ZTO Express (Cayman) Inc. Q1 FY2024 Earnings Call

Good day, and welcome to the ZTO Express First Quarter 2021 financial results conference call. I would now like to turn the conference over to Sophie Li, Head of Capital Markets. Please go ahead.

Thank you, operator. Hello, everyone, and thank you for joining us today. The company's results and the Investor Relations presentation released earlier today 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 Mrs. Huiping Yan, Chief Financial Officer. Mr. Lai will give a brief overview of the company's business operations and highlights, followed by Mrs. 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 relate to events that involve known or unknown risks, uncertainties and other factors, all of which are difficult to predict and many 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 has been 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 intent or otherwise, except as required under law. It is now my pleasure to introduce Mr. Meisong Lai. Mr. Lai will present his prepared remarks entirely in Chinese before I translate for him in English.

Hello, everyone. Thank you for joining today's conference call. In the third quarter of 2024, ZTO maintained its industry-leading service quality ranking with a parcel volume of RMB 7.7 billion, which grew 14% year-over-year. We achieved an adjusted net profit of RMB 2.22 billion, representing a year-on-year increase of 16%. In the first quarter of this year, parcel volume in the express delivery industry increased by 25.2% compared to last year, far exceeding expectations. The booming development, along with frequent promotions by new live-streaming e-commerce and social network retailing, stimulated online consumption and fueled the growth of express delivery volumes. However, this also contributed to a higher proportion of low-priced e-commerce parcels. We firmly believe that the ultimate goal of a business is to create value. ZTO is committed to healthy and sustainable growth and total net growth in profitable parcel volume, within a necessary base level of volume for scale leverage. In the first quarter, our market share contracted by 1.9 percentage points compared to last year. Nevertheless, our earnings lead among industry peers further widened. ZTO's consistent strategy is to maintain a balance among three growth aspects: service quality, profitability, and scale. At the start of 2024, we shifted our focus to service quality. While maintaining a healthy volume level and achieving optimal profit, we placed greater attention and resources on developing differentiated products and services to meet our customers' diverse needs, enhancing ZTO's brand awareness and recognition. In the first quarter, we further solidified our leading position amidst competition, especially with our end-to-end services. Our responsiveness to door and on-demand service capabilities in the last mile improved, and the growth in reverse and retail parcels significantly outpaced the overall market volume growth. While proactively addressing the structural shift in consumption and the competitive pricing in express delivery, we concentrated on expanding our higher value customer base, increasing the proportion of retail parcels, and improving our revenue structure. In the first quarter, our core Express ASP decreased to $0.04 year-over-year, which was significantly lower than the industry average. Thanks to the continued implementation of lean management initiatives, our combined sorting and transportation costs per parcel dropped by $0.06 compared to last year. When combined with a stable corporate cost structure, both profit per parcel and total profit have increased. Entering the second quarter, the industry volume showed strong growth momentum. However, price competition remains intense, particularly in major regions. ZTO remains focused on our strategic objectives, which include: improving transit efficiency through innovative methods within a mature operating framework, leveraging digitization and data analytics for process management, ensuring safety, timely delivery, and effective resource utilization to enhance quality and efficiency; enhancing product mix by diversifying express delivery services and increasing market penetration of unique offerings like ZTO tailored solutions; effectively addressing price competition by staying informed on market trends and refining our pricing policies; strengthening last-mile presence by implementing profit-sharing strategies and increasing retail parcel intake, ensuring a direct connection between sorting centers and delivery personnel; and improving communication with franchise partners to balance long-term and short-term interests, protect stakeholder rights, ensure fairness in network policies, and develop useful technological tools for better operational data visibility and daily operations convenience. The transition from growth driven by quantity to growth focusing on both quality and volume in China's express delivery industry is unavoidable. We have adjusted our strategic focus to prioritize service quality, aiming to build new engines of growth and innovate greater competitive advantages for ZTO's longevity. At this pivotal moment in industry transformation, everyone affiliated with the ZTO brand, including network partners and couriers, will collaborate to maintain ambition and confidence, bolster competitive strength, and ensure ongoing relevance. Through our comprehensive end-to-end capabilities and leadership role, we aim to foster healthy competition and growth within the industry while optimizing last-mile resource utilization and creating value for industry participants, investors, and society as a whole.

Thank you, Chairman Lai, and thank you, Sophie. Hello to everyone on the call. As 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 financial information, including unit economics and cash flow, is posted on our website, and I'll go through some of the highlights here. In the first quarter, while we paid more attention to quality of services and brand value improvements, we adhered to the principle of profitable growth and achieved a 15.8% increase in adjusted net income to reach RMB 2.2 billion. Our parcel volume grew 13.9% to RMB 7.2 billion, representing a market share of 19.3%, which decreased 1.9 points compared to the first quarter of last year. An increase in the proportional share of lower-priced parcels driven by frequent and deep discounts offered by e-commerce platforms, including live streaming and social network retailing that stimulated consumption, prompted us to recalibrate effort and resource allocation between volume and profit. We limited the amount of incremental volume incentives for the quarter and the ASP of our core express delivery business decreased by 2.5% or RMB0.04, which is well below the volume-weighted average ASP decrease of about RMB0.20 for the top four competitors. Our total revenue increased 10.9% to RMB 10.0 billion. Total cost of revenue was RMB 7 billion, which increased 7.7%. Overall unit cost for the core express delivery business decreased by 5.3% or RMB0.06. Specifically, line-haul transportation costs per parcel decreased 7% to RMB0.47, driven by improved resource utilization and route planning. Unit sorting costs decreased 5.4% to RMB0.30, thanks to continued standardization in sortation procedures and improved labor and automation productivity. Gross profit increased 19% to RMB 3 billion, and the gross profit margin rate increased by 2 points to 30.1%. Consistent with gross profit, income from operations increased by 16.2% to RMB 2.3 billion, and the associated margin rate grew by 1.1 points to 22.8%. The SG&A expenses, excluding stock-based compensation as a percentage of revenue grew by 0.1 points to 6%, given a stable and sound corporate cost structure. Operating cash flow was RMB 2 billion, which decreased 25.8% against a high base amount for the first quarter of 2023. In the first quarter last year, receivables collection increased during the process of KA accounts optimization. In addition, KA accounts for the first quarter of 2024 included newly established headquarter-level platform customers who enjoy longer receivable terms. Our retail parcel volume grew over 40% year-over-year under the initiative to increase higher-value parcels. Adjusted EBITDA was RMB 3.7 billion. Capital expenditure totaled RMB 1.7 billion, and we anticipate, again, annual capital expenditure to be below RMB 6 billion. Now moving on to our guidance, we estimated the overall industry growth to be around 15% to 20% for the year, and we reiterate that our parcel volume for 2024 is expected to be in the range of RMB 34.7 billion to RMB 35.64 billion, representing a 15% to 18% increase. We remain committed to our balanced approach for sustainable and profitable growth. We have prioritized improvements in the quality of services and development of differentiated products and services to enhance brand value and recognition. Under the near-term market dynamics, we aim to reach our earnings goal and attain an appropriate level of volume share. The above estimates represent management's current and preliminary view, which are subject to change. Now this concludes our prepared remarks. Operator, please open the line for questions.

And today's first question comes from Qianlei Fan with Morgan Stanley.

Mr. Lai, Ms. Yan, and Sophie, congratulations on the strong earnings growth. I have two questions. The first question is regarding Mr. Lai's comments about the strategic decision to give up some loss-making volumes this year. What led to this shift in focus, and what are your expectations for industry consolidation moving forward? My second question is about unit profitability. It's encouraging to see that unit profit has increased both year-on-year and quarter-on-quarter. If we assume that competition from peers remains largely the same for the rest of the year, can we expect unit profit growth on a year-on-year basis to continue for the remainder of the year?

Thank you very much for your question. We have readjusted our focus on our three main priorities to emphasize long-term profitable growth due to current market dynamics. The marketplace is currently experiencing a higher proportion of lower valued items, which presents challenges to the profitability of express delivery services. Our aim is to sustain profitable growth, leading us to avoid unnecessary volume. We have increased our retail and effective volume to stay focused on profit. Furthermore, in the long term, the quality of our services should be measured by how consumers perceive ZTO, not just by metrics. We need to develop differentiated products and services rather than engage in low-level competition. Regarding your second question, we will continue to pursue balanced growth. There’s a principle in our industry that we avoid loss-making parcels, and strategically, we do not want to handle parcels that are unprofitable. The overall industry is increasingly valuing quality alongside quantity, and our objective is to maintain or enhance our earnings share for future growth.

Our next question comes from Louis Zing with Haitong Securities.

How much has the proportion of individual parcels increased in the first quarter of the company compared to the same period last year? What is the company's outlook for the individual parcel market? What specific actions is the company taking to enhance the penetration rate in the individual parcel markets, including self-owned and reverse logistics? Thank you.

Thank you very much for your question. First of all, as we mentioned earlier, our first quarter retail volume grew over 40%. Our daily average is now 5 million parcels, which includes 3 million from our own operations and the rest, about 2 million, is reverse logistics. One of the key initiatives through which we hope to increase and continue to see results is by freeing up our couriers. We installed certain machinery at our outlets. Once they reach a certain level of daily volume, we require the use of such equipment to free up our couriers. Typically, in the past, carriers would have to go to their station or outlets to help with sortation and then take their own parcels. This is very time-consuming. With these machines installed, couriers are now able to focus solely on delivery services, including pickups. This year, we aim to increase our retail volume to 6 million parcels, up from last year's less than 4 million. Our ultimate goal is to continue to raise this proportion through mainly two initiatives. One is to ensure our couriers receive the front-end pricing benefit so that they can differentiate between pickup and delivery fee income. Secondly, we want to improve what we call direct linkage, as I described earlier, so couriers can spend more time working within a shorter radius in their service area, which will help improve service quality, including on-demand, to-door delivery and quicker response to pickups.

And our next question comes from Ronald Keung with Goldman Sachs.

Two questions. First, given the dynamic landscape of the express delivery industry, if we are prioritizing profitability in the short term over market share expansion, what is our outlook for the next three to five years? Will China's express delivery sector consolidate to feature three or four large players, or do we anticipate it will continue to have one dominant player alongside a couple of smaller ones? How could our strategy change during this period? Secondly, as the Chinese market evolves, what are our thoughts on expanding beyond China and pursuing global opportunities? Have we made any progress or developed new strategies in that regard?

The first question pertains to our strategy and specifically our market share. We emphasize a balanced approach in three key areas: service quality, earnings, and volume. We maintain that our goal of achieving 15% to 18% growth is suitable given the current market conditions. While we still value volume, we are adjusting our focus because we believe that long-term brand recognition is critical for sustainable and profitable growth. Additionally, increasing retail volume or improving our revenue structure will boost the profitability of our locations and couriers. After implementing initiatives to enhance their earnings potential, we anticipate further stabilization of our network and preparation for future growth. In the long run, we will concentrate on our operations; we will focus on ensuring quality, pursuing profitability, and, most importantly, achieving healthy growth that hinges on our brand recognition. Regarding the number of competitors in the market, we cannot ascertain that at this moment. However, we can confirm our goals and focus. We aim to continue enhancing and developing growth drivers and improving our competitive edge. We believe that those who prioritize scale, service quality, and profitability will prevail in the long term. As for the second part of your question concerning international business, this year ZTO has established a comprehensive cross-border product framework, offering various services such as import bounding, direct mail, freight forwarding, and warehousing in Southeast Asia, including Cambodia, Laos, Myanmar, and in Africa, including Nigeria, Kenya, Uganda, and Egypt, as well as in South Asia, including Pakistan. These regions have developed robust local express services. With the recent resurgence in international business driven by standardized prices in the cross-border market, we are looking into smoothly expanding new specialty services. The company will also pursue the development of international individual and boutique services while maintaining a strict focus on cost efficiencies to expand this segment of our growth strategy.

And our next question comes from an analyst with Zhonghong Securities.

Thank you for the opportunity to ask my questions. My first question concerns the current state of the express delivery industry and its implications. We have previously believed that the express delivery industry benefits from economies of scale and that the strong companies will continue to excel. However, the growth rates in capital expenditure last year and in the first quarter of this year do not support this belief. We've noticed a significant rise in the market share of second-tier companies and a notable push towards cost optimization. How do you assess the restructuring of the express delivery industry? Will market share continue to concentrate over the next five to ten years? Is service quality and profitability more important than market share? What is our ultimate goal for market share? My second question is about how long the company expects to take to build consumer awareness and implement product upgrades. What long-term goals do we aim to achieve?

Thank you for your question. When looking at market share dynamics moving forward, it is important to consider an express delivery company from all three perspectives: volume, profit, and the quality of services. We see the growth of the express delivery business as a long-term endeavor. Our focus on these three aspects aims to ensure sustainable growth over time. While we have seen a decrease in our market share in the first quarter, we are also observing a strong level of earnings quality, including that of our network partners. The sustainability of a business relies on achieving balanced growth in these areas. By concentrating on our potential for future growth, which includes enhancing consumer awareness of our brand, we believe we can improve our market presence while generating healthier earnings and offering better products. Regarding service quality, we continue to lead in this area, and our goal is to position ourselves as a top choice among industry competitors. We strive to stand out in a market that is often homogeneous, especially concerning pricing. Our balanced growth strategy does not mean we overlook volume, which is crucial for our scaled business model. In the first quarter, our daily volumes ranged from RMB 95 million to RMB 100 million, showcasing our scale and ongoing productivity improvements. We foresee a trend towards simultaneous growth in quality and quantity, leading to gradual profitability improvements. Logistics costs, as a percentage of GDP, remain inefficient compared to developed nations. We see significant growth opportunities in rural areas and international markets as we leverage our established scale and network resources to take advantage of these developments.

Thank you. And this concludes our question-and-answer session. I'd like to turn the conference back over to management for any closing remarks.

Thank you again, everybody, for joining today's call, and we look forward to speaking with you offline if you have further questions.

Thank you. This concludes today's conference call. We thank you all for attending today's presentation.