ZTO Express (Cayman), Inc. (ZTO) Q2 2023 Earnings Call

ZTO Express (Cayman), Inc. (NYSE:ZTO) Q2 2023 Earnings Call Transcript August 29, 2023 8:30 PM ET

Company Participants

Sophie Li - IR Director

Meisong Lai - Founder, Chairman & CEO

Huiping Yan - CFO

Conference Call Participants

Ronald Keung - Goldman Sachs

Qianlei Fan - Morgan Stanley

Thomas Chong - Jefferies

Operator

Good day, and welcome to the ZTO Express Second Quarter 2023 Financial Results Conference Call. [Operator Instructions]. Please note this event is being recorded.

I would now like to turn the conference over to Sophie Li, Company Secretary. Please go ahead.

Sophie Li

Thank you, operator. Hello, everyone, and thank you for joining us today. The company's results and investor relations presentation were released earlier today and are available on the company's IR website at ir.zto.com. On the call today from ZTO are Mr. Meisong Lai, Chairman and Chief Executive Officer, and Ms. Huiping Yan, Chief Financial Officer. Mr. Lai will give a brief overview of the company's business operations and highlights, followed by Ms. Yan, who will go through the financials and guidance.

They will both be available to answer your questions during the Q&A session that follows. I remind you that this call may contain forward-looking statements made under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements are based on management's current expectations and current market and operating conditions and related events that involve known or unknown risks, uncertainties, and other factors, all of which are difficult to predict in a manner of which are beyond the company's control, which may cause the company's actual results, performance or achievements to differ materially from those in the forward-looking statements.

Further information regarding this and other risks, uncertainties, and factors is included in the company's filings with the U.S. Securities and Exchange Commission. The company does not undertake any obligation to update any forward-looking statements as a result of new information, future events, or otherwise, except as required under law.

It is now my pleasure to introduce Mr. Meisong Lai. Mr. Lai will read through his prepared remarks in their entirety in Chinese before I translate for him in English.

Meisong Lai

Hello, everyone. Thank you for joining today's conference call. In the second quarter of 2023, while maintaining a high level of service quality, ZTO grew its volume by 23.8% year-over-year with a total of RMB7.68 billion, further expanding our market share to 23.5%. Meanwhile, through enhanced revenue structure and process management, we improved overall operational efficiency and achieved an adjusted net profit of RMB2.53 billion, representing a 43.9% year-over-year growth. Relative to a pandemic affected low base of last year, the express delivery industry's overall parcel volume grew 20.9% in the second quarter of this year.

Depending on varied priorities for scale and profit, each brand implemented different competitive strategies. ZTO has consistently pursued sustainable profitable growth, focusing on long-term growth and competitive advantages. In the second quarter, we executed the following key tasks initiatives, which helped generating solid performance results. First, we revamped the talent reserve program and through systematic evaluation, quickly replace those who could not keep up. With a strong talent pool and pipeline buildup under a complete emulate surpass atmosphere, our team of provision managers are becoming younger yet more prepared to take on greater challenges.

Second, we exceeded expectations on cost optimization. In the second quarter, we continue to implement operating process standardization and further refine our evaluation matrix to be more detailed and quantifiable. Our ability to correlate process data to specific behavior of a workstation or individual task operator improved. This enabled us to flat anomalies promptly and effectively rectify problems with precision. Third, we refined volume cost profit tools and further the implementation across the operational network.

We sort through the methodologies for pricing, revenue, and host sharing between sorting centers and outlets. This effectively enhanced the profitability of our entire network and further widen our industry lead. Benefited from post-pandemic recovery in the Chinese economy, the Express delivery industry has with in the healthy growth in the first half of 2023. Despite price-for-volume behavior that are still present, the evolutionary trend of the industry's dynamic is very clear. Market share gains through low-price competition is often unsustainable and, in many cases, lead to more detriment than gains.

We are convinced that high-quality of services, robust infrastructure, and efficient operations are crucial ingredients to a scaled and strike Express delivery enterprise. ZTO's competitive strategy is to maintain flexibility to be offensive or defensive, locking bottom line and the focus on developing our own capabilities from the long run. We will adhere to offer our own pace and steadfastly establishing and strengthen our competitive barriers.

With mindfulness on operational safety, we will keep digging deep trenches in the following four key areas: first, improving service capabilities by focusing on end-to-end timeliness, streamline and improve operational efficiencies through process standardization, establish more direct linkage among sorting centers, outlets, and last-mile careers, ultimately reducing sortation frequency.

Second, expertising the implementation of lost initiatives and encourage network partners to pass on market pricing to couriers, so as developing infrastructure, implementing safety measures, enhancing service quality and digitizing information and management, improving operational efficiencies and last-mile connectivity.

Fourth, expanding last-mile presence and transforming increasing costs into a surge solution for every industry player to reduce last-mile cost, and enhance in-person service capability and connection with consumers. Long-term microeconomic development were adopted trend upwards and cyclical fluctuation only provide opportunities for long-term value seekers to explore potential and build endurance.

The competitiveness -- the competitive dynamics of Chinese express delivery industry have entered into a critical development stage. We are fully aware of our own strengths and advantages. We know what we can do and understand what needs to change. Innovation and entrepreneurial spirits are embedded in our shared success culture, propelling us to create value-first for others in the society. Leveraging the harbor of technology, we aim to enhance operational efficiency for the distinct set of competitive advantages, formulate solutions for over 100 million a day parcel volume, and usher in payback and the prosperity for express delivery participants and investors.

With that, let's welcome Ms. Yan to review our financials.

Huiping Yan

Thank you, Chairman, Lai. Hello to everyone on the call. When I go through our financials, please note that unless specifically mentioned, all numbers quoted are in RMB, and percentage changes refer to year-over-year comparisons. Detailed information on our financial performance, unit economics, and cash flow are posted on our website, and I'll go through some of the highlights here. In the second quarter, ZTO maintained profitable growth, thanks to sound execution of our consistent corporate strategies.

Our parcel volume increased 23.8% to RMB7.7 billion, growing the quarterly market share by 0.5 points to 23.5%. The adjusted net income grew 43.9% to RMB2.5 billion. Total revenue increased 12.5% to RMB9.7 billion. ASP for the core express delivery business decreased 7.8% or RMB0.10, mainly driven by lower average weight per parcel, increases in volume incentives, and a mix shift impact from a decrease in KA volume whose revenues are recorded to include delivery fees. Total cost of revenue was RMB6.4 billion, which decreased 0.3%.

Combined unit cost of sorting and transportation decreased 15.7% or RMB0.12. Specifically, line-haul transportation costs per parcel decreased 14.7% to RMB0.42, mainly attributable to better economies of scale, optimize line-haul route planning, improved low rate, and decreased fuel cost. Unit sorting costs decreased 17.4% to RMB0.25, driven by scale leverage, increased level of automation, improved standardization in operating procedures, and optimized performance evaluation systems. Gross profit increased 50.0% to RMB3.3 billion as a result of increased revenue and cost productivity gain. Gross profit margin rate increased 8.5 points to 33.9%.

SG&A expenses, excluding share-based compensation, as a percentage of revenue, dropped 0.1 points to 5.3%, demonstrating a healthy corporate cost structure and leverage. Income from operations increased 45.0% to RMB2.9 billion and associated margin grew 6.6 points to 29.6%. Operating cash flow was RMB3.76 billion for the quarter and EBITDA was RMB3.88 billion. Capital expenditure totaled RMB2.2 billion for the quarter, and we are anticipating annual CapEx to be in the range of RMB6.5 billion to RMB7.5 billion. We are on track to achieve another year of free cash flow.

Now moving on to guidance. Taking into considerations the current market conditions and our operating situation, the company reiterates that its annual volume guidance to be in the range of RMB29.27 billion to RMB30.24 billion, representing a 20% to 24% increase year-over-year. Relative to the entire industry performance, the company remained committed to achieve at least 1.5 percentage point increase in volume market share for the year. These above estimates represent management's current view and preliminary assessment, which are subject to change. Now this concludes our prepared remarks.

Operator, please open the line for questions. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions]. And our first question will come from Ronald Keung of Goldman Sachs. Please go ahead.

Ronald Keung

Thank you, management. Very quickly on -- management talked about the industry -- Express industry reaching a critical point. This is while we have delivered very strong profit growth while increasing market share, but we have seen some of the smaller players starting to cut prices and become more aggressive. So, do we see this as a temporary kind of act from the smaller players? Will the kind of extending into the fourth quarter peak season this year and how do we assess this round of price cuts from smaller players? Second, is about service quality and our end-to-end delivery time to share some of the metrics there and compare with peers. And how do we plan to widen our differentiation, not just from end-to-end time but any value-added services or anything that we're planning to maintain our service leadership potential?

Meisong Lai

Thank you very much for your question. First question is really, in essence, about the trend of the pricing going forward. It is typical that during a year, around September and October, the pricing will be about 10% higher than August and July because of the seasonality of the year. Also, in November, the price will further increase because the access capacities will then gradually be utilized. The pricing for the market during the second quarter fluctuation, we believe it's more driven by the seasonality.

ZTO has consistently focused on the approach balance across the quality of services volume in market shares and profit our principle is eliminating loss-making transactions. What we've done differently compared to some of our competitors is that we extended our policy from March and April into May and June instead of making changes to them. So, maintained stability in our entire network. Your second question is relating to linkage. First of all, we do have a systematic plan on improving, first of all, our quality services and timeliness because under the same pricing, higher quality of services will attract more volume.

What we've done in two aspects in our operational is that, first, each of the transit linkage, we will push it to its extreme improving productivity, improving correlation between segments -- different segments of our process of sortation, transportation, improving the route planning and so on and so forth. Those are the typical initiatives that we have implemented all along. And then the second area, which is what we have referred to in the past called tri-layer throughput.

In the past, our advantage is a better connection between the outlets and our sortation centers. Going forward and then really starting these past couple of years, we've been slowly but surely building the connectivity between initiation outlet to the destination sorting center and also amongst the outlets from origination and destination so as to develop those three distinct models of sortation because the ultimate goal is to reduce the number of sortation.

What we've done recently is focusing more on helping our outlets improve their processing capability, including equipment, automation, and also their area of -- their work areas so as to ensure the transportation of larger trucks can go in and out to improve the linkage because they then with a certain level of volume in a group of outlets, they are capable of sending the packages directly bypassing the origination center to destination center or in some cases, i.e. The third layer is to go from origination outlets directly to the destination outlet. Hence, this is zero sortation. We have more and more of our outlets or regions having higher volume, which makes it possible for this for this tri-layer throughput model. For example, in Canton and Yiwu, they represent about 10% of our total volume and many of their outlets having over 200,000 packages a day.

And with those scale condition or scale prerequisites, we are in the process of establishing the third and -- the second and the third layer of transportation and sortation throughput. Nowadays, we have on average of two sortation’s, a little over sortation, which means some of the packages will go through sorting centers -- or two sorting centers. Going forward, our focus is to increase one sortation and also zero sortation. The level of decrease in the total sortation will allow us to not only improve timeliness but also reduce cost.

Aside from developing our own capability in operation, we are also focusing on the second area, which is the last-mile development and also focusing on our couriers. The couriers are going to be incentivized because our outlets will pass through front-end market price to our couriers, so as to encourage them to pick up and deliver more on time and more responsively and also increase non-e-commerce packages. To do that, as part of the supplement, we also work with our last-mile presence development. Typically, the packages will go to sortation centers and the couriers would have to spend time and go pick up those packages from the sortation centers. With our scale and redesigned process in our operations in sortation, we are able to direct packages directly over to our last-mile locations or post, which will save plenty of time for the couriers to mainly focusing on delivery.

So, their ability and their services to provide individualized attention to those customers who need door-to-door -- door-to-door delivery will be greatly improved. And this will not only help our couriers will also help the entire industry in reducing last-mile costs. As volume becomes higher going forward, which is a definite future, we do believe helping the whole industry as a solution with our last-mile presence will most certainly help the entire industry's healthy growth.

To sum it all, scale, stability of outlets and our couriers’ improvements in their earnings as well as our outlets become more stable because they are also earning more. These are the three focus areas for us to develop a differentiated competitive advantage going forward. Hope that answers your question.

Operator

The next question comes from Qianlei Fan of Morgan Stanley. Please go ahead.

Qianlei Fan

Thank you, very much for taking my question. Congratulations on a very solid second quarter results despite the aggressive pricing competition in the industry. I have two questions. The first question is about competition. Very glad to hear that the company's strategy has not changed in the second quarter versus the first quarter to maintain a stable pricing compared with some very aggressive competition from our peers. We noticed that in the second quarter, the market share gain of the company was 0.5 percentage points on a year-on-year basis.

Considering management mentioned the target of 1.5 percentage point year-on-year market share gain target remains unchanged, does that mean we will be more aggressive in market share competition in the second half of this year? Or it is because we think because of the utilization issues, some of the peers may lose market share because they don't have the handling capacity? And also, Mr. Lai mentioned earlier that we will lock in the bottom line. So, what's the bottom line of the competition strategy if the market -- the industry competition comes more aggressive than expected? And the second question is about cost.

So very glad to see the second quarter unit cost drop was much significant than expected. So, at earlier, meeting management guided around 5% to 7% drop in unit cost for the full year. So, considering the second quarter, we have achieved better than that towards the outlook for the second half of this year in terms of unit profit. And also, what's the outlook for the next two years?

Meisong Lai

Thank you very much for your question. First question is really about the price competition. In fact, surely, we have observed that during the second quarter, the price fluctuation becomes extremely volatile. From one perspective, what we have done is, as I described earlier, we didn't change our pricing from May and June -- from March and April all the way throughout May and June. Because indeed, as you look at our decrease in ASP, in essence, aside from the objective reasons, we subjectively have allocated or given profit to the pickup in the delivery end.

Our market share did only increase 0.5 points because we do believe that in the longer term, ZTO with the largest scale and strongest competitive advantage, we are also taking on the role of a stable agent to ensure that the entire industry is stable, and especially during the economic recovery. From our personal sentiment, we are all coming from the same place. We come from the villages. And we all know that we are not trying to create detriments to anyone. And we're just simply using the excess capacity.

So, if we take on the price actions severely, it would -- because of our scale and influence will really impact the entire industry, which really not what we intend to do. So, we are hopeful that typically in starting in September, the volume will recover, and the whole industry will enter into a higher season. Although its installed base and capacity will be utilized, and each of the players will become more sensible in matching their capacity and resources to their pricing strategies. One thing we've done differently now is that ZTO make pricing decisions based on the direction of our routes, which is more granular and we have more visibility. In another way, we have much greater flexibility in precision in making appropriate price decision.

In the second half of the year, we are hopeful that the whole pricing trend will stabilize and the price will return and most likely. With regards to the 1.5 points target, we do believe there are still opportunities for us, and then we will strive to achieve our commitment. Second, question on the cost side. What we've done is, aside from what we described earlier to provide better operational efficiency through some of the initiatives that we have implemented, we are also improving the direct linkage. So, when we're able to quickly for doing, as mentioned earlier, is our outlets are gradually being rerouted to pick up or to drop off to the nearest center in their vicinity instead of just geographically or organized by provinces.

So, the whole entire end-to-end timeliness is improving. This will certainly impact the cost. We do believe there is still more room for us to gain on cost productivity. As I mentioned earlier, currently, we're about 2.09 times of sortation throughout the entire network. And each sortation will cost probably about -- approximately about RBM0.25.

So, if we reduce the sortation by 0.1%, that is RMB0.025 cost productivity gain. And we intend to further improve the linkage and reduce the sortation, hence, as I mentioned earlier, the tri-layer throughput model based on our scale will allow us to gain much greater cost productivity going forward. Thank you.

Operator

The next question comes from Thomas Chong of Jefferies. Please go ahead.

Thomas Chong

Thanks, management for taking my question. I have two questions. The first question is about our long-term market share expectations. Given that we have talk about the 1.5% market share gain, just want to see how our market share will be trending in the long run. And my second question is really about the parcel mix. Given that we are seeing some changes in consumer behavior given the macro backdrop, are we seeing the rate of the parcel is having some changes in terms of the heavyweight and the light weight parcel? And how will that affect the cost per parcel trend? Thank you.

Meisong Lai

Thank you for your question. Your question really relates to the competitive strategy. So, on that, ZTO has always focused on building our own competitive strength and remain, stable and profitable -- remain focused on stable and sustainable profitable growth. The Chinese express delivery industry, it has been apparent that when you have cost advantage, you have scale and you have a high level of quality of services, you will attract greater market share. In essence, express delivery is about value.

It's a value proposition with a level of high quality of services, customers will gravitate towards those who have high efficiency or low cost or a reasonable cost. The market is fair. In the past, we have demonstrated and it is evident that when we focus on all three of our corporate focus, i.e., quality, services, market share as well as our own profitable development, our market share continually improves, and increases.

We do believe the -- and more importantly, for an entire network to be healthy and growing, especially because in China, the franchised model we have been, in all throughout our years, focusing closely on the equitable allocation of courier outlet and our company as a brand operator. Each of the players need to focus on fair allocation and sustainable growth going forward.

We believe if you reference to the developed market in China, there will be concentrated market share in a few players, and this has been the trend we've been seeing the concentration in our market share in the past several years. As long as you have a high quality of services, you are also building up scale and efficiency and differentiated competitive advantage, we believe the longer-term market share concentration will continue to demonstrate itself.

Second, question relates to the product mix or parcel mix. Indeed, in the second quarter, we have observed that not only just us, but including our competitive partners in this space, they also experienced lower parcel -- average -- lower parcel weight. And this is indeed, as you have observed and mentioned, the consumer shopping behavior has been evolving and changing towards more sporadic shopping. For us, some of our main e-commerce package production regions, the packages will be lighter, yet we believe more of the inland to the north and south, we are having our regions with more agriculture product coming up, for example, that will be heavier.

As we are developing a pricing strategy based on routes, we will match the load rate of our transportation resources and our space -- operational space and equipment with the sortation center as well as our network partners and in that sense, determine what the appropriate pricing needs to be for a different set of product mix going forward.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

Huiping Yan

Thank you, everybody, again, for joining us today. Sometimes it takes a step back to take the two steps forward, and we are maintaining our stamina in looking into the longer term, and also with our financial resources and our competitive strength, we have much greater flexibility in playing offensive or defensive going forward. Opportunities are ahead for us to look not just at the second half of the year when volume will increase, we are also looking forward too many years ahead where we will continue to take leadership in profitable growth.

Thank you again for your continued support, and we look forward to speaking with you soon.

Operator

The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect.