ZTO Express (Cayman) Q2 2023 Earnings Call Transcript

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August 29, 2023

There are 6 speakers on the call.

Operator

Good day, and welcome to the ZTO Express Second Quarter 2023 Financial Results Conference Call. All participants will be in listen only mode. Please note this event is being recorded. I would now like to turn the conference over to Sophie Li, Company Secretary. Please go ahead.

Speaker 1

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.

Speaker 1

Huiting Yan, Chief Financial Officer. Mr. Lai will give a brief overview of the company's business operations and highlights, followed by Mr. Yan, who will go through the financials and guidance. They will both be available to answer your questions during the Q and A session that follows.

Speaker 1

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.

Speaker 1

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. Meisheng Lai. Mr. Lai will read through his prepared remarks in their entirety in Chinese before I translate for him in English.

Speaker 1

Hello, everyone. Thank you for joining today's conference call. In the Q2 of 2023, while maintaining a high level of service quality, DTO grew its volume by 23.8% year over year with a total of 7 point 68,000,000,000, further expanding our market share to 23.5%. Meanwhile, through enhanced revenue structure and the process management, we improved overall operational efficiency and achieved net profit of RMB2.53 billion, representing a 43.9% year over year growth. Relative to a pandemic affected low base of last year, the Express Delivery Industry's overall parcel volume grew 20 point 9% in the Q2 of this year.

Speaker 1

Depending on varied priorities for scale and the profit, each brand implemented different competitive strategies. ZTO has consistently pursued sustainable profitable growth, focusing on long term goals and competitive advantages. In the Q2, we executed the following key task initiatives, which helped generating solid performance results. 1st, we revamped the talent reserve program and through systematic evaluation quickly replaced those who could not keep up. With a strong talent pool and pipeline buildup under a compete, elevate the past atmosphere, our team of provision managers are becoming younger yet more prepared to take on greater challenges.

Speaker 1

2nd, we exceeded expectations on cost optimization. In the Q2, we continue to implement operating process standardization and further refined our evaluation metrics to be more detailed and quantifiable. Our ability to correlate process data to specific behavior of a workstation or individual task operator improved. This enabled us to flag anomalies properly and effectively rectify problems with precision. 3rd, we refined volume, cost profit tools and further the implementation across the operational network.

Speaker 1

We sort through the methodologies for pricing, revenue and the cost of sharing between sorting centers and outlets. This effectively enhanced the profitability of our entire network and further widened our industry lead. Benefited from post pandemic recovery in the Chinese economy, the express delivery industry has resumed a healthy growth in the first half of twenty twenty three. Despite price for volume behaviors that are still present, the evolutionary trend of the industry dynamic is very clear. Market share gains through low price competition is often unsustainable and in many cases lead to more detriments than gains.

Speaker 1

We are convinced that high quality of services, robust infrastructure and efficient operations are crucial ingredients to a scaled and strong express delivery enterprise. ZTO's competitive strategy is to maintain flexibility to be offensive or defensive. Locking bottom line and focus on developing our own capabilities from the long run. We will adhere to our own pace and fastly establish and strengthen our competitive barriers. With mindfulness on operational safety, we will keep digging deep trenches in the following 4 key areas.

Speaker 1

1st, improving service capabilities by focusing on end to end timeliness, streamline and improve operational efficiencies through process standardization, establish more direct linkage among sorting centers, outlets and lost mail posts, ultimately reducing sortation frequency. 2nd, expediting the implementation of lost mail initiatives and encourage network partners to pass on market pricing to couriers so as to incentivize responsiveness for pickup and delivery, increase non e commerce package volume, hence enhance the profitability of outlets and couriers. 3rd, for those outlets whose volume exceeds certain threshold, we will increase attention and managerial support to help developing infrastructure, implementing safety measures, enhancing service quality and digitizing information and management, improving operational efficiencies and last mile connectivity. 4th, expanding last mile presence and transforming 2 Seat Life Plus into a shared solution for every industry player to reduce lots more costs, enhance in person service capability and connection with consumers. Long term microeconomic development will undoubtedly trend upward and cyclical fluctuation only provide opportunities for long term value seekers to explore potential and build endurance.

Speaker 1

The competitiveness of the competitive dynamics of Chinese Express Delivery Industry have entered into a critical development stage. We are fully aware of our own strengths and advantages. We know what we can do and understand what needs to change. Innovation and entrepreneurial spirit are embedded in our shared success culture, propelling us to create value first for others and the society. Leveraging the power of technology, we aim to enhance operational efficiency, 4 j distinct set of competitive advantages, formulate solutions for over 100,000,000 a day parcel volume and usher in payback and the prosperity for Express delivery participants and investors.

Speaker 1

With that, let's welcome Ms. Yan to review our financials.

Speaker 2

Thank you, Chairman Lai. Hello to everyone on the call. As I go through our financials, please note that unless specifically mentioned, all numbers quoted are in RMB Percentage changes refer to year over year comparisons. Detailed information on 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 Q2, DTO maintained profitable growth, thanks to sound execution of our consistent corporate strategies.

Speaker 2

Our parcel volume increased 23.8 percent to RMB7.7 billion, growing the quarterly market share by 0.5 points to 23.5 percent. The adjusted net income grew 43.9 percent to RMB2.5 billion. Total revenue increased 12.5 percent to RMB9.7 billion. ASP for the core express delivery business decreased 7 0.8% or $0.10 mainly driven by lower average weight per parcel, increases in volume incentives and a mix shift impact from decrease in Ka volume, whose revenues are recorded to include delivery fees. Total cost of revenue was RMB6.4 billion which decreased 0.3%.

Speaker 2

Combined unit cost of floating and transportation decreased 15.7 percent or RMB0.12 Specifically, line haul transportation costs per parcel decreased 14.7% to 0.42¢ mainly attributable to better economies of scale, optimized line haul route planning, improved load rate and decreased fuel costs. Unit sorting costs decreased 17.4% to RMB0.25 driven by scale leverage, increased level of automation, improved standardization in operating procedures and optimized performance evaluation system. Gross profit increased 50.0 percent to RMB3.3 billion as a result of increased revenue and cost productivity gain. Gross profit margin rate increased 8.5 points to 33.9 percent. SG and A expenses excluding share based compensation as a percentage of revenue dropped 0.1 points to 5.3 percent, demonstrating a healthy corporate cost structure and leverage.

Speaker 2

Income from operations increased 45.0 percent to RMB2.9 billion and associated margin grew 6.6 points to 29.6 percent. Operating cash flow was RMB3.76 billion for the quarter and EBITDA was RMB3.88 billion. Capital expenditure totaled RMB2.2 billion for the quarter and we are anticipating annual CapEx to be in the range of RMB6.5 billion to RMB7.5 billion. We are on track to achieve another year of free cash flow. Now moving on to guidance.

Speaker 2

Taking into consideration the current market condition and our operating situation, the company reiterates that its annual volume guidance to be in the range of RMB29.27 billion to RMB30.24 billion, representing a 20 percent to 24% increase year over year. Relative to the entire industry performance, the company remained committed to achieve at least 1.5 percentage point increase in volume market share for the year. These above estimates represent management's current view and preliminary assessment, which are subject to change. Now this concludes our prepared remarks. Operator, please open the lines for questions.

Speaker 2

Thank you.

Operator

You. And our first question will come from Ronald Keung of Goldman Sachs. Please go ahead.

Speaker 3

Thank you, management. Very quickly on management talked about the industry, Express industry reaching a critical point. And this is while we have delivered very strong profit growth while increasing market share, but we have seen some of the smaller players starting to cut prices and become more aggressive. So do we see this as a temporary kind of act from these smaller players? Will this be kind of extending into the Q4 peak season this year?

Speaker 3

And how do we assess this round of price cuts from smaller players? 2nd is about service quality and our end to end delivery time. Did you share some of the metrics there and compared with peers? And how do we plan to widen our differentiation, not just from end to end time, but any value added services or anything that we're planning to maintain our service leadership? Thank you.

Speaker 2

Thank you very much for your question. First question is really in essence about the trend of the pricing going forward. It is typical that during a year around September October, the pricing will be about 10% higher than August July because of the seasonality of the year. Also in November, the price will further increase because access capacities will then gradually be utilized. The pricing for the market during the Q2 fluctuation, we believe it's more driven by the seasonality.

Speaker 2

ZTO has consistently focused on the approach that is balanced across quality of services, volume and market share and profit. Our principle is eliminating loss making transactions. What we've done differently compared to some of our competitors is that we extended our policy from March April into May June instead of making changes to them. So maintained stability in our entire network. Your second question is relating to linkage.

Speaker 2

First of all, we do have systematic plan on improving, 1st of all, our quality of services and timeliness because under the same pricing, higher quality of services will attract more volume. What we've done in 2 aspects in our operational environment is that first, each of the transit linkage, we will push it to its extreme, improving productivity, improving correlation between segments different segments of our process of of sortation, transportation, improving the route planning and so on and so forth. Those are the typical initiatives that we have implemented all along. And then the second area, which is what we have referred to in the past called trilayer throughput. In the past, our advantage is a better connection between the outlets and our sortation centers.

Speaker 2

Going forward and then really starting these past couple of years, we've been slowly but surely building the connectivity between initiation outlets to the destination sorting center and also amongst the outlets from origination and destination, so as to develop those 3 distinct model of sortation, because the ultimate goal is to reduce the number of sortation. What we've done recently is focusing more on helping our outlets to improve their processing capability, including equipment, automation and also their area of their work areas so as to ensure the transportation of larger trucks can go in and out to improve the linkage because then with certain level of volume in a group of outlets, they are capable of sending the packages directly bypassing the origination center to destination center or in some cases, I. E. The 3rd layer is to go from origination outlet directly to the destination outlet. Hence, this is 0 sortation.

Speaker 2

We have more and more of our outlets or regions having higher volume, which makes it possible for this tri layer throughput model. For example, in Canton and Iwu, they represent about 10% of our total volume and many of their outlets having over 200,000 packages a day. And with those scale condition or scale prerequisites, we are in the process of establishing the third and the second and the third layer of transportation and sortation throughput. Nowadays, we have on average of 2 sortations, a little over sortations, which means some of the packages will go through sorting centers or 2 sorting centers. Going forward, our focus is to increase one sortation and also 0 sortation.

Speaker 2

The level of decrease in the total sortation will allow us to not only improve timeliness, but also reduce cost. Aside from developing our own capability in operation, we are also focusing on the second area, which is the last mile development and also focusing on our couriers. The couriers are going to be incentivized because our outlets will pass through front end market price to our couriers so as to encourage them to pick up and deliver more on time and more responsively and also increase non e commerce packages. To do that as part of the supplement, we also work with our last mile presence development. Typically, the packages will go to sortation centers and the couriers would have to spend time and go pick up those packages from the sortation centers.

Speaker 2

With our scale and redesigned process in our operations in sortation, we are able to direct packages directly over to our last mile locations or post, which will save plenty of time for the couriers to mainly focusing on delivery. So their ability and their services to provide individualized attention to those customers who need door to door delivery will be greatly improved. And this will not only help our couriers, it will also help the entire industry in reducing last mile cost As volume becomes higher going forward, which is a definite future, we do believe helping the whole industry as a solution with our last mile presence will most certainly help the entire industry's healthy growth. To sum it all, scale, stability of outlets and our couriers improvements in their earnings as well as our outlets become more stable because they are also earning more. These are the 3 focus areas for us to develop differentiated competitive advantage going forward.

Speaker 2

Hope that answers your question.

Operator

The next question comes from Keon Lee san of Morgan Stanley. Please go ahead.

Speaker 1

Thank you.

Speaker 4

Let me translate for myself. Thank you very much for taking my question and congratulations on very solid second quarter results despite a very aggressive pricing competition in the industry. I have two questions. The first question is about competition. Very glad to hear that the company's strategy has not changed in the Q2 versus the Q1 to maintain a stable pricing compared with some very aggressive competition from our peers.

Speaker 4

We noticed that in the Q2, the market share gain of the company was 0.5 percentage point on a year on year basis. Considering management mentioned the target of 1.5 percentage point year on year, market share gain target remains unchanged. Does that mean we will be more aggressive in market share competition in the second half of this year? Or it is because we think because of the utilization issue some of the peers may lose market share because they don't have the handling capacity. And also Mr.

Speaker 4

Lai mentioned earlier that we will lock in the bottom line. So what's the bottom line of the competition strategy if the market, the industry competition comes more aggressive than expected? And the second question is about cost. So very glad to see the 2nd quarter unit cost drop was much significant than expected. So at the earlier meeting, management guided around 5% to 7% drop in unit cost for the full year.

Speaker 4

So considering the Q2, we have achieved better than that. What's the outlook for the second half of this year in terms of unit profit? And also, what's the outlook for the next 2 years?

Speaker 2

Q2, the price fluctuation becomes extremely volatile. From one perspective that we have from what we have done is, as I described earlier, we didn't change our pricing from May June from March April all the way throughout to May June, because indeed as you look at our decrease in ASP, in essence, aside from the objective reasons, we subjectively have allocated or given profit to the pickup and the delivery end. Our market share did only increase 0.5 points because we do believe that in the longer term ZTO with the largest scale and strongest competitive advantage, we are also taking on the role of a stable agent to ensure that the entire industry is stable and especially in during the economic recovery. From our personal sentiment, we are all coming from the same place. We come from the villages and we all know that we are not trying to create detriments to anyone and we're just simply using up the excess capacity.

Speaker 2

So if we take on the price actions severely, it would because of our scale and influence will really impact the entire industry, which is really not what we intend to do. So we are hopeful that typically in starting in September, the volume will recover and the whole industry will enter into a higher season. Although its installed base and capacity will be utilized and each of the players will become more sensible in matching their capacity and resources to their pricing strategies. One thing we've done differently now is the CTO make pricing decisions based on the direction of our routes, which is more granular and we have more visibility. In other way, we have much greater flexibility in precision in making appropriate price decision.

Speaker 2

In the second half of the year, we are hopeful that the whole pricing trend will stabilize and the price will return and most likely. With regards to the 1.5 points target, we do believe there are still opportunities for us and then we will strive to achieve our commitment. 2nd question on the cost side. What we've done is aside from what we described earlier to provide better operational efficiency through some of the initiatives that we have implemented, we are also improving the direct linkage. So when we are able to quickly find issues and solve problems, we're becoming much more efficient in on the cost side.

Speaker 2

Some of the things that we are also doing mentioned earlier is our outlets are gradually being rerouted to pick up or to drop off to the nearest center in their vicinity instead of just geographically or organized by provinces. So the whole entire end to end timeliness is improving. This will certainly impact the cost. We do believe there is still more room for us to gain on cost productivity. As I mentioned earlier, currently, we're about 2.09 times of sortation throughout the entire network and each sortation will cost probably about approximately about $0.25 So if we reduce the sortation by 0.1 that is $0.025 cost productivity gain.

Speaker 2

And we intend to further improve the linkage and reduce the sortation. Hence, as I mentioned earlier, the tri layer throughput model based on our scale will allow us to gain much greater cost productivity going forward. Thank you.

Operator

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

Speaker 5

Thanks management for taking my questions. I have two questions. The first question is about our long term market share expectations. Given that we have talked about the 1.5% market share gain, just want to see how our market share will be trending in the long run. And my second question is really about the parcel mix.

Speaker 5

Given that we are seeing some changes in the consumer behavior, given the macro backdrop, are we seeing the rate of the parcel is having some changes in terms of the heavy rate and the lightweight parcel? And how will that affect the cost per parcel trend? Thank you.

Speaker 2

Thank you for your question. Your question really relates to the competitive strategy. So on that ZTO has always focused on building our own competitive strength and remain stable and profitable remain focused on stable and sustainable profitable growth. The Chinese Express Delivery Industry, it has been apparent that when you have cost advantage, you have scale and you have high level of quality of services, you will attract greater market share. In essence, express delivery is about value, it's a value proposition With a level of high quality of services, customers will gravitate towards those who has high efficiency or low cost or reasonable cost.

Speaker 2

The market is fair. In the past, we have demonstrated and it's evident that when we focus on all three of our corporate focus, I. E. Quality, services, market share as well as our own profitable development, our market share continually improve and increase. We do believe the more importantly for an entire network to be healthy and growing, especially because in China, the franchised model, we have been in all throughout our years focusing closely on the equitable allocation of Courier, Outlet and our company as a brand operator.

Speaker 2

Each of the players need to focus on fair allocation and sustainable growth going forward. We believe if you reference to the developed market in China, there will be concentrated market share in a few players and this has been the trend. We've been seeing the concentration in our market share in the past several years. As long as you have a high quality of services, you are also building up scale and efficiency and differentiated competitive advantage, we believe the longer term market share concentration will continue to demonstrate itself. 2nd question relates to the product mix or parcel mix.

Speaker 2

Indeed in the Q2, we have observed that not only just us, including our competitive partners in the space, they also experienced lower parcel average lower parcel weight. And this is indeed as you have observed and mentioned, the consumer shopping behavior has been evolving and changing towards more sporadic shopping. For us, some of our main e commerce package production regions, the packages will be lighter, yet we believe more of the inland to the north and south, we are having our regions with more agriculture product coming up for example that will be heavier. As we are developing our pricing strategy based on routes, we will match the load rate of our transportation resources and our space, operational space and equipment with the sortation center as well as our network partners. And in that sense determining what the appropriate pricing needs to be for a different set of product mix going forward?

Operator

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

Speaker 2

Thank you everybody again for joining us today. Sometimes it takes a step back to take the 2 steps forward and we are maintaining our stamina in looking into longer term and also with our financial resources and our competitive strength, we have much greater flexibility in playing offensive or defensive going forward. Opportunities are ahead for us to look not just at the second half of the year when volume increase, we are also looking forward to many years ahead where we will continue to take a leadership in profitable growth. Thank you again for your continued support and we look forward to speaking with you soon.

Operator

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

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Earnings Conference Call
ZTO Express (Cayman) Q2 2023
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