ZTO Express (Cayman) Inc. (ZTO) Q3 2018 Earnings Report, Transcript and Summary

Hello everyone, and welcome to the ZTO Third Quarter 2018 Earnings Conference Call. All participants are in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [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 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 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 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. First, let me translate for Chairman. Hello, and thank you, everyone for joining our call today. Our business achieved another solid volume growth and a strong financial performance during the third quarter of 2018. Parcel volume increased by 36.5% year-over-year to 2.1 billion. Net income was RMB 1.06 billion, which grew 47.7% from last year, all thanks to parcel volume growth. ZTO's market share in terms of parcel volume increased 1.4 percentage points to 16.6%. ZTO continues to solidify industry leadership position with scale advantage as well as superior earnings quality. Our strategy remains which is to manage the healthy pace of growth in relationship to the overall industry and consistently expand our market presence while achieving targeted profit growth and improving quality of service and customer satisfaction. During the third quarter, radical pricing practice still existed, especially in areas with high concentrations of e-commerce merchants or goods. Following our second quarter pricing strategy, we kept our focus on effective parcel growth by protecting existing volume and associated profits, then providing appropriate amount of incentive to steer towards incremental parcel volume that are profitable. While growing volume, we continue to direct attention and resources towards strengthening our transit and sorting capability and productivity improvement. In an environment of rising costs such as that of fuel and labor, our combined transit and sorting hub's cost per parcel declined CNY 0.09 year-over-year during the quarter. At the end of the quarter, ZTO owned and operated over 4,000 transportation trucks, including 2,270 15- to 17-meter long high-capacity vehicles. 200 of which were added this quarter through digitalization, intelligent control technology and the process improvement initiative in smart route planning, improved safe utilization, on-time loading and dispatching, sorting automation, integrated with dynamic weighing equipment, our operating efficiencies improved consistently for the past three quarters. Cumulative of the first three quarters of 2018, our parcel volume grew 38% year-over-year and income from the associated line-haul transportation and sorting hub cost combined all increased by 20%. Continuously and with focus, ZTO has made systematic investments in infrastructure, technology-driven research and the innovation, which gradually yet consistently delivered operational efficiency gains to where economic benefits are maximized and in sync with the pace of steady volume growth. Early investments in scarce resources combined with the modern generational approach through automation that are both effective and cost-efficient is unique only ZTO among scaled express delivery companies in China. This is one of the fundamental reasons why ZTO is more profitable today and why we are in a much better position to achieve sustainable healthy growth for many years to come, taking full advantage of the tremendous growth opportunity within China's express delivery industry. In addition to strengthening our own operational capabilities and efficiencies, we continue to focus on the stability of our overall network and empower our network partners. For those always in regions that have exceeded certain level of volume, we decreased the number of network players and plan for regional resource integration. Implementation of standardized pickup and delivery fee schedules will enable more and more express couriers become entrepreneurs versus contract employees. As of the end of the third quarter, there were 9,500 network partners, with the increased number of 4,160 direct network partners. The stability of our network is founded on cohesiveness created by the ZTO brand, customer satisfaction, shared success culture and fair network policy. Speaking about brand recognition and customer satisfaction, our service quality center has been focusing on five effects throughout the year, including process implementation, resource integration, application of technology, enforcement enhancement, service upgrades. We consolidated 19,000 customer service personnel across our network onto one technology platform to serve over 500 regional centers and quickly improved response rate and processing speed. According to the data released by the State Post Bureau, we ranked first in customer satisfaction during the quarter plus the lowest number of complaints amongst some of the operators. During China's momentous Singles' Day shopping festival on November 11, our order surpassed 115 million. Parcel volume exceeded 87 million. So far, the peak number of delivery reached over 50 million. All these record highs indicated trust and reliance by our customers as well as ZTO's superior capability to handle the sheer volume of parcels through our network. 2018 is near the end. Based on our forecast, this year, we'll increase parcel volume by at least 2.2 billion to reach over 8.4 billion for the year of 2018. And our projected net income will increase approximately RMB 1 billion to reach approximately CNY 4.1 billion for 2018. Looking ahead, we are optimistic about the long-term growth of the China express delivery industry. Total parcel volume for China's express delivery market is poised to achieve an unprecedented annual growth of 10 billion from 2017. And with 50 billion base, we believe China's express delivery market will continue to expand. As the pillar that supported rapid growth of the Chinese consumption and e-commerce, express delivery industry will continue to be an enabler for the future economic growth. ZTO will continue to monitor market condition and industry trends, and manage our pace of investment and growth accordingly. With our strong team and financial resources, we can stay on course of our strategy and further solidify our capabilities and leadership position and deliver sustained profitable growth and value creation for our shareholders. With that, let's ask our CFO, Huiping, to walk us through the details of the financials.

Thank you, Chairman Lai. And hello to everyone on the call. As I review our financial results, please note that unless specifically noted, all numbers quoted are in RMB and percentage changes refer to year-over-year comparison. In summary, ZTO achieved an in line parcel volume growth of 2.1 billion, increasing over 11 percentage points faster than the industry average. Meanwhile, adjusted net income exceeded the high end of our guidance for the quarter to reach CNY 1.06 billion. Our strategy of continued expansion in market share while maintaining high quality of services and profitable volume growth is well executed in the third quarter. Revenues increased 34.7% to CNY 4.23 billion, mainly driven by increase in revenues from express delivery services, which increased 23.3% to CNY 3.69 billion as a result of 36.5% volume increase and offset by per parcel price decrease of about 8.1% year-over-year, or CNY 0.17, which was comprised of CNY 0.05 due to decreased in weight per parcel; CNY 0.03 normal subsidy for label usage; and CNY 0.09 for volume incentive. The freight forwarding business we acquired and started consolidating during the fourth quarter of 2017 contributed CNY 291.2 million of revenues. Revenues from sale of accessories was CNY 200 million, mainly consisted of sales of thermal paper used for printing of digital waybills. Total cost of revenues increased 45.1% to CNY 2.91 billion, which includes CNY 282 million in cost associated with the freight forwarding business. Going into further detail of cost of revenue, line-haul transportation cost was CNY 1.35 billion, an increase of 22.7% from the same period last year. As a percentage of revenue, line-haul transportation cost decreased to 32% from 31 – 35.1% last year, driven by lower weight per parcel, increased usage of self-owned vehicles, more efficient high-capacity transport trucks and improved route planning. Sorting hub operating cost was CNY 765.9 million, an increase of 30.7%. As a percentage of revenues, sorting hub operating cost decreased to 18.1% from 18.6% during the same period last year, mainly due to an increased level of automation in our sorting facilities, which partially offset the continuous increase in labor cost per headcount. As of September 30, 2018, 78 sets of automated sorting equipment have been put into use compared to 41 sets same time last year. The average number of sorting hub headcount increased by 17 – 17.2%, which is well below the increase in volume of 36.5% during the quarter. Combined transportation and sorting hub costs for the quarter decreased by CNY 0.09 per parcel net of increases, which increased – net of increases of cost, which helped absorb a large portion of per parcel price decline. Cost of accessories was CNY 119.2 million, an increase of 28.2%. The increase was in line with the 57.1% increase in the sale of thermal paper for label printing. Other costs were CNY 388 million, an increase of 74.5% compared to the same period last year, primarily consisted of: one, an increase of CNY 91.8 million in dispatching cost associated with serving enterprise customers; two, an increase of CNY 45.7 million in expense related to IT and technology development; and third, an increase of CNY 18.3 million in tax surcharges. Gross profit as a result was CNY 1.33 billion, an increase of 16.5% from the same period last year. Gross margin decreased to 31.3% from 36.2%, mainly driven by parcel volume growth plus again increase in cost of goods sold efficiency, and then was partially offset by a decrease in unit price per parcel. In addition, the freight forwarding business and other early-stage businesses caused minor dilution to gross margin. The dilutive gross margin rate impact from the freight forwarding business was 2.1 percentage points. Total operating expenses were CNY 233.6 million compared to CNY 193 million in same period last year. Selling, general and administrative expenses were CNY 249.5 million compared to CNY 193.4 million during the same period last year. SG&A cost as a percentage of total revenue, decreased to 5.9% from 6.2% last year, demonstrating the healthy leverage of our corporate structure. Other operating income was CNY 15.9 million in the third quarter of 2018. Income from operations was CNY 1.09 billion, an increase of 15.6%. Operating margin decreased to 25.8% from 30.1% in the same period last year, mainly due to a decrease in gross margin by 4.9%. Net income was CNY 1.06 billion, an increase of 47.7% from CNY 717.2 million last year. Basic and diluted earnings per ADS were RMB 1.35 and RMB 1.34, respectively, compared with basic and diluted earnings per ADS of RMB 1 in the same period last year. Adjusted net income exceeded the high end of our guidance slightly, coming in at CNY 1.06 billion compared with an adjusted net income of CNY 730.7 million during the same quarter last year. EBITDA was CNY 1.48 billion compared to CNY 1.1 billion same period 2017. Adjusted EBITDA was CNY 1.47 billion compared to CNY 1.12 billion in the same period last year. Net cash provided by operating activities was CNY 911.7 million compared to CNY 1.02 billion in the same period last year. Based on the current market conditions and current operations, the company's parcel volume for the fourth quarter of 2018 is expected to be in the range of 2,620 million parcels to 2,660 million parcels, representing a 30% to 32% increase year-over-year. And the company's adjusted net income is expected to be in the range of CNY 1.2 billion to CNY 1.3 billion, representing a normalized 13.4% to 22.8% increase from the same period of 2017. Please note that the adjusted net income for the fourth quarter of 2017 included a one-time full year income tax benefit of CNY 285.9 million by one of our company's subsidiaries that qualified for the 15% reduced HNTE tax rate from the normal 25% statutory rate in December of 2017. Out of the CNY 285.9 million, approximately CNY 207.2 million of this tax benefit was attributable to the first three quarters of 2017, which is excluded for our calculation of normalized adjusted net income for the fourth quarter of 2017. These estimates represent management's current and preliminary view, which are subject to change. This concludes our prepared remarks. Operator, now we are ready to begin the Q&A session. Thank you.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Nicky Ge from China Renaissance. Please go ahead.

[Foreign Language] My question is about our fourth quarter guidance. Looking at the guidance, actually, the volume growth has decelerated a lot – a little bit. Just wondering whether we have adjusted our market strategy or are we still targeting 10% outpacing the total market? And looking forward to the 2019, what is our market strategy going forward? And how do I see the market growth of – in next year?

[Foreign Language]

Thank you, Chairman. Let me help translate. There are three questions, so if we may, one by one, elaborate. The first question. Fourth quarter, our guidance, it seems to be – for the entire China market, it seems to be soft. If you look at the third quarter, the price for the entire express delivery industry is declining, which still indicates a pressure or, in other words, competition pressure comes from the growth potential of the industry. So we still believe there are growth potential. However, in the fourth quarter as you also noted from the Postal Bureau, the e-commerce volume does have a downward adjustment. So we are, on one hand, focusing on our strategy to continue to grow our market and at the same time, monitoring what's happening in the marketplace. Our guidance is appropriate at this time, not conservative, neither aggressive. The second question for the total market, are we changing our strategy. Mr. Chairman went into more elaboration on that part of the question. If you look at the overall industry in 2017 to 2018, an estimated CNY 100 million growth, that is a – CNY 1 billion growth, I'm sorry. That's a significant growth and unprecedented. For ZTO we have looked into our past. Our absolute volume growth is consistently increasing year-over-year. For example, 2017, so [Foreign Language], CNY 1.7 billion last year and then CNY 2.2 billion estimated for 2018. And these growth indicated a tremendous opportunity in the marketplace as well as our focus on the following: One, infrastructure development. The way we invest is consistent throughout the past years. We invest in our facility, ensuring that the specific design by our facility would accommodate large capacity transport trucks coming in and out easily. The scarce resources is becoming more of a constraint for a company such as the scale of delivery industries to continue to grow. Our early investment in reference to, if you may look at some of the real estate investment companies, they are looking for 8 to 10 years return. So the rental cost will be higher. As opposed to us, early investment, the 20-year spread of depreciation and the benefit when it comes out of these investments are a great contract. So we believe the investment in our infrastructure provided us great advantage. Secondly, what we are focusing on is also the empowerment of our network, ensuring the stability is there. And one way to look at whether our network is stable or not is to look at the quality of services. The survey results, the customer satisfaction rate for ZTO has been consistently among the top of the Tongda Operators. One other point, for example. During Double 11, if you look at our entire network's performance, not just on our own transport and sorting capabilities, the industry volume of that Singles' Day, we represented about 21% of the total parcel volume collected. And that under extreme pressure we are able to expand with great flexibility. And that's part of the reason of a strong platform as well as very capable and very dedicated network partners. To achieve that, we will continue to empower, continue to support with our shared success philosophy in adding greater capacity and capability and efficiency in our own platform, and hence, supporting the growth of the entire network. Chairman emphasized on the outlook of our business. 2019 or at the foreseeable – with the foreseeable future, our strategy remains, which is to focus on the market expansion while achieving targeted revenue – profit goal, maintaining high quality of services and customer satisfaction. We are in a tremendous growth opportunity in China still with CNY 50 billion base. This whole industry will continue to keep clicking forward and our focus remains on building our own capabilities, supporting our network partners for continued profitable growth and creating value for our shareholders. Thank you. Thanks, Nicky.

[Foreign Language]

Thank you. Your next question comes from Ronald Keung from Goldman Sachs. Please go ahead.

[Foreign Language] I have two questions, Lai, Huiping. First is about the industry, where we have seen online retail growth decelerating in the past few months but the passive growth has actually held up quite nicely. So glad to hear anything that you're seeing on the ground including ticket size or anything that has contributed to a more healthy parcel growth that we're seeing so far. The second question is could you break down a bit on the ASP this quarter? Like what you've done last quarter about how much was the decline contributed to the weight decline and the incentives, and we'd like to hear about the direct shipment and key accounts, whether those have contributed to the ASP changes.

[Foreign Language]

Let me first translate the first question answered by – for the first question. And then I'll answer the second one. Yes, indeed, if you look at the overall e-commerce that there are downward adjustments. But if we look at the entire industry, commerce in China will continue to grow on a large base, particularly if we look at some of the areas that are not fully developed yet or perhaps the spending power is not completely released yet. For example, the rural area and international. As we mentioned earlier, e-commerce in China, the growth of it is supported greatly by the effectiveness and cost advantage of express delivery businesses. And going forward, it will continue to be the supporter of this growth in China. And we are still optimistic and we remain focused on the longer-term longevity of the entire industry's growth. And then second, Mr. Lai emphasized on the fact that there are factors that are not within our control. So we are focusing more on our own capabilities and building our own capacity and efficiency. If you are able to take a relatively stronger position in competitiveness, then you are able to win at the end. If you consider the fact that we have grown consistently, continue to increase the absolute volume in our history and consistent results in our efficiency gain, based on those, then we have higher confidence in the fact that we will succeed in the long journey. Our focus on profitability as well as customer services are supportive of our entire volume growth and market share gain to get up to a higher level of proficiency and earnings quality. So it's important for us to continue to maintain focus on our own capability as opposed to distracted by potential short-term uncertainties of the marketplace. And then for the second question, the breakdown of our ASP. For the overall comment is that the ASP decline are in line with our expectations as well as consistent with the market's competitive condition. For the third quarter, the 8.1% or CNY 0.17 decline is broken – breaking down – broken down by the following three main drivers: one, the decrease in our weight per parcel. The third quarter weight per parcel is 1.19 kilograms compared to 1.14 kilograms in this quarter, which resulted in a CNY 0.05 per ASP decline. Second, the e-waybill usage, we have a normal policy to subsidize. And that impact year-over-year is RMB 3 – yes, is RMB 0.03. The third element, which is the same as what we had experienced last quarter, the incremental volume subsidies or incentives is CNY 0.09. From a quarter-to-quarter basis, these are still the three key drivers. Year-over-year, we believe the impact for the first two will continue and remain stable. The last incentive for incremental volume, again, we manage and control this very closely. In reference to the market, we – because of focusing only on profitable volume increase, the incentives that we give out is maintained in the high single digit as opposed to some of our peers, may be more aggressive. The KA and direct shipment that you asked, Kevin there is no significant changes in our overall progress of these two segments' growth. And specifically with regards to the direct shipment, we are very careful in managing the volume requirements and ensuring that the route planning are consistently applied across applicable and qualified outlets. And the growth of direct shipment is monitored and controlled not at a high speed at this time. The KA as part of our businesses remains a growth point, because there are small pieces or some of the nationwide brands that require services with consistent quality standard across the nation. So we will continue to focus on and provide resources on those segments of the business.

Thank you. Your next question comes from Eric Zong from Macquarie. Please go ahead.

[Foreign Language] I have two questions. The first question is regarding the parcel pricing trend. So I wonder what's the parcel ASP trend so far in the fourth quarter. And also, I found like in October month the industry parcel ASP declined by 4.5% year-on-year. So on a Q-on-Q basis, have you seen the parcel ASP which is higher than the third quarter? So my second question is regarding on cost. So the unit sorting cost declined by 4% year-on-year. So I feel that China is a little bit below expectation compared with the second quarter, which we saw a 6% year-on-year decline. So I just wonder what's the reason behind this trend.

Thank you, Eric. First of all, if you look at the fourth quarter, generally speaking, the weight per parcel will increase. So the ASP will – naturally will decline, and that's what we are seeing. The price increase that we implemented started in November. So there is a blended effect there but still per parcel-wise, we believe there are pressure because of the weight increase. The sorting facility, let's say a little bit more on that, elaborate a little bit more on that. And indeed, the year-over-year efficiency gain is not as apparent if you just look at the sorting hub cost. There are good reasons behind that for specifically this quarter that we had just experienced. The labor cost, first of all, increased per headcount even though we have a total headcount increase well below the volume increase, as well as the fact that if you think about sorting machine – automation machine implementation, it's a gradual process. There are various segments of the use of the equipment. It's currently, first of all, covering a portion, about 50% or so, of our total sorting hubs, not all of the sorting hubs have installed because comparing to the volume, we believe there is an inflection point where utilizing people is still more cost-effective. As we gradually improve and increase the automation installation, you should see continued efficiency – release in efficiency gain. Sorting hub implementation, as I mentioned earlier, it's – as it crossed the entire process of unloading, sorting and reloading onto the truck will take a good – it will take a process as we retool and recalibrate the destination outputs of all the stations. All these are to be planned and in an overall – from an overall perspective. Looking forward as more volume coming in, the automation machine that we have installed, together with the dynamic weighing machine that's integrated into our automation sorting equipment, will gradually and consistently release efficiency.

Thank you. Your next question comes from Edward Xu from Morgan Stanley. Please go ahead.

[Foreign Language] I've got two questions. First is regarding the ASP trend because Mr. Lai mentioned that in fourth quarter, you are going to be more balanced on the volume growth, market share and the profitability side. So does that mean that the ASP decline will narrow? And what do you expect the overall trend for the industry for present competition over the next six to nine months? That's the first question. Second question is that regarding your new services and products, are you planning to promote some more products that can better differentiate your services rather than pure pricing competition? And what is the progress so far?

[Foreign Language]

Let me translate. Our strategy has been consistent throughout the past year, which is to balance the three factors: volume growth, customer service and satisfaction as well as profitability. So there is no change, and for the third quarter in the fourth quarter, it's the same. With regards to pricing, we think that the action that's taking place – on the price action that's taking place in the marketplace is likely to remain. However, that's not a sustainable – that's not sustainable. In other words, a short-term gain on the market share doesn't help solidify the overall competitiveness of the company. And that is why we have always focused on the balance of the three. Very practically speaking, right now, we set our goal to grow approximately 10 percentage points higher than the market average. Why don't we set it at 20? Why don't we set it higher? We have the capacity, we have the capability. But if we look at all three goals that need to be balanced and that need to be achieved, we believe at a consistent pace, not too much, not too little, in reference to the market managing the pace and focusing on our own internal strength and its growth, that will help us win in the longer term. Consistency and focus is the key. Specifically, for example, in some of the areas, because our volume advantage, we are able to quickly draw in volume, but yet we don't do that. First of all, maintaining a level of services require us to look at our capacity and capability. At the same time, we look at our network partners. Their capability as well as the couriers, their employees, the couriers that are hoping to becoming more profitable and in turn, support the stability of the network, all these factors need to be considered. When we look at ourselves, and that is really what we are able to control and focus on, is to continue to build the infrastructure, to build our capability, to consistently gain efficiency and train and improve our team of people that could continue to execute well of our strategy. And thirdly, we could rely on our sound financial strength. If in case there are price wars, we don't believe it's sensible. But indeed, if it does take place, we are in a much better position than everyone in terms of our financial capabilities. But again, we don't believe it is sustainable, and it's not supportive of the longevity of a company that is seeking growth, seeking value for the longer term. The second question that you have, Edward. We have, starting in 2016, modified our overall product line development to be focused on resource planning at the same time of developing our core express delivery businesses. Warehousing, financing, trade as well as some of the smart equipment design and manufacturing, all those were what we refer to as early-stage development businesses. One of the area of LTL business has been taking the leadership in growing up and supplementing the whole ecosystem's growth. The time-definite products that you have referred to in your question will be part of the total logistics services capability that we will build. Our goal is to become a comprehensive logistics service provider. We are planning our resources, and training our team, and gradually and systematically planning the growth of each of the segments that are going to become the future growth engine of the business.

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