ZTO Express (Cayman) Inc. (ZTO) Q2 2022 Earnings Report, Transcript and Summary

Good day. And welcome to the ZTO Express Second Quarter Financial Results 2022 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. Please go ahead.

Thank you, operator. Hello, everyone and thank you for joining us today. The company's results and an 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 then followed Huiping Yan who will go through the financials and guidance. They both will be available to answer your question 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 view and expectations of the market and operating conditions that 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, performances or achievements to differ materially from those in the forward-looking statements. Further information regarding these and other risks, uncertainties and factors are included in the company's filings with the U.S. Securities and Exchange Commission. The company does not undertake any obligations 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 go through his prepared remarks in its entirety in Chinese before I translate for him into English. Mr. Lai, please go ahead.

[Foreign Language] Hello everyone and thank you for joining us today in the second quarter of 2022, ZTO delivered a parcel volume of 6.2 billion, which increased by 7.5% expanding our market share by two percentage point to 23%. The adjusted net income grew 38.2% to 1.76 billion despite pandemic impact and weaker economic outcomes, ZTO delivered a strong performances in both market share and profit. While, we strictly implemented [Technical Difficulty] measures, we actively responded to the nation's call of stabilizing and growing the economy without compromising safety. Being among the first to resume operations, we proactively adapted our strategies to seize market opportunities. Through balanced approach to parcel volume growth and the stock expansion, we're actively advancing our long-term strategy. Firstly, we continued to focus on expanding our market shares through a comprehensive means. We are taking advantage of early resumption of operation, we restored uninterrupted parcel volume in COVID affected regions and enhanced our brand recognition and reputation with improved customer stickiness. Second, we leverage insights from in depth analysis provided by our digital platform to discover execution flaws that underpin the low or negative growth problems. We reexamined the cost of compensation against the effectiveness of pricing structure to stimulate incremental volume. Third, we aligned the resources towards various demands from submarkets to establish new business. For example, we increased our built out of [indiscernible] stores to serve customers with our time-definite product offerings and enhanced our fulfillment capabilities in specialized products and services. At the same time, we improved profitability by implementing process management measures. First, we conducted thorough reviews of KA customer accounts and eliminated unjustifiable loss-making contracts in accordance with the principles of granting fair and transparent policies for network partners and outlets. Second, we further enhanced our real-time data monitoring and analytics of costs enterprising for sorting centers and line haul routes which allowed us to optimize route and shift planning in a timely manner, which improved resource allocation around automation and transportation equipment, as well as human resources. Third, we furthered implementation of standardization in operating procedures across all sorting centers. Through clearer definition of job responsibilities and the standardized operating protocols, we were able to better align compensation and incentives to drive labor productivity. Fourth, we continued our effort through the layer of our network by reducing the number of stops a parcel makes as it flows from end-to-end. Helping others to process parcel aggregation enabling destination segregation at earlier stages of sortation are examples to achieve improved capacity utilization and cost efficiency across our entire network. Stepping into the second half of the year, while we insist on production testing, we will continue to focus on high-quality growth, to widen competitive lead, suspense and differentiated capabilities and implement the following work priorities. First, continue to improve the efficiency of our transit platform. We will standardize every step with digitalization that allows tracking, measuring and evaluation in order to improve the utilization of resources. Second, further implement partner network management. We must ensure that couriers have access to full market pricing associated with incremental volume so that they are incentivized to acquire new customers. We can assist our network partners to install capacity that meets onsite demand. We can lend our capacity to help network partners and share their workload and enhance the ability to sort, to find out [indiscernible] instead of interim destination. Third, accelerate the development of last mile presence and the consolidated last mile resources to further reduce pickup and delivery costs. We will continue to improve our service quality that meets diversified and the personalized to customer demand and improve customer loyalty. Fourth, further refined KPIs and improved rewards and the recommend mechanisms for quality of services. We will tackle root causes of service quality issues throughout the stages of pick-up, sortation, transportation and delivery aiming to improve timeliness and minimizing problems including parcel damages. Fifth, strengthen human capital development by talent attracting, retaining and faster check promotion for a board range of functions or positions. We will ensure our talent reserve as sufficient to support our business development. We will further emphasize performance evaluation of our potential general managers and the sorting center managers on very lower risk to ranking elimination footwork. Sixth, continue to expand the businesses in five key logistics segments within our ecosystem. Namely LTL, cloud warehousing, international coaching and [indiscernible] supported by financing and commerce. We aim to develop cross-selling information and technology integration and the sharing of managerial know-how. We aim to establish standalone competitive advantage by each of these segments, while cultivating energetics eco-advantage that are built around comprehensive logistics service. Even though the short-term outlook is filled with uncertainties due to pandemic and other externals factors, we believe that in the mid to long-term, the logistic industry is resilient and have great market potential. We believe that longer-term positive prospects and room for upside are still in place. ZTO's consistent strategy is to achieve continuous market share expansion and profit targets while maintaining high quality of service and customer satisfaction. Our track record has proven our company [Technical Difficulty]. For example, fairly and apparently aligning interests among our network partners and continuously attending growth in parcel volume and the profit, continuous iteration of technology and the information system and its application and strengthening our diversified logistic ecosystem in an orderly manner. Looking ahead, we focus on our remission with a strong sense of urgency. We will be left behind if we don't progress. We will be the best we can. This momentous opportunities support and cover our network partners and accelerate the widening of our competitive strength. Now let's have Huiping Yan to take us through the financial.

Hello to everyone on the call. If I go through our financials, please note that unless specifically mentioned, all numbers quoted are RMB including changes referred to year-over-year comparisons. Detailed analysis of our financial performance unit economics and cash flow are posted on our website. And I'll go through some of the highlights here. In the second quarter despite the headwind caused by COVID outbreak, ZTO delivered solid growth results, parcel volume increased 7.5% to 6.2 billion, advancing the quarterly market share by 2 points to 23%. The adjusted net income grew 38.2% to 1.76 billion. Total revenue increased 18.2% to 8.7 billion. ASP for the core express delivery business increased 10.5% or 0.13. Normalized competitive environment supported and helped to maintain second half 2021 price increases. In addition, our internal efforts to optimize customer base – [Technical Difficulty] Hello. Operator, can you check if everybody's sound is okay.

Yes, you may proceed.

Thank you. I'll just repeat the last sentence. In addition, our internal effort to optimize customer base is also generating meaningful results. Total cost of revenue was 6.5 billion which increased 14.2%. Overall unit cost of revenue for the core express delivery business increased 6.2% or 0.06. More specifically, line haul transportation costs per parcel increased 2% to 0.49 as a combined result of surging fuel costs and lower than expected volume offset by cost productivity gains through usage of higher capacity trailer trucks, improved low rate and better route planning. We estimated the negative impact from fuel costs hike was 0.04 per parcel for the quarter. Unit sorting costs increased 9.1% to 0.30 driven by increased labor salary and higher depreciation and amortization costs associated with a higher installed base of automation equipment. Gross profit increased 31.6% to 2.2 billion given increased volume in ASP against still relatively stable cost structure. Gross profit margin rate increased 2.6 points to 25.4%. SG&A expense as a percentage of revenue dropped 0.1 point to 5.3% demonstrating a lean corporate cost structure. Income from operations increased 36.4% to 2 billion and associated margin grew 3.1 point to 22.9%. Our operating cash flow grew 95.7% to 3.8 billion capital expenditure totaled 1.5 billion. Being an increasingly integral part of the economic revitalization and daily livelihood, the express delivery industry has shown strong resilience throughout lock downs and facing economic uncertainty. We believe that the industry's long-term growth potential and value prospects remain strong, by enhancing core capabilities, calibrating revenue mix and refining cost management, ZTO continues its consistent strategies to achieve sustainable high-quality growth. Furthermore, with continued efforts on developing integrated logistic ecosystem, we aim at providing comprehensive logistics services to meet diversified and tailored demands forging synergy and enhancing our leading position. Based on current market and operating conditions, the company maintains its previously stated annual volume guidance, which is in the range of 24.96 billion to 25.86 billion, representing a 12% to 16% increase year-over-year. These percentage increase estimate meaningfully above anticipated industry average reflects company's commitment to further our growth strategy and confidence in our ability to deliver despite macro uncertainties that still exist in the marketplace. These estimates represent management's current and preliminary view, which are subject to change. This concludes our prepared remarks. Operator, please open the call for questions. Thank you.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Liu Su with Citi. Please go ahead.

[Foreign Language] Now let me translate my question. Thanks for management to taking my question. My first question is regarding to the service operation in [EU] [ph], according to the latest, the local COVID measures that was announced last night you lifted the closed off management in some region. It also mentioned that the logistics, the ecommerce and the enterprises shall resume operation in an ordinary manner. Could the management kindly share more color on the implementation details? For example, to start with what region whether it requires access paths that how should we anticipate the overall recovery pace? And when would the parcel volume return back to normal? And what would the parcel volume impact during the prior seven days service suspension period in EU? And my second question is regarding to the ASP trend. So the whole industry overall, ASP were relatively stable this year, even during the slow season. And aside from previously mentioned, some internal customer-based optimization, and what do you think are -- some like external factors behind that such as policy, high fuel price, the COVID resurgence or some other factors? And going forward how do we force the ASP trend in the third and fourth quarter or even in longer period? And the do you see any short-term price pressure from the recent domestic fuel price jump and the service resumption in EHU. And meanwhile some of our peers slightly increased the ASP EHU at end of July and we seemed didn't -- what was the logic behind that and whether we would follow their steps going further. And thank you very much.

[Foreign Language] Thank you for your question. First of all relating to EHU, indeed started 11th of this month, there are lockdown and it's gradually resuming. However, for express delivery businesses, we need to stay coordinated with the government's inspection because it is a concerted effort across all industry as well as logistics. Some of our outlets have already started picking up packages. So it's a good indication that things will return to normal. EHU represents about 10% of our total volume. So it's about 6 million to 7 million packages a day. Now the question regarding pricing. EHU has always had a level of premium against all the other tongda pricing. So we think that it has something to do with the recent price increases, and our prices already slightly higher. So we are not preparing or anticipating any changes at this moment. Second half of the year, we think that the overall theme is stabilizing for the pricing. Typically in the industry, there is a normal variation from month-to-month. For example, from August to September, there's about six to seven points increase and from September to October, and so on so forth, all the way through November, the increase in volume demand, and it's associated also with the price gradual increase. So overall, for the second half the year, we think the price will go up slightly for third to fourth quarter, will hike up about 20 points or so. So it's a stabilizing increases. And if I may, supplement to the longer-term, the industry is with significant growth potential and because it is indeed part of the day-to-day life with varied channels of ecommerce development, for example, video streaming and all that. So we think that the overall pricing will continue to stabilize and being such a low starting point for express delivery because it's associated largely with ecommerce costs being the largest concern going forward, we think the upper increases is very much likely.

Our next question comes from Tian Hou with TH Capital. Please go ahead.

[Foreign Language] The first one is, I saw the margin in second quarter, it was really good, much better than other quarters in last year. So earlier this year, management did give the guidance for the full year profit. So I would like to hear more about the margin trends, which was the second half of 2022. That's number one. Number two is amongst all the parcels, what's the portion from ecommerce and as we grow into new business, so maybe ecommerce portion is going to be less than before? And also for the --among ecommerce how what's the portion of -- from the new platforms such like TikTok? Okay, that's all my question. Thank you.

Thank you, Tian for the question. Let me try to answer these questions. First question relating to the margin. Why are the good reasons for the margin increase? As we stated earlier, the price for -- first of all, we are able to sustain the price that was increased from the past year. And because of the competitive environment it is stabilizing, and for the second half of the year, we think because the price hike was started in the second half of last year or the relative ASP increases will be tapering off and that leads to the comment on profit. Profits, second half of the year, relative to the first half of the year, the pace of expansion will be slower, certainly because it's the base. And then, if I may comment a bit more on the qualification of -- behind your question, although I don't think I can give you the specific numbers. The revenue increases driven by ASP we've explained but I think most importantly is what we're doing on a cost side. Cost side of initiatives are including addressing specific loss-making transactions, improving our mix and advancing our volume. So that we could utilize all our improved utilization of our capacities. So, all these are intact and in place and with the labor cost increases we have automation, we have better route planning, so that the transportation costs will also be reduced. And I think if you recall, we had addressed the overall cost, productivity gain, it really is associated with our total sort of delayering or shortening the distance from package flow -- for package flow. So in other words, reducing the number of sortation for a particular package as it goes through all the stages of the transit. So these are structural improvements that will give us longer term price productivity gains. Third quarter fourth quarter, the businesses so far what we have observed is still relatively stable. So that answers your first part of your question. Second part relating to the ecommerce as a proportion of our total business. It has been stable, as ZTO being the largest player in the express delivery industry, we have maintained a high level of market presence and that applies the same to existing traditional or new commerce into the ecommerce space. So our proportion is consistent with our total market presence.

Our next question comes from Qianlei Fan with Morgan Stanley. Please go ahead

[Foreign Language] So I'll translate for myself, I have two questions. The first question is about CapEx and daily capacity. So considering a slowdown in the industry volume growth. Do you have any adjustment or new guidance on the full year CapEx? And also what's the daily handling capacity by the end of the year? And my second question is about cost. So, we have seen that if we exclude impacts from inflation, actually in the second quarter unit cost optimization has continued. So wondering, is there any guidance on cost efficiency improvement in the second half of the year? Thank you.

Okay. So let me answer the question for the CapEx. Indeed, our goal and target for growth is significantly above the industry average. And because we, it's reflected in our strategy and we believe that growing volume, growing our market share is crucial for considering the nature of our business, right? It is a scale driven business. So our CapEx spending, although with that said, is very much managed against the demand. And what we have anticipated the overall growth, we don't want to over invest ahead of the time too much. But yet, we don't want to stay behind because we are with a focus growing our volume. So the current CapEx goal is still kept somewhere around 9 billion. We're not going to exceed that. And then I think the likelihood is probably somewhere around 6 billion to 7 billion, but we want to make sure that we capture the market opportunities. So this range is pretty wide. However, it is going to be managed closely. The second part of the question is indeed we have put in a lot of effort in addressing our cost productivity gains. With that also considering the second half of the year the seasonality, the volume changes, we think that the cost will continue to have leverage.

[Foreign Language] So let me further translate for the Chairman. It is consistent to what I had just described. In relative to the first half of the year because the volume is below our expectation, our scale leverage is not necessarily fully demonstrated. We indeed have significant capacity preparedness and in the second half as the volume for the whole industry, which is anticipated, a higher than first half we think our scale leverage will further demonstrate and the cost per unit will decrease.

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

[Foreign Language] Thanks management for taking my questions. We have seen a very impressive earnings in the second quarter. I just want to get some color about investment strategies. How should we think about the investment in new initiative going forward? And with that stack of wood, we use some of our earnings to invest for the future. And my second question is about our market share. Given that we have increased our market share by two percentage points during the quarter, just want to get some color about our long-term target in terms of the market share gains story. Thank you.

Thank you for your question. The first question relating to our investment. I think I understand that you are referring to both our new products within our core businesses as well as the investment perhaps in our ecosystem. Now I'll just answer to those two areas of investment strategy. The first part, we think that to differentiate ourselves from the rest of the tongda we are, and we have been investing in time and energy in developing differentiated products to allow consumers or customers to have a different experience and also allowing them to meet to receive individualized services for their diversifying needs. And our capability of fulfilling these commitment are requiring investments. So indeed, that is part of our strategy and plans. Although the volume as of now is not significant so we are carefully, and we are prudent in investing on those part of the new capabilities development. And the second part to our ecosystem. The ecosystem, if you look back to our past, our approach has always been rather it's an extension of our existing capabilities and resources because our goal is to fully utilize or double and triple usage of our existing investment and existing resources. So the growth of our ecosystem is also a very coordinated and it has its own pace, where if you referring to invest in new initiatives that could add to our existing capabilities or capability that are missing, then it refers to our normal M&A businesses. So yes, we will continue to look and we will continue to see based on the opportunities that are there for us to expand our comprehensive capabilities and we will look inward to see what do we have what we don't have. So that's a part of the normal M&A but we're not saying that we will be deviating from our traditional, our established way of investment discipline. Market share longer-term goal, as we had anticipated the overall potential in the industry, the growth prospects, we think that we are in a very good position to reach 30% or even 40% of the overall market in the next five to 10 years. Again, that's a very loose range. However, as we mentioned, it is a scaled business, a scale leverage is important. And as the demand is there, as the growth potential is there, we have the best competitive advantage we are in the better, most favorable position to achieve a higher market share and that is indeed what we are trying to achieve. Hope that answers your question.

Our next question comes from Frank Yip with Daiwa Capital. Please go ahead.

[Foreign Language] So two questions, first related to the more longer-term industry parcel volume and the ASP growth target. And the second one is related to the -- do you consider doing the dual primary listing on the HKEX. Thank you.

[Foreign Language] Let me translate for Chairman the first question in the next two to three years, the growth of the industry. So, we remain confident in the entire industries longer-term growth, because the potential is deep and the ability to expand is still very strong, particularly speaking, the penetration into rural, agriculture as well as manufacturing opportunities are just starting to present itself. So, we expect the industry will continue to grow especially when you have this concentration in the top players continue to increase the scale and the leverage will further support and propel the healthy growth of this industry. The second part of the question relating to a dual primary listing including in the U.S. and Hong Kong. We have been researching and I think the company has no hurdle so therefore it is an option for us to achieve such in due time.

[Foreign Language]

[Foreign Language] Let me translate. Our overall view is that the industry pricing will be stabilizing and slightly and gradually increase. It is fermented by its nature and the current development trend as the players -- as the market share becomes more and more concentrated in other words the pricing power will be there. We believe the pricing going higher and increasing is very much likely it has a high probability of increasing.

[Operator Instructions] Our next question comes from Yiling Chen with JP Morgan. Please go ahead.

[Foreign Language] I would like to -- have mentioned, wanted to make a comment on a difference in digitalization level with its peers -- with its closest peers such as [indiscernible]? Thank you.

[Foreign Language] Relative to the other industry peers, technology has always been a core competency or core focus of our business. We have invested consistently and amongst tongda, we invest the largest amount. And also, we are the most innovative there are many application of the technology uses are originated from the ZTO. This year, we will continue to strive for this competitive advantages development. For example, the initiatives include one expanding our technology, empowerment and extend that capability to our outlets, helping them carrying out more online and real-time management of their operations ensuring their policymaking financial analysis, are all done with digitized solutioning. And also it includes the end of the line management capabilities all the way extending to the couriers. The second part, which is also a very effective initiative that is generating significant results for us that is the -- what we call it [indiscernible] meaning we are focusing more on real-time, more frequent more in time visibility to the data and so that we could find issues, find problems as soon as we can and resolve them as soon as we can. And this extends to all across -- it extends to across our operations all the segments, including the sortation, the transportation, the route planning, the labor, utilization, labor productivity and so on and so forth. And this will further our ability to gain productivity in all front. That is what we are. I don't think we want to try to compare with all the other players because each has a different starting point and each has different resources and capabilities and focus, they are doing well and some of them are, what we are able to learn from and some are that we are able to do better.

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

Thank you again for joining us for the call and we look forward to speaking with you further if you have any more questions.

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