ZTO Express (Cayman) Inc. (ZTO) Q2 2024 Earnings Call Transcript

ZTO Express (Cayman) Inc. (NYSE:ZTO) Q2 2024 Earnings Conference Call August 20, 2024 8:30 PM ET

Company Participants

Sophie Li – Corporate Secretary and Director of Capital Markets
Meisong Lai – Chairman and CEO
Huiping Yan – CFO

Conference Call Participants

Ronald Keung – Goldman Sachs
Qianlei Fan – Morgan Stanley
Lu Wei Jiang – Haitong Securities

Operator

Good day and welcome to the ZTO Express to announce Second Quarter and Half Year 2024 Financial Results Conference Call. All participants will be in a listen-only mode. [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.

Sophie Li

Thank you, Cathy. Hello, everyone, and thank you for joining us today.

The company’s results and the Investor Relations presentation were released earlier today and available on the company’s IR website at ir.zto.com. On the call today from ZTO are Mr. Meisong Lai, Chairman and Chief Executive Officer; and Mrs. Huiping Yan, Chief Financial Officer. Mr. Lai will give a brief overview of the company’s business operations and highlights, followed by Mrs. Yan, who will go through the financials and guidance. They will both be available to answer your questions during the Q&A session that follows.

I remind you that this call may contain forward-looking statements made under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements are based on management’s current expectations and current market and operating conditions and relate to events that involve known or unknown risks, uncertainties and other factors, all of which are difficult to predict and many of which are beyond the Company’s control, which may cause the Company’s actual results, performance or achievements to differ materially from those in the forward-looking statements.

Further information regarding this and other risks, uncertainties and factors is included in the company’s filings with the U.S. Securities and Exchange Commission. The Company does not undertake any obligation to update any forward-looking 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 break through his prepared remarks in their entirety in Chinese before I translate for him in English.

Meisong Lai

[Foreign Language] Okay, 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 ranking. And recovered couple [Indiscernible] growth at 10% year-over-year that reached 8.45 billion. We achieved adjusted net income of 2.81 billion which increased 11% over last year demonstrating continued strong profitability.

In the second quarter, despite macroeconomic softness, driven by booming developments of ecommerce promotions, online consumption maintained relatively high growth. Customer value of China Express Delivery industry increased 21.3% exceeding expectations. However, the proportion of low price income – continues to stand up and price competition further intensified.

However our tightening service margin ZTO continued to among service quality, process and drive sustainable and healthy developments of the entire network.

During the second quarter, upon further elimination of unprofitable volumes, our market share contracted by two percentage points compared to the same period last year. At the beginning of this year, across all three of our major metrics, we put greater emphasize on quality while maintaining a scale advantaged volume levels and appropriate level of profits, we directed attention and network to operations, customers, mix refining differentiated products and services and enhancing brand awareness and customer satisfaction.

Our last mile developments were implemented in niche areas to explore opportunities to reduce last mile delivery costs and improve the profitability for outlets and courier. In the second quarter, ZTO’s end-to-end delivery time ranked top among Tongda peers and the customer [Indiscernible] continued to decrease.

Meanwhile, with improved response time and on-demand service capabilities, the ratio of retail parcels were further expanded. As the optimization of revenue structure partially alleviated unit price pressures driven by price competition, our ASP was flat combined with the cost efficiency gain and a reasonable SG&A structure both the unit covered and the total profitability remains industry-leading.

Entering into the second half of the year, the industry volume captured a strong growth momentum, meanwhile, despite the intense price competition in the production regions, we observed a limited means further price cuts given the typical cost plus pricing model. It’s time for the entire industry’s shift from high quantity to high quality development.

Pricing to fulfill social viability and serve capital objectives. ZTO’s leadership actions helped for high quantity to high quality stems from our long-lasting focus on being the best we can and achieve balance among quality profitability and scale.

Considering the market conditions, we put more efforts on enhancing brand awareness and recognition on the balance of achieving advantaged volume levels to our markets. In addition, we are committed to actively address the interest and the needs of the network – and career. Specific actions under implementation [Indiscernible]

First, we will ramp with them and improve network quality to ensure performance relevancy, transparency and awareness with clearly work or recommend effectiveness.

Second, we will continuously enhance service quality with refined indicators closing tighter performance valuation. Our main support to improvements for underperforming outlets 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 price fluctuations and achieve more income.

Fourth, we will accelerate the expansion of last mile deliveries encouraging larger outlets to invest in winning business, establish direct linkage to our last mile posts to reducing delivery cost and bringing up delivery personnel to concentrate on servicing last mile customers. Through the consolidation of resources we intend to provide solutions to 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 logistics ecological resources to expand capability of comprehensive supply chain, improving brand awareness and customer appreciation.

Sixth, a vigilant and maintain a sense of heightened facing market uncertainties and fluctuations we will increase effectiveness of communication with our network partners, investing in and bring forth confidence and advocate balanced between long-term and short-term interest – network stability.

Despite uncertainties in the macro environment, the current delivery industry has demonstrated resilient and broad economic cycles by offering robust support for the advancement of digital economy and improving the duration. We are updating opportunities in front of the challenges including intensified industry competition.

ZTO will focus on service quality, further last mile strategic objectives, and enhance profitability for outlets as well as courier by establishing unique competitive advantages so as to gradually and steadfastly differentiate ourselves from the Tongda in brand recognition and customer satisfaction. Providing more choices for customers – for consumers and customers, we are aiming to create value for the country, society, as well as employee and shareholders.

Now let’s hear from Ms. Yan, about our financial results and targets.

Huiping Yan

Thank you. Thank you, Chairman Lai, and Sophie. And 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 the year-over-year comparisons. Detailed financial performances unit economics and cash flow information are posted on our website and I will 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 continued to fine tune resource allocation to achieve optimal balance between volumes and profit in the second quarter. ASP for our core express delivery business stayed flat at RMB1.24, as the impact of decline in average weight per parcel, an increase in incremental volume incentives were offset by the positive impact of the volume increase in non-ecommerce parcels, our total revenue increased 10.1% to RMB10.7 billion.

The cost of revenue were RMB7.1 billion, which increased 10.4%. Overall unit cost for the core express delivery business increased 0.7% or $0.01, specifically, line haul transportation cost per parcel decreased 6.8% to $0.39, driven by improvements in fleet operations with better resource utilization. Unit sorting cost increased 4.6% to $0.26 due to increased D&A cost on new equipment and facilities.

Unit’s KA cost decreased $0.04 or increased $0.04 in line with KA revenue increase. Gross profit increased 9.6% to RMB3.6 billion and gross profit margin rate decreased 0.1 points to 33.8%. Consistent with gross profit, income from operations increased 11.7% to RMB3.2 billion and our 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 $3.5 billion, which decreased 7.5% mainly due to dividend tax and increase in financing on loans to our network partners.

Adjusted EBITDA was $4.3 billion, an increase of 11.7%. Capital expenditure totaled RMB1.3 billion for Q2 or RMB2.9 billion for the first half of the year. With that, we anticipate annual CapEx in 2024 to come in below $6 billion as previously planned.

The company has announced an interim cash dividend of US$0.35 per ADS and ordinary share for the six 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^th, 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. Betsy, please open line for questions. Thank you.

Question-And-Answer Session

Operator

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

Ronald Keung

[Foreign Language] Thank you, management. First is about our profitability of 10% and slower than the industry. So, as we talked about in the announcements volume is not an important as it brings us scale leverage. So want to hear how full year guidance implies at the half, should we expect some fine tuning of our strategy to maximize the scale of parcel volume and profitability?

And second is for the unit profit was stable that implies the underlying unit cost action has been quite stable as well. Is there further room to improve on operating efficiencies? Or have maxed out all of the efficiencies second half or further could we improve the operating leverage of the business? Thank you.

Meisong Lai

[Foreign Language] Thank you, Ronald, for your questions. So let me translate for the Chairman. First question, indeed the parcel volume for the total industry has grown and exceeded our expectations. In the second half of the year, we do have the following traps and our market share decreased 2%. The main reason being that first, there a lot more price competition or price competition intensified.

There are a lot more ineffective or what we call it ineffective is indeed it is just below the cost, is priced below the cost. So, overall, a portion of non-profitable 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 set out in the beginning of the year to focus more on quality of services and with that to achieve proper level of profit and in turn market share. If we look at in overall perspective, our capacity and the volume are in tune and are reasonably matched.

In the first half of the year, the results that we achieved is out of the range of 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, we want more volume which will 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 achieve the focus on improving quality of services, developing differentiated products to achieve reasonable level of profit and volume level.

Second part of the question, indeed for the entire industry throughout these years of fine tuning of operations and investment of automation and so on and so forth, the unit cost, productivity again 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 of to 50% of volume demand, we are still well on track to consistently and gradually release [realize] meaningful cost efficiency going forward.

Then for the unit profitability based on the overall capacity, as well as the reserves, 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.

Ronald Keung

[Foreign Language]

Operator

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

Qianlei Fan

Thank you, operator. [Foreign Language] Let me translate it myself. Congratulations on the very resilient profit in the second quarter. I have two questions. The first question is about the retail profits. In the announcement, the company mentioned that we are on track to double our retail profit volume and would you please remind us our current daily retail profit volume, the percentage in – of retail volume and 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 stand at the competition of express in the group business it’s not only about cost reduction at the line haul, but also about cost reduction at the whole network, especially at 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 room, cost saving room in the next few years? Thank you.

Meisong Lai

[Foreign Language]

Thank you very much for your questions. Currently, our daily volume of non-ecommerce parcels exceeded 500 – 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? 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 refer in our remarks of non-ecommerce packages as their ratio to our delivery total. So in other words, if I deliver a 100 packages and there needs to be at least six packages pick up as non-ecommerce.

So, one of the things that there are four specific strategies that we implemented to improve the portion of non-ecommerce 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 efforts 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, increase customer loyalty through 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 pick up 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 customer complaints or anticipate any potential problems that could arise. So hence improve the overall experience.

Number four, strengthening the corporation with ecommerce platforms, enhancing direct coordination between the headquarters in those platforms. Currently, while we have achieved direct settlement process with White Bands, Pinduoduo, as well as [Indiscernible]. Then improving the – the second part is reducing the cost of the last mile.

The initiatives, there are two-fold. The first one is relating to the couriers or 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 outlets’ profitability. We – last year, we have about close to 2,000 outlets installed machinery and equipment that enable them to provide package that are sorted or directed or destined directly to post. Chairman gave an example. In the past, the couriers has to go through the post – sorry, go to the outlets help sorting or they have to ride to the outlet 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 outlets 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 initiative relates to the outlets. With the direct – sending the packages directly to the couriers, as well as sending the packages directly to last mile post, the outlets’ owners are able to reduce their delivery cost. For example, in the past, each packages on average would cost outlet about $0.80 for the couriers to deliver.

Now couriers would then put part of their packages into the post which will share their $0.80 or $0.40 out of that $0.80 will go to the post. With that initiative that we implemented, the direct linkage between outlets and the post would allow a greater portion close to 60% or 40% of the packages going to the post directly. So then the outlets does not need to pay the whole $0.80.

So, we estimated and we calculated of that $0.40 because it still need to be sent through the post. The outlet owners would pay on average between $0.10 to $0.20 to achieve that direct delivery to the post. So, with, first of all the $0.40 reduction in payment through the courier and then a cost of about $0.10 to $0.20 to send those packages to the post, the outlets could match about $0.20 or so saving on the delivery cost.

Going forward, we are going to focus on these initiatives in fully implementation, then we will achieve a goal of not only improving the outlets’ profitability, as well as the courier’s 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 reductions not only for us, but also potentially as a solution to the whole industry.

This is a not a overnight goal 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 homogenized price competition and establish competitive – unique competitive advantage.

Qianlei Fan

Thank you very much.

Operator

The next question comes from Lu Wei Jiang with Haitong. Please go ahead.

Lu Wei Jiang

[Foreign Language]

First of all, congratulations to the 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 areas of investments will allocated to and how could we make the capital expenditures flat? Second question is about cost reduction in place about the whole process in the future? Thank you.

Meisong Lai

[Foreign Language]

Thank you very much for your questions. What we – the first question is about the CapEx. In the past, we have been consistently investing in CapEx mainly to build sortation centers and establish transit capabilities. So today, most of our super sorting centers are self-owned and above 90% to be specific that makes supplement. So, going forward, we won’t be in need of expanding our CapEx spending.

Based on the economic development, some areas or are weaker areas we have also reserved Phase 200 to 300 hectare acres for example. If our volume demand increases one-fold or even two-fold, we have sufficient reserve already there. So we don’t need spend capital to acquire further more significant land use rights which is need to either develop them or upgrade them.

The consideration however do need to be given to our initiatives in the longer term developing comprehensive logistic capabilities. For example, warehousing or in-warehouse processing, LTL businesses, or those ecosystem businesses due on branch basis from us so that they are able to form a comprehensive and higher efficient – efficiently co-located products and services by utilizing our capacity.

And going forward, it is very clear that acquisition for land use rights, building super centers are going to be very minimum. The growth of our – of putting in line of services, putting services, the capacity is very much directed or matched with our anticipated demand of capacity in the sortation, transportation and other segments of our operations. We are able to foresee with very clear visibility going forward, we will be able to generate increasing free cash flow or what we talked about giving back return to our shareholders is 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 have been leading this effort for the whole industry, it has been continuously achieving high cost efficiency. In the past, what we’ve been doing and what we’ve been achieving greater results or ahead of everybody is that our collections 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 visibility over 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 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 compact as again we said earlier, we were able to improve the connectivity between outlets and sortation center.

Going forward, as volume increases, we are able to establish greater connectivity between this origination outlets to destination sorting center or the third layer being the origination centers through the destination outlets for the origination outlets to destination outlets. All these is simply put an effort to reduce the number of sortation.

In the past, we were at a 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 one time 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 two 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 have 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 or what we anticipate to come with the most optimum volume and optimum cost. Thank you for your question.

Operator

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

Sophie Li

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-ecommerce packages is reflected in our bottom-line.

Balanced approach will continue to be our future focus including the last mile initiatives what we believe we are building long-term competitive advantages, so that we are differentiated from the rest of the Tongdas. We look forward to speaking with you in the future and thanks again for joining today’s call.

Operator

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