ZTO Express (Cayman) Inc. (ZTO) Q2 2024 Earnings Report, Transcript and Summary

Good day, and welcome to the ZTO Express to announce Second Quarter and Half Year 2024 Financial Results Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Sophie Li, Corporate Secretary and Director of Capital Markets. Please go ahead.

Thank you, Betzy. 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 investments 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 read through his prepared remarks in their entirety in Chinese before I translate for him in English.

[Foreign Language]

[Interpreted] Let me translate for Chairman first. Hello, everyone. Thank you for attending today's conference call. In the second quarter of 2024, ZTO maintained industry-leading service quality management, and with our parcel volume growth at 10% year-over-year that reached RMB 8.45 billion. We achieved adjusted net income of RMB 2.81 billion, which increased 11% over last year, demonstrating continued strong profitability. In the second quarter, despite macroeconomic softness, driven by booming development of e-commerce promotions, online consumption maintains relatively high growth. Parcel volume of China's express delivery industry increased 21.3%, exceeding expectations. However, the proportion of low-priced e-commerce parcels continue to trend up and price competition further intensified, while prioritizing service quality. ZTO continued to [ 6,000 ] among service quality to process and the scale to drive sustainable and healthy development of the entire network. During the second quarter, upon further elimination of unprofitable volumes, our market share contracted by 2 percentage points compared to the same period last year. At the beginning of this year, across all 3 of our major metrics, we put greater expertise and quality while maintaining a scale advantage towards level and appropriate level of profit. We directed attention and resources towards upgrading customer mix, refining differentiated products and services and incoming brand awareness and customer satisfaction. Our last-mile development, we implemented these initiatives to explore opportunities to reduce last month delivery costs and improve the profitability for all-list and careers. In the second quarter, ZTO's end-to-end delivery time ranked top among Tongda peers and the customer complaint rate continued to decrease. Meanwhile, with the improved response time and on-demand service capability, the ratio of retail parcels was further extended. As the optimization of revenue structure partially alleviated unit price pressure, driven by price competition, our ASP was flat. Combined with the cost efficiency gain and a reasonable SG&A structure, both the unit profit and the total profitability remained industry leading. Entering into the second half of the year, the industry volume kept a strong growth momentum. Meanwhile, despite the intense price competition in the production regions, we observed a limited room for further price cuts given the typical cost-plus pricing model. It's time for the entire express industry to shift from high-quantity to high-quality development, driving to fulfill social viability and serve capital objectives. ZTO's leadership action to transform from high-quantity to high-quality stems from our long-lasting focused on being the best retailer and achieve balanced among quality, profitability and scale. Considering the market conditions, we work more effort on company brand awareness and recognition on the premise of achieving scale advantage to volume level large campaign process. In addition, we are committed to actively address the interest and needs of the network partners and peers, specific actions under implementation in [ the system following ]. First, we will revamp, present and improve network policies to ensure performance relevancy, transparency and fairness with clear rewards or recommend effectiveness. Second, we will continuously enhance service quality with refined indicators closely tied to performance evaluation. Our tailor-made support and improvement for underperforming ours to drive high quality as well as differentiated services. Third, we will firmly advance the last-mile profit allocation strategy, promote courier's proactiveness to increase the retail parcel ratio and achieve more income. Fourth, we will accelerate the expansion of last-mile offerings, encourage larger outlets to invest in this winning business, establish direct linkage to a last-mile proposed, reducing delivery costs and the free income delivery personnel to concentrate on servicing last-mile customers. Through consolidation of resources, we intend to provide solutions alleviate delivery cost pressure for the whole industry. Fifth, we will further enhance our products and increase the penetration of high-end products, strengthen collaboration with online platform and leverage ZTO's logistic ecological resources to expand capability of comprehensive supply chain, improving brand awareness and the customer appreciation. Sixth, be vigilant and maintain the sense of prices facing market uncertainties and fluctuations. We will increase effectiveness of communication with our network partners, unified thinking and reinforce confidence and advocate that balance between long-term and short-term future, gaining network stability. Despite uncertainties in the macro environment, the express delivery industry has demonstrated resilience across economic cycles by offering robust support for the advancement of digital economy and improving circulation efficiencies. With our seizing opportunities in front of challenges, including intensified industry competition, ZTO will focus on service quality, further last-mile strategic objective and enhanced profitability for allies, as well as couriers by establishing unique competitive advantages so as to gradually but satisfactorily differentiate ourselves from the rest of Tongda in brand recognition and customer satisfaction, providing more choices for customers -- for consumers and customers. We're aiming to create value for the country, society as well as employees and shareholders. Now let's hear from Huiping Yan about our financial results and targets.

Thank you, Chairman Lai and Sophie. Hello to everyone on the call. As I go through our financials, please note that unless specifically mentioned, all numbers quoted are in RMB and the financial changes refer to the year-over-year comparisons. Detailed financial performances, unit economics and cash flow information are posted on our website, and I'll only go through some of the highlights here. In the second quarter, we adhered to the principle of profitable growth and achieved a 10.9% increase in adjusted net income to reach RMB 2.8 billion, while continuing to improve the quality of services and brand value. Our parcel volume grew 10.1% to $8.45 billion. We continue to fine-tune resource allocation to achieve optimal balance between volume and profit in the second quarter. ASP for our core express delivery business stayed flat at RMB 1.24 as the impact of decline in the average weight per parcel, an increase in incremental volume incentives were offset by the positive impact of the volume increase in non-e-commerce parcels. Our total revenue increased 10.1% to $10.7 billion. The cost of revenue was RMB 7.1 billion, which increased 10.4%. Overall unit cost for the core express delivery business increased 0.7% or RMB 0.01. Specifically, line haul transportation costs per parcel decreased 6.8% to RMB 0.39, driven by improvements in fleet operations with better resource utilization. Unit sorting costs increased 4.6% to RMB 0.26 due to increased D&A cost on new equipment and facilities. Unit KA costs decreased RMB 0.04 -- or increased RMB 0.04 in line with KA revenue increase. Gross profit increased 9.6% to RMB 3.6 billion, and gross profit margin rate decreased 0.1 points to 33.8%. Consistent with gross profit, income from operations increased 11.7% to RMB 3.2 billion and associated margin rate grew 0.4 points to 30%. SG&A expenses, excluding SBC, as a percentage of revenue grew 0.3 points to 5.5%. Corporate cost efficiencies remained intact. Operating cash flow was RMB 3.5 billion, which decreased 7.5%, mainly due to dividend tax and increase in financing or loans to our network partners. Adjusted EBITDA was RMB 4.3 billion, an increase of 11.7%. Capital expenditure totaled RMB 1.3 billion for Q2 or RMB 2.9 billion for the first half of the year. With that, we anticipate annual CapEx in 2024 to come in below RMB 6 billion, as previously planned. The company has announced an interim cash dividend of USD 35 per ADS and ordinary share for the 6 months ended June 30, 2024, which is a 40% payout ratio, to holders of its ordinary shares and ADS as of the close of business on September 10, 2024. Now moving on to our guidance. We stay committed to our balanced approach to sustainable and profitable growth, prioritizing improvements in quality of services and development of differentiated products and services to enhance brand recognition and value. We are reiterating our 2024 volume growth guidance of 15% to 18%. These estimates represent management's current and preliminary view, which are subject to change. This concludes our prepared remarks. Betzy, please open the line for questions. Thank you.

[Operator Instructions] The first question today comes from Ronald Keung with Goldman Sachs.

[Foreign Language] First is about our parcel volume of 10% and slower than the industry. So as we talked about in the announcement as well, volume is not an important as it brings scale leverage. So I want to hear your guidance to be implied second half. Should we -- will we expect some fine-tuning of our strategy to maximize the scale, parcel volume and profitability? And second is for the unit profit, we see mostly stable. That implies the underlying unit cost actually has been quite stable as well. Is there further room to improve on operating efficiencies? Or have we maxed out all of the efficiencies that were done in the past? What further could we do to improve the operating leverage of the business?

[Foreign Language]

[Interpreted] Thank you, Ron, for your questions. So let me translate for the Chairman. First question, indeed, the parcel volume for the total industry has grown, and it exceeded our expectations. In the second half of the year, we do have the following plan. Our market share decreased 2%, the main reason being that, first, there are a lot more price competition or price competition intensified. There are a lot more ineffective, or we call it, ineffective indeed, it is just below the cost, it's priced below the cost. So the overall proportion of nonprofitable volume has increased. So what we do is we very effectively controlled such volume coming into our network because we adhered to our strategy that's set out in the beginning of the year to focus more on quality of services, and with that, to achieve appropriate level of profit, and in turn, market share. If we look at it in an overall perspective, our capacity and the volume are in tune. They are reasonably matched. In the first half of the year, the results that we achieved is out of the range of our 15% to 18% guidance for the whole year, which means that in the second half of the year, we should at least to achieve 18% of growth in order to come into the range of our previous guidance. And based on the current conditions and current view of our businesses, we have a high confidence of achieving such target. So more from a theoretical perspective, if we want more volume, we can simply reduce the price. But we didn't choose to do that, again, because we wanted to focus on profitable growth while achieving reasonable match between the capacity and our market share volume gain. We should be able to achieve healthy growth on both. Second half of the year, again, we will continue to focus on improving quality of services, developing differentiated products to achieve a reasonable level of profit and volume balance. Second part of the question, indeed, for the entire industry through all these years of fine-tuning of operations and investment of automation and so on and so forth, the unit cost productivity gain has been declining. For us, however, in the first half of the year, we exceeded our goal for cost productivity gain for the year. We have invested for over 26 super sorting centers. There are reserves, ample reserves for capacity release in the future. We do believe that the capacity installed, as well as its flexibility in meeting as up to 50% of volume demand, we are still well on track to consistently and gradually release meaningful cost efficiency going forward. Then for the unit profitability, based on the overall capacity as well as the reserve, we think that the strategy being consistently carried out, there will be stability in our profit growth on a total level as well as unit level.

The next question comes from Qianlei Fan with Morgan Stanley.

[Foreign Language] Let me translate to myself. Congratulations on the very resilient profit growth in the same quarter. I have 2 questions. The first question is about the retail process. In announcement, company mentioned that we are on track to double our retail parcel volume. And would you please remind us our current daily retail parcel volume, the percentage in operating volume in our total volume, our target for this year and probably the target to achieve for the next few years? The second question is about cost reduction. We understand that the competition of express delivery business is not only about cost reduction at the line-haul, but also about cost reduction at the home network, especially at your network partners and last-mile. So would you help us to better understand our initiatives to help the network and last-mile to reduce cost and potential cost-saving room in the next few years?

[Foreign Language]

[Interpreted] Thank you very much for your question. Currently, our daily volume of non-ecommerce parcels exceeded 5.4 million, and our year-end goal is to achieve daily volume average 6 million packages. You know that in last year we started off with daily volume about 4 million packages, and we are on track to achieve our goal to double that volume because the peak volume would most likely exceed 7 million parcels per day. And this is our goal and we are confident to achieve that. How do we achieve that? And Chairman went into the details, so give me some time, I will go through the specifics with you. First of all, it's related to increasing the ratio, is what we referred to in our remarks, of non-e-commerce packages as a ratio to our delivery total. So in other words, if I deliver 100 packages and there needs to be at least 6 packages pick up as non-e-commerce. So one other thing. There are 4 specific strategies that we implemented to improve the portion of non e-commerce or what we call it, individual parcels or retail parcels. One is to enhance consumers' willingness to send parcels at our post through deliberate marketing effort and the promotions in using of digital tools. So the handheld, building your own focused group or targeted group is something that are being implemented. Number two, training our couriers to improve their awareness of serving customers in the customer loyalty. So more personalized, more higher-quality standards issued to our couriers so that they are able to be recognized having the capability of serving to-door as well as pickup from the consumers -- from the customers. Number three, shifting quality management of the delivery services, focus from post-event to pre-event, so thereby reducing the customer complaints or anticipate any potential problems that could arise, so hence, improve the overall experience. Number four, strengthening the corporation with e-commerce platforms, enhancing direct coordination between the headquarters and Tongda platforms. Currently, while we have achieved direct settlement process with [ Meituan ], Pinduoduo as well as [ Xiu ]. And improving -- the second part is reducing the cost of the last-mile. The initiatives, there are 2 folds. The first one is relating to the couriers, what we call it [Foreign Language] policy or initiatives, which started last year. The goal is to increase the income of our couriers. So early on in our remarks, we talked about allowing the couriers to achieve market pricing or gaining the majority share of the market pricing is to incentivize them so that they are motivated to make a special trip to go pick up. The second part of the initiatives relates to improving the outlet's profitability. Last year we have about close to 2,000 outlets installed machinery and equipment that enabled them to provide package that are sorted or directed or destined directly to post. Chairman gave an example. In the past, the couriers have to go to the post -- sorry, go to the outlet, help sorting or they have to ride to the post -- ride to the outlets to pick up the packages that are bound for their delivery service area. So with the installation of those machines, the outlets no longer rely on manual sortation. So the riders or the couriers do not need to travel to the outlets anymore. And instead, they will receive packages directly from the outlet, either through autonomous driving vehicles or electrical vehicles that are utilized by the outlet to send those packages directly to the couriers. So that the couriers can work within a much smaller and more concentrated service area radius, and hence, allowing them more time and more focus on serving to-door and also pick up from the door. Another aspect of this second initiatives relates to the outlet. With the direct -- sending the packages directly to the couriers as well as sending the packages directly to last-mile post, the outlet owners are able to reduce their delivery cost. For example, in the past, each packages, on average, would cause the outlet about RMB 0.80 for the couriers to deliver. Now couriers would then put part of their packages into the post, which will share their RMB 0.80 -- RMB 0.40 out of that RMB 0.80 will go to the post. With that initiative that we implemented, the direct linkage between outlet and the post would allow a greater portion of close to 60% or 40% of the packages going to the post directly. So then the outlet does not need to pay the whole RMB 0.80. So we estimated and we calculated, of that RMB 0.40, because it still needs to be sent to the post, the outlet owners would pay, on average, between RMB 0.10 to RMB 0.20 to achieve that direct delivery to the post. So first of all, the RMB 0.40 reduction in payment to the courier and then a cost of about RMB 0.10 to RMB 0.20 to send those packages to the post, the outlets could net about a RMB 0.20 or so saving on the delivery cost. Going forward, we are going to focus on these initiatives in full implementation, then we will achieve a goal of not only improving the outlet profitability as well as the couriers earnings, so hence, the long-term effect would be for the overall network stability to be established because the profit level will be increased. And it will provide support for our overall delivery fee reduction, not only for us, but also potentially as a solution to the whole industry. This is not an overnight ago. We are working towards this change in shift from volume to quality, to focus on more differentiated products and services so that ZTO could break away from marginalized price competition and establish competitive -- unique competitive advantage.

The next question comes from [ Lu Jiang with Haitong ].

[Foreign Language] First of all, congratulations to company for achieving good performance in the second quarter. My question is about the capital expenditure plan for the years 2024 and '25 and the longer period. I'd like to know which area of the investments were allocated to and how we make the capital expenditures flat? Second question is about the cost reduction place about the whole process in the future.

[Foreign Language]

[Interpreted] Thank you very much for your question. Well, the first question is about the CapEx. In the past, we have been consistently investing in CapEx, mainly to build sortation centers and established transit capabilities. So today, most of our super sorting centers were self-owned and above 90% to be specific, if I may supplement. So going forward, we won't be in need of expanding our CapEx spending. Based on the economic development, some areas or weaker areas, we have also reserved base 200 to 300-hectare acres, for example. If our volume demand increases onefold or even twofold, we have sufficient reserves already there. So we don't need to spend capital to acquire further more significant land use rights. We just need to either develop them or upgrade them. The consideration, however, do need to be given to our initiatives in the longer term, they have a lot being comprehensive logistic capabilities, for example, warehousing or in-warehouse processing, LTL businesses or those ecosystem businesses do rent spaces from us so that they are able to form a comprehensive and higher-efficient -- efficiently co-located product and services by utilizing our capacity. Going forward, it is very clear that acquisition for land use rights, building supercenters are going to be very minimal. The growth of our -- or putting in line of services, putting services, the capacity is very much directed or matched with our anticipated demand of capacity in this sortation, transportation and all the segments of our operations. We are able to foresee with a very clear visibility, and going forward, we will be able to generate increasing free cash flow, where we talked about giving back return to our shareholders. It's based on the fact that the cash generation will continue to be healthy, and the CapEx spending will be stable or reducing going into 2024, 2025, so that our overall return to the shareholders will increase. The second part relates to the question on how we are able to continue to reduce the operating cost. Indeed, as you look into the past, even though ZTO has been leading this effort, but for the whole industry, it has been continuously achieving high cost efficiencies. In the past, what we've been doing and what we've been able to achieve greater results or ahead of everybody, is that our connection between the outlets and the sortation center has been more advanced or more ahead of everybody. Now going forward, as we continue to rely on lean operations, looking into greater visibilities of each of the segment of our operations, we are still able to, as volume increases, as our productivity gain continue to release, we still believe there are plenty of opportunities for us to achieve scale leverage as well as, on a unit level, continued cost efficiency. And then the second consideration, which is more of a long-term but steady visibility to us is that because of the route planning, we talked about in the past, the tri-layer throughput concept, as again, we said earlier, we were able to improve the connectivity between the outlets and sortation center. Going forward, as volume increases, we are able to establish greater connectivity between the origination outlets to a destination sorting center, or the third player being the origination center to the destination outlets, or the origination outlets to destination outlets. All these are -- simply put, an effort to reduce the number of sortation. In the past, we were at the level of 2.5 per parcel. We are reducing it now to 2.09 and continue to decrease because of better our planning and volume increases. We estimated for each onetime reduction of the sortation, we are able to reduce about $0.25 being $0.10 in sortation and $0.15 for transportation. With that, we have clear room for the future to further reduce our unit level cost because of this tri-layer throughput concept. Market share, as we looked at the first half of the year, declined 2 points. This is still matched relatively well with our capacity or capacity in services. Anywhere outside of that range will not generate as effective economy of scale and will cause us to have increased marginal cost with diminished marginal benefit. So we are, as you asked the question, how we plan our capital investment and deployment. It's very much a science related to what we are able to serve, what are the capacity build up, what we anticipate to come with the most optimal volume and optimal cost.

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

Thanks again for your continued attention and support. Our strategy shift in the beginning of the year has been very effective for us, specifically in improving the non-e-commerce packages. It's reflected in our bottom line. Balanced approach will continue to be our future focus, including the last-mile initiatives. We believe we are building long-term competitive advantages so that we are differentiated from the rest of Tongda. We look forward to speaking with you in the future, and thanks again for joining today's call.

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