Alibaba Vs. PDD Holdings - Which Chinese ADR Is Best?

Alibaba Group Holding (BABA) and PDD Holdings (NASDAQ:PDD) are two of the most popular Chinese ecommerce ADRs among Western investors. The former is an established e-commerce giant doing $17 billion a year in free cash flow. The latter is a newly profitable up and comer with blisteringly fast growth rates. Notably, the two companies are in competition with one another both domestically and internationally, which makes them more similar to one another than either of them is to JD.com (JD). If any two Chinese ADRs are worth comparing side by side, these two are the ones.

The comparison is a pretty interesting one. There are parts of Alibaba’s business that are in head-to-head competition with PDD Holdings. AliExpress is functionally equivalent to TEMU, and Alibaba’s domestic business competes with Pinduoduo. Therefore, there is much that is similar between these two companies.

There are also many differences between them. Alibaba is a much older and more mature company than PDD Holdings, as such it has a whopping $75 billion in cash on its balance sheet. This gives it a bit more room than PDD has to deliver value to shareholders, through buybacks and spinoffs (which have been approved), and through cash dividends (which have not been approved). PDD Holdings, for its part, beats Alibaba on growth, despite being only slightly more expensive.

When I last covered Alibaba and PDD Holdings, I rated both stocks strong buys. My buy thesis on Alibaba revolved around its cheap valuation, and catalysts such as upcoming spinoffs and China's economic recovery. My buy thesis on PDD Holdings revolved around the company's growth and the success of Temu in the United States. Today, I remain bullish on both stocks, although I am increasingly aware of certain risks facing PDD holdings that are worth exploring in detail.

In this article I will explore BABA and PDD Holdings side by side, to help investors determine which is the better buy. I will look at the similarities and differences between the two companies. I will look at their growth, profitability and valuation. Finally, I’ll explain why I’ve chosen to overweight Alibaba relative to PDD Holdings in my own portfolio, even though (as I’ll explain shortly), the latter has much more upside in a “best case scenario.” My buy thesis on PDD Holdings revolves around the company's growth and profitability metrics, both of which are far above average. However, as I will show in a dedicated section on the company's risk exposures, it is more vulnerable to U.S. market-related political risk than Alibaba is.

BABA and PDD - How Similar Are They?

When comparing two stocks, it helps to know how similar the underlying companies are. As I said at the start of the article, BABA and PDD are more similar to each other than either one is to JD.com, but that doesn’t mean that they are the same company. There are important differences between them, as well as similarities.

To begin with, here is what Alibaba and PDD have in common:

• Both are e-commerce companies.

• Both operate domestically as well as internationally.

• Both have apps that sell low priced Chinese goods to consumers.

These are meaningful similarities. However, there are differences between Alibaba and PDD Holdings as well–most of them revolving around Alibaba having segments that PDD does not. A few notable differences include:

• Cloud segments: Alibaba has one, PDD doesn’t.

• News media: Alibaba owns assets in this space (e.g. the South China Morning Post), PDD doesn’t.

• Grocery: Alibaba owns a grocery store chain (Freshippo), PDD doesn’t.

• Wholesale: Alibaba has a business supplying bulk Chinese goods to foreign buyers, PDD Holdings is strictly business-to-consumer (“B2C”).

• Returns to investors: Alibaba has been returning capital to investors through buybacks and a planned spinoff, PDD’s share count has been progressively growing.

So, Alibaba and PDD Holdings are similar enough to compare, though not identical. They will become more similar after the spinoff concludes. When the spinoff is done, Alibaba will no longer have the cloud, the grocery store, or Lazada. It will continue holding its domestic business as well as AliExpress, so the remaining post-Spinoff Alibaba will be quite similar to PDD.

Profitability

Having compared Alibaba and PDD Holdings’ operations, we can now look at the first of the factors we’ll be using to determine which is the better buy:

Profitability

Both Alibaba and PDD Holdings are highly profitable, scoring A+ in Seeking Alpha Quant. However, PDD’s margins are a little higher across the board.

The following are some profitability ratios for Alibaba and PDD Holdings:

As you can see, all of the relevant ratios are higher for PDD than for Alibaba. Going by historical profitability, PDD takes the cake. The only caveat here is that Alibaba, on a corporate level, is weighed down by some unprofitable segments (e.g. media) and some with razor thin margins (the cloud). If you look at just the China commerce business, it did ¥32.5 billion in EBITA on ¥140 billion in sales. That’s a 23.2% margin, which is pretty comparable to PDD’s EBIT margin. So, there is reason for optimism that Alibaba’s successor companies, post-spinoff, will have margins similar to PDD’s.

Growth

Another factor we can look at to compare Alibaba and PDD Holdings is growth. Both Alibaba and PDD Holdings have historically grown quite rapidly. Indeed, both continue growing rapidly on the bottom line (earnings and free cash flow) today, although as we’ll see, the sources of growth are quite different.

In the trailing 12-month period, Alibaba and PDD Holdings grew at the following rates:

As you can see, PDD Holdings grew much faster than Alibaba did recently. There is one factor here that might slightly favor Alibaba, however: a longer track record of growth. Over the last 10 years, it has grown at the following rates:

• 38% in revenue.

• 22% in EBIT.

• 23% in EPS.

• 25.5% in FCF.

PDD Holdings does not have such a long growth track record, so the possibility of its recent growth being a “startup growth spurt” can’t be discounted.

Valuation

Now we can get into valuation, a factor that slightly favors Alibaba.

According to Seeking Alpha Quant, BABA and PDD Holdings trade at the following multiples:

Alibaba's multiples suggest that the stock is cheap. Similarly, if you discount Alibaba’s 12-month free cash flow per share ($9.18) at the current 10-year treasury yield (3.8%) plus a 4% risk premium, under a no-growth assumption, you get a $118 price target, which is significant upside.

Apart from the GAAP P/E, PDD’s multiples are all much higher than Alibaba's So, going by multiples alone, Alibaba is the cheaper stock, with the caveat being that if PDD can keep up its growth into the future, then it will begin to look like it was extremely cheap at today’s prices.

As far as PDD's discounted cash flows go using the same assumptions as I used for Alibaba, PDD’s free cash flow ($6.63 per share) is worth $85. This again implies some upside, although not as much as Alibaba has in the same exercise. However, the no-growth assumption is probably less valid here, as PDD Holdings is growing its free cash flow by triple digits and nothing happened recently to suggest it’s going to slow down in the current quarter.

Risk Exposures

Having reviewed Alibaba and PDD Holdings in terms of growth, profitability and valuation, it’s now time to look at risk exposures.

Here, I believe, PDD Holdings is much more vulnerable than Alibaba.

PDD Holdings’ recent growth has come from its international segment, and this segment is exposed to many regulatory and political risks.

In the first quarter of 2022, PDD’s revenue only grew at 7%. In September, Temu launched in the U.S., and became one the most downloaded apps in the app store in a few short months. By the third quarter, PDD’s revenue growth was back up to 65%. It appears that the launch of Temu was a big part of PDD’s rapid return to growth. Top line growth was decelerating before the launch. After the launch, it was back to high double digits. Unfortunately, PDD’s earnings releases don’t break down earnings by region, but we can infer that the international growth was better by the fact that domestic-oriented JD only grew at 11% in the same period, as well as the fact that PDD’s own growth was decelerating before Temu launched.

This reliance on international markets for growth is a risk for PDD. The U.S. market, in particular, is becoming very hostile toward Chinese companies. The U.S. recently held a hearing on banning TikTok, which was quickly followed up by the state of Montana actually banning it. Later, Temu was accused of data risks, Pinduoduo was banned from the play store for using spyware, and Shein was accused of abusing its workforce. So far, Temu itself has remained on app stores across America, but the regulatory overhang will likely remain a dark cloud on the horizon as long as U.S./China tensions continue running hot.

The U.S. and China are at odds with each other over several issues. These include computer chips, Taiwan, and social media privacy. Although the U.S. has been extending some Olive branches to China recently, the moves (such as Janet Yellen’s visit) have been mostly symbolic. There has been little slackening in actual policy on either side.

This entire risk category is much smaller for Alibaba because its international segment isn’t nearly as America-centric as Temu’s. Alibaba has Lazada in Singapore, AliExpress in Brazil, and Alibaba.com for wholesaling around the world. Its international segment is much more geographically diversified than PDD’s is, and in an era of rising U.S./China tensions, that’s an important advantage.

The Bottom Line

Having looked at Alibaba and PDD Holdings side by side, it’s time to answer the question I started the article with:

Which of these ADRs is best?

In the end, it comes down to your risk appetite. PDD has much more upside than Alibaba in a best case scenario where it’s allowed to remain in the U.S. market indefinitely, but Alibaba is significantly less risky, as its business does not depend on access to the U.S. market as much as PDD’s does. On the whole, both names are worth owning if you’re interested in diversifying your portfolio into Asian stocks.