ZTO Express (Cayman) Inc. (ZTO) Q2 2021 Earnings Report, Transcript and Summary

Welcome to the ZTO Reports Second Quarter 2021 Unaudited Financial Results Conference Call. All participants will be in 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 Sophie Li, Director 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 were released earlier today and are available on the Company’s IR website at irzto.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 in 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 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 brief through his prepared remarks in their entirety in Chinese before I translate for him in English. Meisong, please.

[Foreign Language]

Thank you, Meisong. Now please allow me to translate first. Hello, everyone, and thank you for joining us today. In the first half of 2021, the express delivery industry demonstrated steady growth momentum. ZTO maintained a consistent strategy to balance the long-term competing priorities of service quality, volume and earnings. By focusing on effective pricing and avoiding unnecessary loss making volumes, ZTO achieved 5.8 billion parcels and delivered adjusted net income of [RMB1.3 billion]. Meanwhile, our customer satisfaction scores ranked top of the peer group, and our performance in total process timeliness and the 72-hour time definitiveness stood out among the Tongda operators. Network stability and network partners’ confidence and willingness to invest in long-term growth are vital to growth and the longevity for a franchise model. It is even more critical at times of diminishing profit or even losses given prolonged and deep price competition. ZTO’s shared-success culture and long-term practice are highly aligned with the recent regulatory interventions aim to ensure social stability. We have always relied on our operational efficiencies to deliver best-in-class quality of services and the profitability while consistently empowering our partners to achieve [indiscernible]. This is precisely the reason why consecutively for the past several years ZTO was able to deliver increasing proportion of aggregate Tongda net profit ranging from 45% to as high as 80% with approximately 25% to 27% volume share, overall maintaining a stable partner network. Policy supportive of healthy competition, sensible pricing and fair being well, undoubtedly helped solidify ZTO’s competitive advantage and allow us to pull further away from the competition. ZTO always focused on being our best self, setting our size on the future and strengthening our core competencies, including infrastructure, we have made further progress on network upgrades, last-mile extension and brand building during the second quarter. First, we continue to implement initiatives to support or reform our partner’s operations. Through a top-down and grade-by-grade approach, we enhanced a transparency and fairness, boosted trust and confidence to improve network stability. Specifically, for example, the closed or absorbed those always – that were no longer competitive. We identified always with growth potential are important for strategic placements and established a goal for capacity expansion with added financing support, digital diagnosis, pricing optimization, legal and financial advisory services and equipments and technology upgrades, we ensure the capacity and the capabilities for pickup and delivery operations that kept the pace with transit and sorting expansion. In addition, consistent with the regulatory attention to the rising interest of those in the frontline will increase the participation of direct payment of last-mile delivery fees with the courier, extended coverage for courier, group accidental and employers’ liability insurance. We set up a 100 million plans for courier care and have improved the star level measurement matrix that promotes courier growth. This proactive measures have not only tangibly improved sense of belonging, feel safe and achievement across grassroots community, but also provided added protection against loss of growth by our network partners. Secondly, we raised the development of last-mile to a strategic level for ZTO’s growth. Adhering to the shared-success philosophy, we designed partnership structure to promote the deeper integration of operational and ownership level with our network partners, aiming at building a last-mile networks with wide and deep coverage of urban and rural area, while services, standards and the consistent images are maintained. At the end of second quarter, we have over 70,000 last-mile posts with an increasing lead over our peers. This location can cater towards diverse needs of our customers as express delivery network becomes less layered and more streamlined. Last-mile network carries great facility that are beyond our imagination. While accelerating the expansion of last-mile posts, we improved store standardization and explored various e-commerce opportunities, value added and neighborhood services during which content and improved policy for better experiences and higher competitive and the value proposition for the store owners or operators. Third, we actively extended new product experimentation by collaboration and integration with our logistic ecosystem, drive to establish differentiation in brand awareness and value recognition. According to the objectives we set from the beginning of the year, we improved connectivity with merging e-commerce platform particularly in areas of reverse logistics. We extended distinctive service category to cover fresh food, wine, spirits and specialty foods. We explored one-stop logistics service offerings to deliver comprehensive industrial solution. At present, the time definite service has been made available in nearly 100 cities with determinable events, phone alert and other customized for human guarantees. This new initiatives are generally well received by our customers and test groups. The coaching business under our ecosystem has launched time definite services across its newly formed nationwide network, where regional operation teams are being quickly assembled. We are further advancing and deploying resources to lay the foundation for a future capable of universal inclusive in the well integrated commodity products and services. We believe the express delivery industry will maintain a medium to high speed of growth in the next two to three years. The industrial landscape has clearly been dividing not only in volume or quantity, but also in quality, such as overall operational strength and the profitability. But the very nature of express delivery plus the partner network model requires long-term accumulation of capabilities, including our assets, seasonal counts and network coherent in which the capabilities in all four segments of pickup, [rotation], transportation and delivery must continuously improve in [indiscernible]. Moreover, as volume continues to grow, the structure of the network must also evolve and become more agile so as to continue to generate cost productivity while maximizing scale advantage. With the approaching daily volume of 400 million or even 500 million parcels, ZTO will maintain its consistent and effective strategy by suitable expansion of its transit and sorting platform, reduce overall frequency of transit and rely on digitization and a data-driven decision making to in-house connectivity and efficiency. Meanwhile, we pay close attention to the appropriate and in-time extension of our network partners’ capacity. Last-mile network development [indiscernible] express plus e-commerce opportunities. We will steadily develop our e-com this year and build competitive advantages with comprehensive product and services that are differentiated for brand value and the recognition. Now, I would ask Ms. Yan to take us through the results of our financial performance.

Thank you, Sophie. Thank you, Chairman. 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 analysis of our financial performance, unit economics and cash flow are posted on our website and I will go through some of the key points here. In the second quarter by executing our consistent strategies, we achieved profitable volume growth and grew parcel volume by 25.6% to RMB5.8 billion while attaining RMB1.3 billion adjusted net income. Our leading market share was 21% for the quarter. Total revenue increased 14.4% to RMB7.3 billion. ASP for the core express delivery business declined 5.9% or RMB0.08 with approximately RMB0.04 related to volume incentives and another RMB0.04 from parcel weight drop. Average weight per parcel declined 8% to approximately 0.92 kilo. The cost of revenue increased 22% to RMB5.7 billion. Overall unit cost of revenue for the core express delivery business increased 1.7% or RMB0.01. More specifically, line-haul transportation cost per parcel increased 10.2% to RMB0.48. Unit sorting costs increased 2.4% or RMB0.01. Normalized for one-time benefits such as ETC toll road fee waivers, lower oil prices and social welfare exemption we benefited last year during the COVID outbreak, combined transportation and sorting costs per parcel generated positive productivity gain over last year. Gross profit decreased 5.4% to RMB1.7 billion. Gross profit margin rate decreased 4.8 points to 22.8% as a combined result of price decline increased costs against the lower base due to one-time benefit during last year's COVID-19 outbreak. SG&A increased 26.1% to RMB394 million from increases of compensation and benefits, office expenditures, depreciation and write-offs of obsolete assets. Income from operations decreased 11.6% to RMB1.5 billion. Associated margin rate declined 5.8 points to 19.9%, mainly driven by that 4.8 points decrease in gross margin. Adjusted net income decreased 12.5% to RMB1.3 billion. Adjusted net income margin declined 5.3 points to 17.4%. Operating cash flow increased 54.3% to RMB1.9 billion. CapEx outlay totaled RMB2.2 billion. As we further strengthen our infrastructure in preparation of increasing demand for the core express business as well as resource planning for development of our ecosystem, our annual cash flow or CapEx is expected to be around RMB9 billion to RMB10 billion. Turning to business outlook. Based on the current market and operating conditions, the company maintains its previously stated annual guidance of 35% to 40% increase year-over-year for the volume. Our annual parcel volume is estimated to be in the range of RMB22.95 billion to RMB23.8 billion. These estimates represent our current and preliminary view and it is subject to change. This concludes our prepared remarks. Operator, please open the lines for questions. Thank you.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Ronald Keung with Goldman Sachs. Please go ahead.

Thank you, management. I've two questions. First is on the competitive landscape and how we think about the second half. Particularly as our full-year parcel volume guidance would imply for at least some 27% to 35% implied positive growth for the second half, so that will be faster than the second quarter. So I just want to hear as we balance profitability and growth, which we did very well in the second quarter as we currently expect based on the guidance some faster growth in the second half, would that be overall industry acceleration that we are expecting or would that be any fine tuning of our strategies in pricing and market share gains in the second half? And then my second question will be on our cost productivity. As [Yandong] talked about the positive productivity once we take out the one-off factors. So on a unit cost perspective, particularly as we head into the second half, how do we see the room to further cut on our unit costs, particularly on sorting and trucking? Thank you.

[Foreign Language]

I'll translate the answer to the first question first, and then I'll answer the second question. Our strategy maintains and the expectation for the second half of the year's growth is stable and maintaining or perhaps there's a chance of below second quarter growth. And as we continue to seize opportunities and rely on our own capability to gain market share, we want to point out to you that fourth quarter typically in the past, the market share of us is below the second and the third quarter. This is largely driven by seasonality. And the second question, we – after excluding the one-time effect for the COVID-19 benefits, second quarters per parcel cost is positively better than – the productivity gain is still there. Well, we expect the second half as we achieve a higher level of volume because of the seasonality and reaching closer to our optimal production level, the cost productivity will still be there and our current estimate is around 5% to 6% gain per parcel year-over-year. Thank you, Ronald.

Thank you, Meisong, Huiping Yan.

The next question comes from Eric Zong with Macquarie. Please go ahead.

Thank you, management. Hello. This is Ellie calling from Macquarie. So I have a question regarding – the management comments in the opening remarks regards to potential to opening up more channels towards the emerging e-commerce channels. So I would assume that includes a lot of the short-form ZTO channels. So could you provide some color in terms of the channel mix for the parcel volume and for these emerging channels? Would it be more negative impact or positive towards the overall ASP trend since they might have lower weight overall? So that's one question. And the second is quickly on the recent regulatory overhang. So we've seen governments issuing guidelines saying, some price control in the kind of last-mile, could we think we are now kind of in a inflection point where the overall price should be reaching more of a stabilizing stage. So from now on or second half we should be seeing at least on the competition side, this should be continued to be [indiscernible] from now?

Hey, Ellie. Thanks for your question. The first question, we have been expanding our penetration into all these new e-commerce channels. And typically what happens is as we take on these new parcel activities, we are usually represented as the largest share some as high as 25% and above. Now this entirety is still our attempt to enrich our product mix or to improve our product mix because we are typically, traditionally rely more on the traditional e-commerce. With the new development and innovation taking place in the market place, we are keen in making these connections with new up and coming channels and the results have been very positive. Now, still, I would say the total volume with respect to our core express business catered more towards e-commerce is still not large, but the trend is very promising. The second part of the question, regulatory intervention is indeed helping the stabilization of the entire express delivery operations. Price bottom is set because the sufferings typically is more felt at the last totem pole of the chain i.e., the grassroot level of operators and particularly so including couriers. So what we believe the price stabilization is a continued trend. Again, as we mentioned, this is very consistent with ZTO’s long-term practice in supporting our network partners. And in some cases, we may even provide more support because we set our sights on the longer-term, the ups and downs in the marketplace shakes the confidence and also the hope for the future, but yet at the same time, we believe it is critical for us to maintain confidence across the network where our network partners would be willing to invest. So with our strong corporate earnings, we are willing to provide more support than the market practice, at the same time maintaining the profitability, quality of services as well as market share gains.

And was there a follow-up, Ellie? Or does that answer your question?

No. Thank you. Thank you very much for the answer.

Thank you, Ellie.

Thank you. The next question comes from Lin Chen with JPMorgan. Please go ahead.

I have two questions. The first question is that we noticed that the company's market share has declined a little bit in second quarter, but that applies declines achieved a modest amount on top players. So my question is, whether it is a short-term change of a strategy or more like a longer-term change of strategy? And is the company still committed to 25% market share target in year 2022? And then my second question is about a social security payment. I understand that some employee have signed the contract with a third-party agents. So I would like to know how many employees have signed this kind of contract. And since the government encourage the direct employment of employees, so has the company has any plan to transfer these employees into permanent headcount and what will be the impact on the cost? Thank you.

[Foreign Language]

Our consistent strategy is to achieve targeted profit goal, maintain high quality of services while growing volume and market share. The temporary decline in market share for the quarter resulted from our emphasis on profitability without taking unnecessary losses and also under the positive influence of the regulatory intervention, so that we can allow our network partners to be less burdened by price competition, maintaining stable operations and restore confidence for their future. Prolonged and intensified price competition in recent years has threatened the very survival of outlet operators and couriers. Their legitimate rights and interests are under siege because they're often suffered the most. Raising attention to social stability, the relevant regulatory agencies has issued several policies and procedures this year intended to promote fairness and healthy growth of this industry. And we have said earlier that this has been consistent with our long-term shared-success philosophy as well as practice. ZTO is regarded as the industry leader to uphold government policy and help maintaining overall stability. So not only because of our shared-success philosophy and long-term practice is to achieve win-win with our network partner, but also because we strive to achieve optimal balance among quality of services, volume growth and profitability, we’re being more prudent on pricing practice and choose to let go loss-making volume during the quarter, so our market share retreated slightly. Again, as Chairman mentioned earlier, it takes real competitive edge to win and express delivery business relies largely on scale and efficiency. So we believe with a stable market operation and competition returning to sensibility, our competitive advantage will become even more apparent. We all have noticed the clear division in the market dynamics. So looking forward into an environment where growth is stable and also the market dynamic shifts could very well take place in any time. We are still hopeful and we will continue to strive to achieve our goal in volume growth and market share gains. The second question relating to the social welfare, indeed our 100% compliance is being closely monitored as well as uphold, including the outsourced employees, outsourced labor force, their social welfare are well established and we welcome practical solutions or planning on even better support the grassroot communities to protect their rights and interest going forward.

Does that answer your question or was there a follow-up, Mr. Chen?

I'm good. Thank you very much, Meisong and Huiping.

Thank you.

Thank you. The next question comes from James Teo with Bloomberg. Please go ahead.

Maybe I'll translate my question. And my question is regarding the ASP drop. There was RMB0.08 mentioned of which RMB0.04 was due to the lower parcel – weight per parcel. And I just like to know what is the reason and whether this trend would now continue?

Great. Thank you for your question. The RMB0.04 decline relating to the parcel weight, we have actually observed that trend. And the reason being that, that e-commerce itself is also evolving where – particularly also because of the COVID, people learn to shop online and they learn to shop more sporadically. Whenever there is a demand or a need for goods purchase, they would go online and they will do the shopping. So on one hand, we believe the efficiency and also the timeliness of express delivery business provided and supported that shopping behavior. So we believe that decline is a trend and it's a natural trend. Now I think the concern maybe – this is where I'm offering more explanation to your question. Concern maybe that as the weight continued to decline, the price will continue to drop. Actually we do have a minimum weight requirement and – so anything below that would be a flat rate. And as we continue to observe how the weight changes, I believe the industry in order to cover its fundamental costs, which is they're either heavier or lighter, we'll make necessary changes to the pricing structure. Hope that answers your question.

Yes. Thank you.

Thank you.

The next question comes from Parash Jain with HSBC. Please go ahead.

Thank you so much for taking my question. And I was just wondering if you can talk about your CapEx guidance. Where would we expect the second half CapEx to be deployed? And also if you can talk about the prospects of non-express businesses? Where do you see the most opportunity, whether it's cross-border or whether it's freight forwarding? And would you approach organic growth strategy or the focus would be to grow through acquisitions? Thank you.

Thank you, Parash for your question. The first part of the year we deployed RMB2.2 billion and our plan for the whole year on a cash outlay basis is RMB9 billion to RMB10 billion. About 70% of these are towards acquisition of land use rights and development of our infrastructure. Some of which are designed for comprehensive logistics service capabilities, and that shall be the similar proportion going forward for the second half of the year. As you know the land use rights and development of facilities takes cycles and there are pipelines that are visible to us. So RMB9 billion to RMB10 billion is what we are currently estimating. The second part of question relates to our development of the ecosystem. So you mentioned the cross-border, as well as coaching that we have talked about in our prepared remarks, as well as those already in operation for several years, including the cloud warehouse business, the freight forwarding or the freight LTL business, all these are in its totality coordinating and also addressing up and coming in evolving demand in the marketplace. Now if you compare to the western countries where large scale and also professional logistics service providers, they are very geared towards specialty services. And for ZTO because our express scale unprecedented and also in China market only, it has a better chance of evolving into specialized logistics services. And that is why we have planned our entire ecosystems development to be that. The special requirements for example, temperature control needed rights, cross-border as they continued to develop are all part of our overall strategy. The timing is most important, for example, international activities, while we do have growth developing in, we have delivery network developing in the Southeast Asia Pacific countries. Their structure are also limited because of their size and because of their local e-commerce conditions. Across the board going into Africa, going into Europe, we are currently in the stage of planning resources. So it is a very staged approach, not necessarily immediately spending investment across the board because again, our philosophy and our practice in the past is prudent and profit seeking. So it's inevitable. The planning is there. All the ecosystems will need to be working together. The cloud warehouse business provides one solution where in-house processing and also delivery pickup are connected with our LTL business, with our express business. And now we are connecting coaching business to it as well. So it is from one focal point in adjacency combined holistic solution to be provided to our customers.

That's very, very clear Ms. Yan. And if I can squeeze one more question. And you haven't drilled that in thoughts in earlier questions. When we talk about competition and consolidation, and there are moving parts where some of the provinces are trying to create a floor to ensure that the system is not stressed out. But does it mean that some of the rather subscale player may – the consolidation may delay as a result of it because the stress on their cash flow may not be immense as a result on – another way to think about it is that it will give an opportunity to better service provider like yourself to gain market share as a result because competition will shift from price to the service quality. And in that respect, how do you see the competition evolving outside Tongda players? Thank you.

Sure. Very good question. Again, as we mentioned that the growth of express delivery business rely largely on its infrastructure and it takes years to accumulate, and not a immediate quick fuel by the capital or a largely concentrated customer base would mean that much in our scenario where we are indeed servicing the entire country. And e-commerce platforms are also evolving with multi channels. With all that, I believe the smaller players have been exiting the scene or not able to sustain because they are lacking the operating efficiency and lacking the scale advantage or leverage. The M&A considerations, in that regard, we believe the quality of service, the value of the brand, the customer base, all these taking the consideration on top of whether they are profitable or not, has always been our gauge in whether to consider M&A or other types of merge. In the past, I believe Chairman has described a very interesting analogy where we don't need to acquire the brand or acquire the entire business, but because of the operations on the ground, naturally gravitates to those that are with higher brand awareness, stability as well as long-term prospects. So we believe in the current market dynamics, we are now willing to pay for a brand. Even though at the operational level, there has been consolidation taking place. The smaller players think they need to grow, I think specifically with a company perhaps starting with the letter day. Its growth is very unique and its capital structure, the cash utilization and the pricing strategy approach is an anomaly in our understanding, and certainly we will continue to simply focus on what we can do in growing our business with a long-term objective well maintained. And I hope that answers your question, if not, we can certainly have …

Absolutely. Thank you so much. Have a lovely day. Yes, sure. Thank you so much.

Thank you.

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

Thank you, operator. In closing, on behalf of the entire ZTO management team, we'd like to thank you for your interest and participation in today's call. If you require any further information or have any interest in visiting us in China, please feel free to reach out to Capital Markets department. Thank you for joining us today. This concludes the call.

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