ZTO Express (Cayman) Inc (ZTO) 2016 Q4 法說會逐字稿

Good evening and welcome to the ZTO fourth quarter and full year 2016 earnings conference call. All participants will be listen-only mode. (Operator instructions).

I would now like to turn the conference over to Christian Arnell, please go ahead.

Thank you operator. Hello everyone and thank you for joining us today. The Company's results and 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 Mr. James Guo, Chief Financial Officer. Mr. Lai will give a brief overview of the Company's business operations and highlights followed by Mr. Guo, who will go through the financials and guidance. They will both be available to answer your question during the Q&A session that follows.

I'll 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 marketing 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 these and other risks, uncertainties and factors is included in the Company's filings with the US Securities and Exchange Commission. The Company does not undertake any obligation to update a forward-looking statement 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. Meisong please.

(Spoken in Mandarin)

This is Christian again, I will now translate for Meisong in English. Hello and thank you everyone for joining our call this morning. I'm proud to announce another strong quarter of operational and financial results as we close out another very successful year in which we further strengthened our industry leading position, generated robust growth in parts of volumes, further expanded our bottom line and to solidified our leading position in terms of quality of service.

During the fourth quarter, we handled 1.484 billion parcels and generated RMB3.190 million in revenues, an increase of 44.2% and 45.8% respectively.

Net income during the fourth quarter was in line with our expectations, coming in at RMB740 million, while adjusted net income which excludes a gain on deemed disposal of equity method investments increased 52.7% year-over-year.

We now have a total of 12 sets of automated sorting equipment installed and operating in 10 of our sorting hubs across various parts of China to improving sorting and operating efficiency. Our fleet of high capacity 15 to 17 meter-long trucks, also rapidly expanded to 1,145 from 820 last quarter.

By investing in automation and fleet expansion, we are not only able to reduce labor and transportation cost, to improve the reliability of our services over the long-term, but also strengthen brand loyalty among our customers and merchants. As the scale of our network expands, we will be able to handle larger parts of volumes with increasing efficiencies.

Our distinctive shared success model aligns the interest of our network partners with ours, while maximizing their growth and profitability and continues to enhance our competitiveness, as well as increased operational efficiency and improved stability across our network. With 69 of our 75 sorting hubs directly operated by ZTO, we are not only able to keep a lid on expenses, to better control the express parcel delivery flow, but also find new and innovative equipment and ways to further optimize efficiency.

These initiatives were able to reduce the impact of seasonality during the quarter, where we were hit with rising oil prices and the temporary increase in the hiring of additional workers and vehicles. This also helps us maintain a very healthy level of profitability.

Our strategic focus in 2017 will be on increasing our parcel volume at a faster rate than our competitors in order to gain market share. We have started off the year strongly in this regard with our market intelligence indicating that we delivered many more parcels on a daily basis than our major competitors did following the Chinese New Year holiday period. We will also continue to implement initiatives to improve the management, capabilities, stability and service quality of our pick-up and delivery outlets.

We have created a special network management committee to identity network partner management issues and improve the efficiency of our service outlets. We are also working to enhance their performance measurement systems and further standardize their operating procedures.

Leveraging our sophisticated IT systems, we will be able to provide customized technical support to our service outlets, as well as help them adopt new technology to improve efficiency. Furthermore, we will organize further training for our service outlet employees to improve their business development capabilities. Our outlet network already has a reputation for stability and these initiatives will further strengthen their loyalty to the ZTO brand and improve service quality and customer satisfaction.

I am extremely confident in our strategy and ability to execute it as we create greater value for our shareholders. With that, I'll now turn the call over to James, who will go over our financial results in more detail. James. Please go ahead.

Thank you Mr. Lai. Our results during the quarter demonstrate how our growing economies to scale and investment we make in fleet expansion starting automation and other cost cutting initiatives are beginning to bear fruit. As operational efficiency and our ability to consistently generate solid profitability are improving.

Revenue increased by 45.8% to RMB3.19 billion on the back of strong parcel volume growth, which increased by almost 44% to nearly RMB1.5 bb. To further underline my point about our increasing level of efficiency and operating leverage, adjusted net income rose by 35.2% sequentially and 52.7% year-over-year to RMB740.1 million.

I would like to go over a few housekeeping items before I go through the numbers in detail. We believe year-over-year comparisons are one of the most useful ways to judge our performance. All percentage changes I'm going to give will be on that basis.

So, to start, parcel volume during the quarter increased by 44.2% to nearly RMB1.5 billion. Our number of self-owned trucks increased to over 2,930 as of December 31, 2016, from 2,400 as of September 30, 2016. Larger trailer trucks are usually more cost efficient than regular trucks. A greater carrying capacity reduces unit transportation cost as we further increase our economies of scale.

Revenues increased by 45.8% to RMB3.19 billion, primarily as a result of an increase in parcel volume, thanks to our expanding market share, and growth of the overall market.

Cost of revenues rose to RMB2.02 billion, an increase of 49.8% primarily due to increases in line-haul transportation, sorting hub operating, and accessory costs, which were partially offset by a decrease in waybill material cost because of the increased use of digital waybills by our end customers, which had lower costs than paper waybills.

Going in to greater detail. The line-haul transportation cost increased 56.4% to RMB1.23 billion. The increase was in line with the increase in parcel volume and was primarily due to increased cost associated with our self-owned fleet which includes fuel, tolls, drivers' compensation, depreciation and maintenance expenses. This also includes RMB264.2 million in cost associated with outsourced transportation services to cope with demand during China's peak e-commerce season.

As a percentage of revenues, line-haul transportation cost accounted for 38.6%, an increase from 36% in the same period last year, mainly due to increases in the fuel cost, depreciation and outsourced transportation cost. The entire industry was affected by these seasonal costs, but as Mr. Lai mentioned earlier, we have the industry's largest self-owned truck fleet, which allows us to better upsell those costs and sustain our leading cost percentage in the industry.

Sorting hub operating cost rose by 43.3% to RMB572.8 million primarily due to increase in labor cost as a result of wage and headcount additions. Depreciation cost and cost associated with consumable materials used in our automated sorting hub facilities.

As a percentage of revenues, sorting hub operating cost accounted for 18%, a decrease from 18.3% in the same period last year, as a result of economies of scale and improved sorting efficiency.

Cost of accessories increased significantly to RMB97 million which was in line with growth in our revenue from the sale of accessories. Other cost increased 23.6% to RMB127.1 million, primarily due to an increase in cost associated with serving key accounts as well as related parcel volume growth.

Gross profit rose 39.4% to RMB1.16 billion, while gross margin decreased to 36.4% from 38.1% in the same period last year, mainly attributable to the increase of line-haul transportation cost.

Total operating expenses declined to 1.3% to RMB185.1 billion. Taking a closer look, SG&A expenses increased 5.6% to RMB196.9 million, primarily due to advertising and rental expenses incurred during our initial public offerings.

Income from operations rose RMB976, an increase of 51.2% from the same period of last year. In Q4, net income rose to RMB739.8 million, compared with RMB703.1 million we made during the same period last year.

Basic and diluted earnings per ADS was RMB1.04 compared to RMB1.09 during the same period last year.

Adjusted net income surged to RMB740.1 million, compared with RMB484.5 million during the same period last year, which once again demonstrates how effective our initiative are to increase operational efficiency and reduce costs.

EBITDA was RMB1.1 billion, an increase from RMB914.5 million during the same period in 2015. Adjusted EBITDA was RMB1.1 billion, significantly increased from RMB695.9 million during the same period last year.

Net cash provided by operating activities was RMB1.1 billion compared with RMB1.05 billion during the same period last year.

I will now quickly go over some of our year-end numbers. Revenues were RMB9.78 billion, an increase of 60.8% from last year. Gross profit was RMB3.44 billion, an increase of 64.9% from 2015. Net income was RMB2.05 billion, an increase of 54.1% from last year.

Adjusted EBITDA was RMB3.23 billion, an increase of 77.8% from 2015. Adjusted net income was RMB2.16 million, an increase of 76.8% from last year. Basic and diluted earnings per ADS was RMB2.91 compared with RMB2.15 in 2015.

Net cash provided by operating activities in 2016 was RMB2.53 billion compared with RMB1.86 billion in 2015. As of December 31, 2016, the Company have RMB11.9 billion in cash and in cash equivalents, an increase of RMB9.18 billion from RMB2.72 billion as of December 1, 2015.

Going forward, we will issue quarterly guidance on revenue rather than adjusted net income. By far and large, Chinese companies listed in the US, provides topline guidance only. As Chairman Lai mentioned earlier, our strategic focus in 2017 will be on growing partial volume and increasing our market share. Providing topline guidance is historically in line with these strategic objectives. This is already evidenced by the strong post-Chinese New Year growth we have seen parcel volume.

So, turning to guidance, for the first quarter of 2017, we expect revenues to be in the range between RMB2.5 billion to RMB2.6 billion or $360 million, to $374 million, representing a year-over-year growth rate of approximately 27.6% to 32.8%.

This concludes our prepared remarks. Before we open the call up for Q&A, I would like to remind everyone to please limit themselves to two questions.

Operator, we're now ready to begin the Q&A session. Thank you.

Thank you. We will now begin the question-and-answer session. (Operator instructions). At this time, we will pause momentarily to assemble our roster.

Our first question comes from [Ella Gee] with Renaissance. Please go ahead.

Thank you for taking my questions. I have two questions. First of all, regarding your margins performance for the quarter, I see that on a per parcel basis, the per parcel revenue didn't really increase year-over-year, but per parcel cost increased a lot year-over-year and we're both talking about peak seasons. So, I wonder if Management can explain the reasons behind the declining gross margin.

And then my second question is regarding your CapEx. Could you provide a CapEx budget breakdown for 2017, maybe by for example, land, warehouse, sorting hubs etcetera. Thank you.

Okay. Thank you for your questions Ella. First of all, let me answer your first question first, so you asked us about, why there is a drop in the revenue per parcel in the last quarter, but was an increase -- there was an increase in the cost per parcel in the last quarters, and as a result of this, there was a drop in the gross margin.

So, as we mentioned earlier in the earnings release, we saw a spike in the cost of transportation during the e-commerce peak season in the last quarter. So, as a result of this, we see the gross margin was under pressure in the last quarters.

As for your second question about the CapEx, for 2017, we expect to incur about RMB4.5 billion in total CapEx, and a majority of those spending will be focused on the acquisition of land use rights, and the construction of sorting hubs.

Thank you James. May I just follow-up with my first question. And I'm comparing year-over-year, so theoretically, that removes the seasonality pressure and so just wonder if increased the cost of transportation, do you think will only happen around the fourth quarter every year or do you think it will likely be the trend going forward?

The last quarter is a little bit unusual because we saw a significant increase in fuel cost in the last quarter. And as a result of this, the transportation costs increased significantly. And also because of a shortage in the third party trucking capability in the marketplace, we also saw an increase in also, transportation costs as well in the last quarter.

Thank you.

Our next question comes from Edward Xu with Morgan Stanley. Please go ahead.

Thank you for taking my question. I have two questions. So first of all is for Mr. Lai, I think we are hearing some of the news about like YTO, they got the franchisee issues and also I'm happy to hear that you are growing faster in terms of volume year-to-date.

So can you share with us your color on how you look at this issue and why you can maintain a smooth operation and can grow faster. What's your market share target for this year? That's the first question.

The second question is also related to your cost. So the cost -- just the previous analyst just asked about the linehaul cost as well, so given these few cost increase and also recently, we are hearing that the cardboard, the paper cost also increased, so how do you look at your cost and is there anyway to pass through this cost pressure through higher ASP or whatever. That's my second question. Thank you.

Okay, Chairman Lai will answer your first question and about the growth trend and the long-term margin for 2017, I will answer your second question.

(Spoken in Mandarin)

Let me do the translation for Chairman Lai, so to answer your question, we expect to achieve higher parcel volume growth than the industry average in 2017 thanks to our competitive stretch. According to the State Post Bureau, the industry parcel volume growth is estimated to be around 35%. We expect our growth is well above the industry growth rate.

Looking forward, we expect the ASP will eventually stabilize in 2017 as the industry slowly begins to consolidate, and we will continue to leverage our scale and operating efficiency to maintain a healthy and stable operating margin in 2017. So to answer your question about cost, yes, we did saw an increase in the transportation costs in the last quarter, there will be some minor spillover impact on Q1 2017.

But our main focus for controlling costs to improve operating margin has been to increase the efficiencies through continuous automation and also increase the number of self-owned trucks, so to this regard, we have taken a lot of measures to further contain costs in 2017 which includes, increase the use of self-owned trucks by 50% in 2017 and also reduce the use of third party trucks.

And second, to further optimize transportation booths and improve truck utilization. And third through competitive bidding and central sourcing, fulfill, supply, and this will help us with the fuel cost going forward.

And fourth, in 2017, we plan to install about 40 automated sorting equipment to improve efficiency and reduce our labor costs and last, we also use more and more recycled canvass bags to replace fabric bags to reduce low value consumable cost in 2017.

Operator, next question, please?

Our next question comes from Alex Yao with JP Morgan.

Please go ahead.

Good morning, Meisong and James, thank you for taking my question. My first question is regarding the new -- the recent news report that some of your competitors are having difficult situation for their network partners because these guys are operating under unsustainable agreements or underpaid, which has resulted in disruption in their operation.

So I just want to understand is there a general industry trend? What's your view on this trend? And are you guys facing a similar problem?

And then the second question is regarding your 2017 marketshare target, can you share with us what the target share that -- the target for marketshare for 2017 and then what's your pricing strategy to achieve the target share.

A related question is when you answered the question regarding using the investments in transportation in sorting hub, etc, to absorb the cost pressure from transportation costs. Does it mean, philosophically, you guys would rather absorb those costs through your own innovation investments, rather than passing to the cost hike to the consumer through ASP. Thank you.

Okay, the chairman will answer your first question and I will answer your second question.

(Spoken in Mandarin)

I will do the translation for the chairman. The chairman mentioned that the recent events faced by some of the express delivery companies in China resulted from manufacturers, including seasonality, the incentive mechanism of our peers network, and also the entrance of other omnichannel last mile delivery companies into the express delivery sectors.

And he believes that this issue has drawn attention from government regulatory bodies and key industry players, and all of which are taking measures to address those issues.

And ZTO was not affected as significantly as some of our peers because of the share success system and the well established interest balancing mechanism that we put in place with our network partners. As a result of this, our network partners are very loyal to the ZTO brand and our network is very stable. And in effect, we took advantage of those opportunities to grow our presence in some of the key markets during this post Chinese New Year period and our parcel volume growth continued to gain momentum during the recent period.

For your second question, about the marketshare targets in 2017, our target market share in terms of parcel volume in 2017 is to increase our marketshare by 1 to 2 percentage points in 2017 and to achieve this goal, we will adapt a differentiated pricing strategy so we are going to use differentiated pricing strategies in different markets in order to boost the parcel volumes in those markets.

And to answer your question about whether we can pass through some of the cost increase to the end consumers, we are going to adapt two alternatives to contain the costs. On the one hand, we are looking to pass through a portion of the costs, in particular, the increase of the fuel cost, to our end customers, hopefully, that will help us to lower the entire operating costs.

And secondly, we will continue to improve operational efficiency by increasing the level of automation and also the expansion of self-owned fleet to improve the operational efficiency of the Company as a result of this, we expect to lower our unit operating cost as well and that has been demonstrated in our historical financial performance.

Our next question comes from Vivian Tao with Citi. Please go ahead.

Good morning. (Spoken in Mandarin)

This is Vivian from Citi. First of all, congratulations on a very great result in the fourth quarter. I have two questions. The first question, I wonder what is the Management's view of the current industry competitive landscape and what is Management's take from some of the recent industry consolidation such -- assuming that [Zunings] takeover [Tien Tien] and does the Management expected will be further industry consolidation in the near term.

The second question is regarding your unit revenue, we have noticed that in the fourth quarter, that unit revenue per parcel increased from RMB2.14 in the third quarter to RM2.15 in the fourth quarter and in place, just mentioned, right, and you were trying to pass or share some of the cost to your network partners.

So I wonder with that, the pricing mechanism and also with our expectations that unit cost actually will be likely to decline in -- what do you expect the unit cost will continue to decline in 2017, if we combine those two factors, what do you expect that unit revenue trend in the first quarter of 2017 also for the entire year of 2017.

And what should we expect the margin change? Thanks.

Yes, the chairman will answer your first question and again, I will answer your second question.

(Spoken in Mandarin)

The chairman says that we expect that the industry will undergo a consolidation process over the next 5 to 10 years. The major players will continue to gain marketshare and the smaller players will undertake a business transformation or gradually exit the market for lack of scale and operational efficiency.

Zuning's recent takeover of Tien Tien express is a good example of what is going on in the industry. The competition over the next few years will be based on service quality, new technology adoption and also the ecosystem's expansion. In 5 to 10 years from now, we expect that there will be two to three key express delivery companies with the largest one having a marketshare of over 25% and few smaller players, each of which will have a smaller marketshare.

For your second question, yes, the ASP in Q4 last year did increase from about RMB2.14 per parcel in Q3 to about RMB2.15 per parcel. And the main reason behind that increase is that we reduced the subsidies that we paid for the adoption of digital waybills because we already got a very high digital waybills adoption rate within the Company.

And looking forward as the chairman mentioned earlier, we expect the ASP will be gradually stabilize in 2017 as the industry continues to consolidate and this consolidation may take place over the next five to 10 years and because we will continue to leverage our scale and operating efficiency to maintain a stable and healthy operating margin in 2017.

And our next question comes from [Baoying Jai] with Credit Suisse. Please go ahead.

(Spoken in Mandarin).

Okay, so I will translate my questions. So, good morning, Mr. Lai and Mr. Guo and thanks for taking my questions. Okay.

Hello? Hello.

Yes, Baoying, go ahead.

Yes, so I'm just translating my questions. So my questions are focused on the first quarter results and also 2017 outlook. So on the first quarter results, James, could you please give us the electronic waybill adoption rate by the end of 2016?

And the other question regarding the fourth quarter results, if you look at the SG&A, if we deduct the IPO fee on a year-on-year basis, actually, the SG&A was down, so what's the reason behind that?

2017, I guess a lot of people have already asked this question but because we know that volume growth is a high priority for 2017, so which means we need to give up a little bit on the pricing, right? Because the market is still very fragmented.

And from the cost perspective, we can see the transportation cost is still going up in terms of the fuel cost and [social-logistics] pricing and we also said the labor cost is going up, it's not only on the ZTO it's also on franchisees.

We can see in there a computation from food delivery and also the CPI inflation of the whole [severities] of the labor cost is going up. So would that mean we need to provide more subsidies to franchisees as well which would also pressurize our margins in 2017.

And also do we have any more ideas about M&As because I remember we mentioned that we want to do cross border delivery business, right? So is there any potential M&A at the year, so far?

Thank you so much.

Yes, let me answer your first question and the chairman will answer your second question. So the adoption rate of the digital waybill in the fourth quarter of 2016, it's around 78%, and this has increased from about 48% at the end of 2015.

And in terms of the your question about the drop in the SG&A expenses, after excluding the IPO cost, the major reason behind the drop in the SG&A expenses in Q4 2016 is because we outsource some of our backend functions to third party outsourcing companies so that we manage to reduce our labor costs in Q4 last year.

(Spoken in Mandarin)

Let me do the translation for the chairman and he believes that we will maintain a very stable ASP and well as operating margin in 2017 and actually the Management has taken quite a few cost cutting initiatives to contain our costs in 2017 which includes the increased use of the self-owned trucks in order to reduce the -- and also reduce the use of third party trucks.

And we also reduced our fuel supply costs by competitive bidding and centralized sourcing for fuel supplies and also continue to install more and more automated sorting equipments to improve operational efficiency and reduce labor cost.

He believes that this cost strategy initiative will offset the increase in the operating cost going forward.

As a result of this, expect that we will maintain a healthy and stable operating margin in 2017. In terms of potential M&A opportunities, we will continue to explore M&A opportunities in particular, opportunities that can enhance our cross border delivery capabilities. And yes, and we will explore future potential M&A opportunities in target companies as long as those companies can provide synergies for growing our business.

Our next question is from Ronald Keung with Goldman Sachs. Please go ahead.

Thank you Meisong and thank you, James for taking my question. When thinking about some new business areas or what is the next growth driver for ZTO, could you just update us on some new business ideas?

You just mentioned about cross border, how about your supply chain, your less than truckload business which is the LTL associate? Do you have any business initiatives to target, for example the intra-city parcels which are the same day or next day delivery target. Can you go to what's your long-term outlook on your parcel mix of inter and intra city parcels? Thank you.

(Spoken in Mandarin)

(Spoken in Mandarin) The chairman mentioned our key revenue growth drivers includes first, continuous growth of e-commerce parcels through increasing the urban coverage density and the rural penetration of our service outlets and enhanced service quality.

And second, growth in a cross border parcel delivery, and third, growth in our non-ecommerce parcels such as business documents and major enterprise parcel shipments. And in the long-term, we will expand our ecosystem to expand into adjacent service areas such as LTL, cloud warehousing solutions and supply chain [finance]. And our LTL business is not included in the listed company but it plays important roles in our ecosystem.

It is still in an early stage of development since its establishment in the second half of 2016 and currently, our LTL business is on track to achieve its strategic goals.

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

Thank you, operator. In closing and on behalf of the entire ZTO Management team, we would like to thank you for your interest and participation in today's call. If you require any further information or have any interest in visiting us in China, please let us know.

Thank you for joining the call. This concludes the call.

Thank you.

Thank you.

The conference has now concluded, thank you for attending today's presentation, you may now disconnect.