PDD Holdings Inc (PDD.O) | Buy | PT: 272.00 USD | Kenneth Fong

Equity Derivatives

PDD is different from those names which brought down the China E-commerce sector this week. As both UBS Research & investors are positive for its outlook, which option structure makes the most sense to add longs going into its earnings next week?

PDD’s share price was down 4% yesterday amid multiple headwinds in the China e-commerce space, including VIPS revising down Q3 guidance (-17.5%), weak e-commerce result from Kuaishou’s earnings (-9.9% on Wed), and Walmart selling stakes JD (-8.7% in HK). But PDD might not share the same pain as others.

UBS Research recently conducted several channel checks on China e-commerce and found these trends:

1. Amid moderating consumption, discretionary saw the most decline, especially in apparel & cosmetics (-VIPS). But online has fared better than offline, while lower-tier cities outperformed (+PDD).
2. Merchants are prioritising profitability & cash flows, which include cutting Ad budget & shifting from live-streaming back to marketplace (-BABA, -JD, -Kuaishou, -Douyin).

With both consumers & merchants cutting spending, PDD is better positioned with low-price advantage, exposure to lower-tier cities & simpler operating model, not to mention its visible growth overseas (Temu). PDD is UBS Research analyst Kenneth’s most preferred name in China e-commerce, and he sees attractive risk-reward with low valuation.

Investors generally agree with Kenneth’s bullish call on PDD. UBS Advisory Sales’ recent Survey on China Internet & Consumer (see Figure 1, credit to Philip Wu & Audrey Zhao) shows that PDD was the top pick for both HFs & LOs within China Internet. Interestingly, investors were not that negative towards e-commerce with ~60% LOs holding a positive view (50% for HFs), while views for cross-border e-commerce are skewed to the positive side for both LOs & HFs (+PDD/Temu, again).

But PDD’s popularity among investors could also be its Achilles’ heel, at least for its share price. In the last two earnings, PDD failed to repeat the double-digit rally seen in earlier quarters, although both results were solid beat vs estimates. Crowded position amid a lack of inflows into China equities could be a major driver.

With PDD share price becoming increasingly stable. IV has dropped from >100v to <40v with RV dropping even lower, as shown by Figure 3. 1m implied vols now only briefly pick up for earnings.

How to position for its earnings on 26-Aug?

As shown by Figure 2, options are implying 7.4% post-earnings move, which is much lower than 2y average (12.3%), but significantly higher than the last two quarters (+1.1% & +3.5%). Given such history, one would be reluctant to pay for the extra vol being priced in for earnings, as positions might still be crowded.

Considering PDD’s positive outlook but 17% rebound from the July low, it makes more sense to be more defensive. One could be long PDD into earnings via short/flat-vega structure (to avoid paying for the extra implied move) with floored downside – hence, call ratios. For example:

• Buy PDD US 18Oct24 1:2x $155-170 (107.5-117.9%) call ratios for $1.65 (1.1%), indicative pricing, spot ref $144.22, 4 Delta, breakeven $183.4 (127.1%), max net payout 8.1x. Considering historical share price movement, the 18% upside cap & 27% upside breakeven would be a high bar to reach.