help to consumers, despite many economists calling for cash grants or consumption vouchers, at least for low-income groups. Nor have measures been taken to support wage growth, which is essential to boost consumer spending. Rigorous regulations in a range of industries, from tutoring to finance, have also worsened the labor market.

Currently, many investors are still relying on PDD to at least outperform its competitors in a turbulent economy.

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

– With support from Yujing Liu, Catherine Ngai and Dong Lyu.

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