ZTO Express (Cayman) Inc. (ZTO) Q2 2018 Earnings Report, Transcript and Summary

Good day, and welcome to the ZTO’s Second Quarter 2018 Earnings Conference Call and Webcast. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Ms. Sophie Li, Investor Relations Director. Please go ahead.

Thank you, operator. Hello, everyone, and thank you for joining us today. The company’s results and the 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 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 is included in the company’s filing with the U.S. Securities and Exchange Commission. The company does not undertake any obligation to update any forward-looking statement 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. Mr. Lai, please go ahead.

[Foreign Language] Okay. Now, let me translate for Chairman. Hello, thank you, everyone, for joining our call this morning. Our business delivered a strong performance during the quarter. Once again, we exceeded our expectations with parcel volume growing to 2.12 billion parcels, while generating adjusted net income of RMB1.1 billion. We also enhanced the quality of our services and improved our customer satisfaction scores. Our parcel volume increased by 41.7% [ph], faster than the industry average by 16.7 percentage points. During the quarter, our market share increased to 17.4% from during the same period last year. Adjusted net income rose by 50%, and net cash provided by operating activities increased by 63% year-over-year. Our strong second quarter performance is a result of our commitment to and focus on implementing our overall growth strategy and ensure growth of parcel volumes that are effective, with the growth prospects of the express delivery industry in China. Our goal is to grow our parcel volume faster than the industry average by 10 percentage points each year, hence increasing our market share. On the premises of achieving targeted profit and improving service quality, during the quarter, in response to off-season price fluctuations in certain regions or markets, we selectively implemented appropriate pricing and incentive policies to protect existing parcel volume, incentivized additional parcel volume at the reduced yet still profitable levels. In other words, the incremental volume is effective in which it is still profitable. Therefore, our rapid growth rate is a profitable growth. While we continue to carefully balance parcel volume and targeted profits, we continue to focus on developing and improving our parcel pickup, transits and delivery capabilities. We once again significantly improved transportation efficiency during the quarter by refining warehouse management and constantly optimizing vehicle capacity allocation. Additional automated sorting equipment put into operation also increased our operational efficiency during the quarter. Automated sorting equipment will play a significant role to improve the efficiency during the peak season, following further fine-tuning to better integrated into the entire process. We also saw initial success in our efforts to improve labor efficiency in sorting hubs, which helped to partially offset the impact of higher labor costs from temporary workers during peak season. Our express delivery network stability is derived from fair, reasonable and adaptable policies. To ensure the stability and the profitability of our allies [ph] during the quarter, we continue to detect anomalies throughout our pickup and delivery payment systems, helped our allies to identify and solve problems such as earnings comparatives of couriers, hence increase the profitability and the stability of the allies . The investments led by Alibaba and Cainiao successfully closed during the quarter. Coordination and planning have gone underway and execution on certain joint initiatives have been on track. Our accomplishment during the first half of the 2018 are derived from our strategic focus on building a strong and scalable platform that is fully integrated and can neatly serve end customers. First, we focused on enhancing service quality and improving customer satisfaction. Second, we managed to expand the scale of our infrastructure, strengthen our ability to process information, enhance our intelligent decision-making and boost operational automation. Third, we reinforced the flexibility and the stability of our network. And lastly, we further optimized our organizational structure to improve accountability and effectiveness. Competition in China’s express delivery industry could become increasingly fierce over the short term, judging by recent market developments. We remain confident in our ability to continue growing steadily. We believe that price adjustment is a commonly used approach to gain market share in a fast-growing market, especially in a price-sensitive industry. However, short-term and longer-term gain must be balanced. Only effective volume increase is worthwhile. Our strategy going forward will focus on proactively increasing efficiency and growing to scale in order to maximize benefits. Our solid track record demonstrates our ability to manage a business of this scale and expand parcel volumes profitably. Over the next three to five years, we are of the view that express delivery industry in China will continue to grow, led by solid management team with on-the-ground operational knowledge and an efficient and stable network. We will continue to focus on enhancing our capabilities, scale our infrastructure, improve operational efficiency and develop intelligent decision-making systems to steadily expand our business and ensure our leadership position in the industry. With that, I will now turn the call over to our CFO, Huiping, who will go over our financial results in more detail.

Hello, everyone. I’m glad to go behind the numbers to explain what is taking place in our business. Please note that all the numbers are in RMB unless specifically mentioned. All percentages refer to our changes from prior measuring period unless otherwise specified. In the second quarter, we continue to build our platform out to scale and to quality with efficiency gains in both sorting operation and transportation. As of June 30, we have 64 sets of automatic sorting equipment in service across the network compared to the 22 sets during the second quarter last year. This allowed us to manage the average headcount cost of sorting hub workers to an increase of only 16.7%, which is significantly lower than the parcel volume increase of 41.7% in the quarter. In addition, we added more than 170 high-capacity, 16- to 17-meter long trucks to our own fleet. Quarter-end number of self-owned trucks increased from 3,500 as of March 2018 to 3,800. Since late 2016, we have gradually reduced our dependency on outside transportation services, which are relatively less cost-effective compared to our own managed fleet. Revenue increased in the quarter by 41.3% to RMB4.2 billion, primarily driven by an increase in volume, offset by slight ASP or price decrease. The volume increased by 41.7%, and our per package price declined by 7.5%. This decline was driven by three factors: decrease of average weight per parcel; as well as the incremental incentive we provided for additional volume growth; and also the consistent use and increase of e-waybill. Cost of revenue rose to RMB2.74 billion, an increase of 48.3% primarily due to an increase in line-haul transportation [ph] cost, again, below the increase of revenue, as well as sorting hub operation cost, accessories and other costs. This total cost of revenue also included RMB288.3 million of freight forwarding cost as a result of the freight forwarding business acquisition during the fourth quarter of 2017. Now going a little bit more into further detail. Line-haul transportation costs increased 19.7% to RMB1.27 billion, as a percentage of revenue, the line-haul transportation cost accounted for 30.3%, which is decreased from 35.8% in the same period last year. And this was due to mainly the decrease in weight per parcel, hence, increased the packing efficiency and utilization of the truck capacity; two, increased use of our self-owned fleet are more efficient and with higher capacity. The total transportation cost of self-owned trucks accounted for 61.8% of the total truck transportation cost in the quarter compared to 52.6% in the same period of 2017. Sorting hub operating cost rose 33% to RMB702 million. As a percentage of revenue, sorting hub operation cost accounted for 16.7%, again a decrease from 17.8% in the same period last year. This is mainly as a result of increased level of automation in our sorting facilities, which absorbed a portion of the continuously increasing labor cost per headcount. Cost of accessories increased 50.2% to RMB125.7 million, which is in line with the increase in the sale of thermal paper compared to the same period last year. Other costs increased by RMB178.9 million to RMB352.4 million primarily due to an increase in IT investment, tax surcharge as well as increased dispatch cost associated with servicing enterprise customers. Our gross profit rose 29.7% to RMB1.46 billion, and gross margin decreased to 34.7% when compared to the same period last year. The decrease was mainly driven by increase in volume, offset by price while we maintain our cost structure efficient and stable. Total operating expenses were RMB268.4 million compared to RMB202.6 million in the same period last year. If we take a closer look at our SG&A expenses, which increased from RMB202.7 million to RMB 269.2 million. And is primarily due to an increase in share-based compensation expense, an increase of salary and accrued bonuses as well as professional fee – professional service fee associated with technology development as well as the increase in depreciation and amortization expenses associated with automation expenses. Income from operation was RMB1.19 billion an increase of 29% from the same quarter last year. In this quarter, we reported a gain from disposal of equity investment of RMB562.6 million associated with our disposal of share investment in the Hive Box, which generated a consideration of RMB697.9 million in cash, and we will receive that proceeds in the third quarter this year. In the second quarter, net income rose to RMB1.5 billion compared to RMB716.9 million during the same period last year. Basic and diluted earnings per ADS were both RMB2.08 compared RMB1 during the same period last year. Adjusted net income surged to RMB1.1 billion, which is a significant increase from RMB730.4 million in the same period last year. EBITDA was RMB2.05 billion compared to RMB1.09 billion last year, and adjusted EBITDA was RMB1.52 billion, an increase from RMB1.1 billion during the same period last year. Net cash provided by operating activities was RMB1.48 billion compared with RMB903.2 million during the same period 2017. As of June 30, 2018, the company had approximately RMB15.67 billion, in cash and cash equivalents as well as short-term investments, which increased from RMB10.65 billion at the end of last year. Now turning to our guidance. For the third quarter of 2017, we expect our parcel volume to be growing in the range of 35% to 38% to reach 2.073 billion and 2.12 billion, in that range. Our adjusted net income will be expected to increase by the range of 36.9% to 43.7% to arrive at RMB1 billion to RMB1.05 billion. Now these are representative of management’s current and preliminary view and are subject to change. This concludes our prepared remarks. Before we open the call for Q&A I like to remind everyone to please limit your questions to two. Operator please open the line for questions. Thank you.

We will now begin the question-and-answer session [Operator Instructions] Your first question comes from Edward Xu from Morgan Stanley.

Hello. Can you hear me?

Hi.

[Foreign Language] The first question is regarding your cost control. We found that unit cost continue to decline, but the magnitude of the cost decline is not as significant as we saw in first quarter. So can you share with more color on your cost control and also give us some guidance on the cost trend in the next few quarters? And the second question is regarding your financial income because we noticed that your cash balance increased a lot. And especially in third quarter, you are going to see more cash increase. So is there any way of more effective cash management and to enhance your efficiency? Thank you.

[Foreign Language] Okay. Let me translate for Chairman first. Thank you, Edward, for your question. If I may remind everyone that our second quarter comparatives indicated that the transportation cost had decreased significantly from last year. And part of that decrease was due to much higher cost in 2017 as we were working on reducing the reliance on third-party transportation cost. So for second quarter of this year, the decline of RMB0.21 in our transportation cost partly was against – comparative against an unusual amount of cost in prior year. So the normal decrease we have discussed last time in our call is that RMB0.10 is reasonable. So in this quarter, for 2018, we were able to achieve around RMB0.11 decrease for the transportation cost, so that’s reasonable and normal. Now you mentioned about the cost of gasoline. The cost of gasoline actually had a minimal impact as it increased by only 4%. So the unit cost, operating cost in our operation continues to decrease. Excluding the impact of acquisition of COE, our unit cost decreased to RMB1.16 during the quarter from the previous RMB1.24. And unit cost – the transportation unit cost decreased to RMB0.60 during the quarter from the previous RMB0.71 in 2Q of 2017. And this decrease was mainly due to a decrease in the parcel weight – per parcel weight, so that we are able to optimize the packing of our trucks. And then also, coupled with use of high-capacity trucks, this entire efficiency has increased. And then we’re continuing to decrease the dependency on the third-party transportation services. As we indicated earlier, the use of self-owned vehicles increased to 62% in this quarter from 53% last year same period. Unit sorting cost also decreased to RMB0.33 from RMB0.35 a year ago, and this decrease was attributable to, of course, our economy of scale and increased automation. There are 64 sets of automating – automation sorting machines in place in the second quarter compared to 22 last year. We will continue to implement cost controls going forward, and these will include optimizing the transportation route, planning and selection, reduce distance, enhance efficiency and also address fuel consumption and secondary transportation fees as well as increasing the portion of self-owned vehicles to generate better efficiency. And we also placed small capacity – replaced small-capacity vehicles with high-capacity, 15, 17 meter long trailer trucks to work to improve performance by these sorting hub personnel. And increase investment in our sorting equipment and automated conveyance belts as well as the dynamic weighing machine will gradually come online, and towards the end of the year, we hope to have a wide coverage across all our sorting centers so that the efficiency in our sorting hub operations will significantly increase. So with that, I hope we answered that question. Now for the second question, if I may take that, it’s regarding to our interest income. Let me clarify one thing, that majority of our investment led by Ali and Cainiao were in place in the second quarter. There was a small lag that will come in, in the third quarter. Together with all these cash, we are making plans for securing a level of sound liquidity and at the same time, preparing for a structured investment into either deposits or deploying into our capital increases. Our overall capital plan for the year has not changed. We are actively securing land-use rights as well as securing contracts to develop sorting capabilities. Going forward, the automation, the dynamic weighing machine as well as smart decision-making, our processes and IT development will also all require us to make a sound investment.

Okay. Thank you.

The next question comes from Vivian Tao from Citi. Please go ahead.

[Foreign Language] So I have two questions. The first question is on the cost side. Earlier, the management explained the line-haul transportation cost, the unit cost has declined from RMB0.71 per parcel last year to RMB0.60 per parcel this year. Management attribute this naturally to – because of the decline of the average parcel weight as well as increase of this self-transport proportion. So my question is that – because we understand that direct shipment also has been increasing recently. Does that also help to reduce the line-haul transportation cost? If it is, can you please further break down that RMB0.11 cost savings? How much of that is coming from the lower average weight? How much is from the increase of the self-transportation portion? How much is from the hub, the increase of the direct shipment? The second question is on the market condition. Earlier, Mr. Lai mentioned, based on the market condition in the third quarter, management expect the competition might intensify in the near term. I’m just wondering, management, would you please further elaborate now what have you seen in the market in the third quarter?

[Foreign Language] So the first question, let me translate first. First of all, the direct shipment route is a approach to connect the pickup service outlet to the destination sorting hub. And the direct shipment has been developed since 2017. Parcel volume of the direct shipment business accounts for less than 5% of our total volume during the quarter. And the direct shipment business accounted for about 7% of the total routes. And before 2017, only certain outlets that reach a volume would be qualified for running this direct route. And direct route is very much a efficiency gain as well as cost management approach. With the increase in volume, it is inevitable in the future that more and more direct routes will open up. But again, it’s gradual. There are volume requirements. Typically a sorting hub, if it reached about 50,000 tickets a day, it would most likely then able to fill a truck that is destined to the destination hub, so as to bypass the starting sorting activity. Currently, we have the number of sorting – the times a package went through the sorting, we have certain statistics if we may go through with you, about 12.6% of our total parcel’s gone through sorting only once. 63%, which is a larger portion, 63% are sorted twice; 21% sorted three times; about 2.6% sorted four times; and above five times is almost negligible. There is none. And with the increase in the package volume, we are targeting to reduce the number of times a parcel is sorted to three times or even less. We want to increase the proportion of parcels sorted once so as to increase efficiency and eliminate unnecessary cost. With our better route planning, it is the main driver of our cost reduction this quarter. As we mentioned, we aim to reduce the number of sorting stops along the way for each package. With digitization and the visibility to our volume and its direction, we are increasing our capability to produce better route planning and selection, and that is the main driver. Now if you look at some of the numbers, representing 5% of the total package or 7% of the routes, roughly, it represents about RMB0.02 of reduction on a cost per ticket. And hope that answers your question, Vivian. [Foreign Language] Okay, if I may translate. The – if you look at the market, the CR8 has represented increasing portion of the market. The CR8 index rose to 80.7% last quarter to 81.5% in this quarter. That indicates a further market consolidation. And even within that kind of come through, we are noticing the division. For ZTO, we continue to lead the growth with our large base. We are increasing more than 16.7% above the average growth. So we did notice that as a growing market, certain areas in the second quarter, especially, for example, with a large outbound volume, the competition is increasing. However, we also noticed that some of the smaller express delivery companies that fall behind in terms of additional scale will lose its competitiveness and will most likely lose out their market share and gradually fade out. So for us, in the longer term, we continue to focus on our market strategy, which is to maintain our bottom line and increase our volume effectively. Increase effective volume again means that all our incremental tickets or incremental package carry a reasonable level of profitability. So as when we expand our total market shares, we are also ensuring that our targeted margins are achieved. And Chairman further emphasized on the fact that the competitive advantage for the longer-term gain really lies within the business capability, so we will continue to focus on our platform capacity and scale as well as ensuring the end network are stable and with market-competitive pricing capability. So that our couriers, the entrepreneurs will continue to provide stability as well as consistent growth for our market. Thank you, Vivian.

Your next question comes from Nicky Ge [ph] from CCBI.

[Foreign Language] My first question is about Pinduoduo’s volume contribution to us and its parcel economics versus other ordinary parcels. And my second question is about the progress of our cooperation with Cainiao.

Okay. So your question relates to Pinduoduo. As we mentioned in the past, Pinduoduo is part of a fast-growing e-commerce business in China. In the second quarter, Pinduoduo represents roughly about 13% of our total volume and a slight increase from our previous activity levels. And Pinduoduo, in terms of its pricing, I think, for ZTO’s perspective, we don’t differentiate significantly what platform or e-commerce platform it comes from. We do price our packages by weight and by distance. So in that sense, it has very limited impact on our business as a whole. And then the third – the second question relates to our collaboration with Alibaba. The investment carries a long-term focus on digitizing the e-commerce as well as the supply chain, including logistics operation. Alibaba invested in a leading operator in this logistics business, which is ZTO, and we have been focusing on developing on-the-ground activities or on-the-ground initiatives. Some of our prior time-definite products are being upgraded. And certain aspects or segments of the entire process are being fine-tuned so as to truly differentiate from the day-to-day express packages. Cainiao Post also specifically we have piloted programs in a number of cities in cobranding and increasing the capacity of our delivery courier capacity. So all of these are underway. And some of the activities are carried out because of ZTO’s leadership, and we will be able to take along all the other key players as well in exercising and executing the strategy and the plan. Thank you.

Your next question comes from Xin Yang from CICC. Please go ahead.

[Foreign Language] So my first question is about the ASP. I don’t know how much of the ASP decrease was due to the decrease of the weight, the average weight of the parcel. And the second question is related to the structure or the competitive landscape. We saw that the complaint ratio of STO and BEST, actually, it’s better than ZTO in the last period. So what do you think about the future competition? Thank you.

Okay. For the first question, our ASP per package reduced 7.5% or RMB0.15. About RMB0.05 is attributable to the weight decline, RMB0.02 is associated with our regular incentive for e-waybill usage. That is the same amount from last quarter. And then the RMB0.08, driven by incremental incentive, so all together, RMB0.15 decrease are driven by these three factors. And then Chairman will answer the second question.

[Foreign Language] So first, let me explain the metrics that is used for measuring complaint rates. Prior to June, for example, in April, there’s one set of complaint rates, and that is considered effective complaint rate. An effective complaint rate is as a result of customer service, solving problems, also making necessary reimbursements or damage – pay for damages and all. So after all those work has been done, then the complaint rates is published. Now starting in June, the postal – government agency postal bureau initiated a new set of metrics that opened up – provided visibility to the complaint – entire complaint process. So first of all, how many complaints come in initially. And then second, how many complaints were settled satisfactory – to consumers’ satisfaction. And then those measurements provided a better measurement to indicate, first of all, the entire quality of service of a company, of the delivery services. And then it zeroes in on the capability of a company’s customer services on solving the issues, solving the problem. So Chairman has read through some of the numbers, if I will also do the same. In April, ZTO’s effective complaint rates, again, under the old metrics, we ranked number three, that is 1.19 per million compared to some of the other, for example, BEST, 0.35 per million that ranked number one. We are number three. In May, similarly, we are 0.65 compared to Shentong, STO’s 0.64. So again, these figures are after the complaints being submitted and issues resolved. So now let’s look at the set of metrics in June. If you look at in June, the total complaints that came into the pool, which means everyone that has a complaint that came into the play, ZTO has the lowest amount, which in other words, the entire service quality measured as a whole before customer service injection, before any of the fines or any of the damages were paid, ZTO stands the best. We are at 18.31 compared to some of highest at 33.44. Going forward, we will continue to monitor and balance between the quality of services as well as our volume growth and profitability to continue to secure and protect our number one position in the current geostatistics. Our total complaint rates that came in was at 0.52, which is, again, ranked number one in the entire measurement. At the end of the year typically, the postal government will issue a more comprehensive set of data, which includes satisfaction rate as well as on-time delivery, on-timeness. In all those measurements in the past, ZTO has always been ranked in the top three. So we will be continuingly focusing on a comprehensive set of data as well as a more indicative complaint rate metrics going forward. Thank you for your questions.

Thank you. This concludes our question-and-answer session. I would now like to turn the conference back over to Sophie Li for closing remarks.