ZTO Express (Cayman) - Q2 2024

Transcript

Operator (participant)

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. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your touchtone phone. To withdraw your question, please press star, then two. 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 (Director of Capital Markets)

Thank you, Betsy. 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. Mason Lai, Chairman and Chief Executive Officer, and Miss Weiqi 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 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. Mason Lai. Mr. Lai will read through his prepared remarks in their entirety in Chinese before I translate for him in English. Thank you.

Meisong Lai (Chairman and CEO)

[Foreign language]

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 ratings, 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 promotion, online consumption maintained 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 continues to trend up, and price competition further intensified. While prioritizing service quality, ZTO continued to seek balance among service quality, profit, and 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 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 emphasis on quality, while maintaining a scale-advantaged volume level and appropriate level of profit. We directed attention and resources towards upgrading customer mix, refining differentiated products and services, and enhancing brand awareness and customer satisfaction. On last mile development, we implemented new initiatives to explore opportunities to reduce last mile delivery costs and improve the profitability for all its end carriers. In the second quarter, ZTO's end-to-end delivery time ranked top among Tongda peers, and customer complaint rate continued to decrease. Meanwhile, with the improved response time and on-demand service capability, the ratio of retail parcels was further expanded.

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, the total profitability remains 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, striving to fulfill social viability and serve capital objectives. ZTO's leadership action to transform from high quantity to high quality stemmed from our long-lasting focus on being the best we can and achieve balance among quality, profitability, and scale.

Considering the market conditions, we will put more effort on company brand awareness and recognition on the premise of achieving scale advantage to volume level, plus healthy profit. In addition, we are committed to equitably address the interests and needs of the network partners and couriers. Specific actions under implementation include the following: First, we will revamp and improve network policies to ensure performance, relevancy, transparency, and fairness with clear rewards or recommend effectiveness. Second, we will continuously enhance service quality, which refine indicators closely tied to performance evaluation. Offer tailor-made support and 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 couriers' proactiveness to increase the retail parcels ratio, and achieve more income.

Fourth, we will accelerate the expansion of last-mile footprints, encourage larger outlets to invest in sorting equipment, establish direct linkage to a last-mile post, reducing delivery costs and the freeing of 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 product mix, increase the penetration of high-end products, strengthen collaboration with online platforms, and leverage ZTO's logistics, ecological resources to expand capability of comprehensive supply chains, improving brand awareness and customer appreciation. Sixth, be vigilant and maintain a sense of crisis, facing market uncertainties and fluctuations. We will increase effectiveness of communication with our network partners, unify thinking, and reinforce confidence and advocate balance between long-term and short-term interests, maintaining network stability.

Despite uncertainties in the micro environment, the express delivery industry has demonstrated resilience across economic cycles by offering robust support for the advancement of digital economy and improving circulation efficiency. We are seizing opportunities in front of challenges, including intensified industry competition. ZTO will focus on service quality, further last-mile strategic objective, and enhance profitability for outlets as well as couriers by establishing unique competitive advantages, so as to gradually but steadfastly differentiate ourselves from the rest of Tongda in brand recognition and customer satisfaction. Providing more choices for customers and 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 Ms. Yan about our financial results and targets.

Huiping Yan (CFO)

Thank you. 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 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'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 RMB 8.45 billion. We continued 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 and 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 RMB 10.7 billion. The cost of revenue was RMB 7.1 billion, which increased 10.4%. Overall unit costs 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 CapEx costs on new equipment and facilities.

Unit KA costs decreased RMB 0.04, increased four cents 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 RMB 0.35 per ADS, an ordinary share for the six months ended June 30, 2024, which is a 40% payout ratio to holders of its ordinary shares and ADSs as of the close of business on September 10th, 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 product services to enhance brand recognition and value. We are reiterating our 2024 volume growth guidance of 15%-18%.

These estimates represent management's current and preliminary view, which are subject to change. This concludes our prepared remarks. Betsy, please open the line for questions. Thank you.

Operator (participant)

We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. In the interest of time, please limit yourself to one question and one follow-up. At this time, we will pause momentarily to assemble our roster. The first question today comes from Ronald Keung with Goldman Sachs. Please go ahead.

Ronald Keung (Analyst)

Thank you, Lai and Sophie. Thank you, management. First is about our parcel volume of 10% and slower than the industry. So as we talked about in the announcement, our volume is not unimportant, as it brings a scale leverage. So want to hear our guidance, the implied second half. We expect some fine-tuning of our strategy to maximize the scale, parcel volume, and profitability. And second is, for the unit profit, which is 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 a lot of the efficiencies that are done in the past? What further could we do to improve the operating leverage of the business? Thank you.

Meisong Lai (Chairman and CEO)

[Foreign language]

Thank you for your question. 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, and 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 nonprofit or 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 appropriate level of profit and in turn, market share. If we look at in the 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%-18% guidance for the whole year. Which means that in the second half 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 product to achieve 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. Well, 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. They are our reserves, ample reserves for capacity release in the future. We do believe that the capacity installed as well as its flexibility in meeting 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.

Operator (participant)

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

Qianlei Fan (Equity Research Analyst)

Thank you, operator. [Foreign language] Let me translate it myself. Congratulations on the very resilient profit growth in the same quarter. I have two questions. The first question is about the retail parcels. 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 of retail 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.

... it's not only about cost reduction at the line haul, but also about cost reduction at the whole network, especially at the 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 (Chairman and CEO)

[Foreign language]

...Thank you very much for your question. Currently, our daily volume of non-eCommerce parcels exceeded 505.4 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. 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'll go through the specifics with you.

First of all, is related to increasing the ratio, is what we refer to in our remarks, of non-eCommerce packages as a ratio to our delivery total. So in other words, if I deliver a hundred 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 we call it individual parcels or retail parcels. One is to enhance consumers' willingness to send parcels at our posts 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, increase 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 cooperation with e-commerce platforms, enhancing direct coordination between the headquarters and those, platforms. Currently, while we have achieved direct settlement, process with ByteDance, Pinduoduo, as well as Douyin. The second part is, reducing the cost of the last mile. The initiatives, there are twofold. The first one is relating to the couriers.

We call it the Dao Jia Dao Bian 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 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 outlets, help sorting, or they have to 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 electric 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 initiative 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 cost the outlet about RMB 0.8 for the couriers to deliver. Now, couriers would then put part of their packages into the post, which will share their RMB 0.8, RMB 0.4 out of that RMB 0.8 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 need to be sent to the post, the outlet owners would pay on average between RMB 0.10-RMB 0.20 to achieve that direct, delivery to the post. So with, first of all, the RMB 0.40 reduction in payment to the courier, and then a cost of about RMB 0.10-RMB 0.20 to send those packages to the post, the outlets could net about a RMB 0.20 or so saving on their delivery, cost.

Going forward, we are going to focus on these initiatives in a full implementation, then we will achieve a goal of not only improving the outlet's 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 reductions, not only for us, but also potentially as a solution to the whole industry. This is not an overnight goal. We are working towards this change and shift from volume to quality, to focus on more differentiated products and services, so that ZTO could break away from a marginalized price competition and establish a unique competitive advantage.

Qianlei Fan (Equity Research Analyst)

Thank you very much, Mason Lai, Weiqi Yan.

Operator (participant)

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

Loyu Jiang (Analyst)

Mason Lai, Weiqi Yan, [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 2025, and longer periods. I'd like to know which areas the investments will allocated to, and how we make the capital expenditure plan. Second question is about the cost reduction plan, about the whole process in the future. Thank you.

Meisong Lai (Chairman and CEO)

[Foreign language]

Thank you very much for your question. What we... the first question is about, the CapEx. In, in the past, we've been being consistently investing in CapEx, mainly to build sortation centers and establish transit capabilities. Till today, most of our super sorting centers were self-owned, and above 90% to be specific, if I may supplement. So the 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 a space 200 hactares-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 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, developing comprehensive logistics capabilities. For example, warehousing or in-warehouse processing, LTL businesses, all 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, and going forward it is very clear that acquisition for land use rights, building super centers, are going to be very minimal. The growth of our capacity is very much directed or matched with our anticipated demand of capacity in the sortation, transportation, and all the segments of our operations.

We are able to foresee with a very clear visibility that going forward, we will be able to generate increasing free cash flow. 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 re-reducing in going into two thousand and four--two thousand and twenty-five, 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, 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 layer being the origination center to the destination outlets, or 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 the level of 2.5 per parcel.

We are reducing it now to two point 0.9, and continue to decrease because of better route planning and volume increases. We estimated for each one-time reduction of the sortation, we are able to reduce about RMB 0.25, being RMB 0.10 in sortation and RMB 0.15 for transportation. With that, we have a 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 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, and what we anticipate to come, with the most optimal volume and optimal cost. Thank you for your question.

Operator (participant)

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

Huiping Yan (CFO)

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 the Tongda. We look forward to speaking with you in the future, and thanks again for joining today's call.

Operator (participant)

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