PDD Holdings, Inc. (PDD, HOLD) - 2Q26: Earnings: Margin Surprise Offsets Slower Growth; Investments Remain the Focus; Maintain HOLD and $100 PT

PDD Holdings, Inc. (PDD, HOLD) - 2Q26: Earnings: Margin Surprise Offsets Slower Growth; Investments Remain the Focus; Maintain HOLD and $100 PT

PDD reported a mixed 2Q26, with revenue modestly below our expectations but profitability stronger, driven by a better-than-expected gross margin. Revenue increased 8% y/y to RMB112.4bn, while non-GAAP operating profit rose 5% to RMB29.1bn. However, the quarter did little to change our broader view on the business: domestic monetization remains subdued, investment in merchant support and supply-chain capabilities is set to continue, and overseas operations are entering a more costly localization phase as the regulatory environment evolves. Management also acknowledged that the rollout of its first-party brand initiative has progressed more slowly than initially expected. We therefore view the strong 2Q margin as encouraging but insufficient, on its own, to signal a sustainable earnings inflection. Revenue Missed, but Profitability Was Better Than Expected. 2Q revenue increased 8% y/y to RMB112.4bn, 2.5% below our RMB115.2bn estimate. Online marketing services revenue increased just 3% y/y to RMB57.6bn, largely in line with our estimate, while transaction services revenue rose 13% to RMB54.7bn, approximately 5% below our forecast. The revenue mix continues to highlight relatively muted advertising monetization despite ongoing GMV growth, consistent with management's emphasis on improving merchant economics rather than maximizing near-term take rates. The major upside surprise came from gross profitability. Gross profit reached RMB64.3bn, implying a 57.3% gross margin versus our 55.1% consensus. Sales and marketing expense was broadly in line with our forecast, while G&A came in higher and R&D somewhat lower. Merchant and Supply-Chain Investment Remains the Priority. Management reiterated that the RMB100bn support program remains central to its strategy. The program now extends beyond fee reductions and traffic support into product development, manufacturing upgrades, logistics, agricultural supply chains and brand building. We see merit in these investments if they strengthen PDD's differentiation around value-for-money products rather than subsidies. However, management acknowledged that supply-chain investments may not generate immediate returns. We therefore expect monetization and earnings benefits to lag spending. Platform governance is another area of sustained investment. PDD has introduced more than 150 trust-and-safety measures and increased resources for product quality, intellectual-property protection, food safety and merchant compliance. This supports the ecosystem's long-term health but suggests elevated R&D and administrative spending may persist. First-Party Brand Strategy Intact, but Ramp Is Slower. Management described the first-party brand strategy as an extension of PDD's supply-chain capabilities, not a replacement for its third-party marketplace. The company plans to work with selected manufacturers on product planning, R&D, quality standards and market testing. Management also acknowledged that the initial rollout has taken longer than expected. We therefore remain conservative on its near-term financial contribution and do not assume meaningful standalone 1P revenue in the near term. Temu Faces a More Expensive Localization Phase. Recent European changes affecting low-value cross-border parcels will reduce fulfillment efficiency and raise costs in affected markets, with a “considerable impact” on those portions of the business. PDD is responding by onboarding more local merchants, building local warehouses and expanding local fulfillment. Localization should improve supply-chain resilience over time, but it also changes the economics of Temu's original asset-light model. Warehousing, fulfillment, compliance and consumer protection require additional investment. We have therefore become more conservative on near-term Temu GMV growth and assume a slower path to margin improvement. We agree that the long-term opportunity remains significant, but the next stage of international growth will likely be more operationally complex and less capital-light. Staying Out of Quick Commerce Is Positive. Management maintained that instant retail requires different supply chains and operating models, with limited current synergies with PDD's core business. The company therefore plans to focus on areas where it already has differentiated capabilities rather than pursue aggressive quick-commerce investment. We view this discipline favorably. Avoiding another subsidy battle reduces the risk of incremental expense pressure, allowing capital to remain focused on product supply, merchant economics and logistics. Overall, 2Q was a better profitability quarter rather than a fundamental growth inflection. The domestic business remains highly profitable and cash-generative, while supply-chain investments could strengthen its position over time. However, online marketing growth is subdued, Temu faces higher operating costs, and the timing of returns from ecosystem and 1P investments remains uncertain. We therefore maintain our HOLD rating and $100 price target.