ZTO Express (Cayman) Inc (ZTO) 2017 Q1 法說會逐字稿

Good day and welcome to the ZTO first quarter 2017 earnings conference call. (Operator Instructions)

Please note this event is being recorded. I would now like to turn the conference over to Ms. Sophie Li. Please go ahead.

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 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 questions 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 of 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 US Securities and Exchange Commission. The Company does not undertake any obligation to update any forward-looking statements as a result of new information, future events, or otherwise, except as required under law.

It is now my pleasure to introduce Mr. Meisong Lai. Mr. Lai will read through his prepared remarks in their entirety in Chinese, before I translate it for him in English. Meisong, please go ahead.

(Spoken in Chinese)

Okay. Let me give a translation for Chairman.

Hello and thank you everyone for joining our call this morning. I'm proud to announce that we started off the year on a very strong footing. Our market share and parcel volume continued to grow rapidly during the quarter. Our parcel volume increased almost 41.9% year over year to ir.zto1.175 billion and generated RMB2.6 billion in revenues, which exceeded the high end of our guidance.

Our adjusted net income surged during the quarter to RMB503 million. I believe these strong results demonstrate the effectiveness our strategy is having on strengthening our industry-leading position and our ability to provide high-quality service to our customers and the users.

To further underline this point, according to the data compiled by China State Post Bureau, ZTO received the highest score for customer satisfaction among the Tongda operations and the second highest overall in the first quarter. We are proving adept at finding a careful balance between growing our market share with service quality and profitability, all while creating a strong and stable network, by aligning our interest with those of our network partners. This ability to carefully balance interests across our entire network forms the backbone of our distinctive shared success model.

To further support the stability of our network partners, we are creating new and innovative ways to support and drive their growth by improving their marketing and business development capabilities, strengthening big data analysis, integrating real-time data tracking across our network, helping them diagnose and resolve operational issues with enhanced training and strengthening their day-to-day management of service outlets and career to improve service quality.

All of these measures have effectively ensured the stability of our network, improved our reputation and customer satisfaction, and enabled us to provide more cost-effective services and products.

We are leveraging the economies of scale being created by the rapid growth in our parcel volume to further cut costs and improve operational efficiency. We extended our line haul vehicle fleet and installed six additional sets of automated sorting equipment during the quarter in key geographic markets such as Ningbo, [Suzhou], Wuxi, Chongqing, [Taoyuan] and [Weifa].

While investing in automation and fleet expansion, we are improving our operational efficiency and reducing labor and transportation costs, which provide the customers with superior services and better value for their money. This initiative has also increased trust and strengthened customer and merchant stickiness to our brand. At the scale of our network expand, we will be able to handle larger parcel volumes with increasing efficiency.

By leveraging the scale of our network, high-quality services, and the strong operational capacity, capability, we are well-positioned to achieve healthy and sustainable growth. I am confident that we will be able to carefully balance market share, service quality, and profitability. We're growing our business to create more value for our business partners, customers and shareholders.

With that, I will now turn the call over to James who will go over our financial results in more detail.

Thank you, Chairman.

I'm pleased with our performance during the first quarter, with revenue exceeding the high end of our guidance. Our economies of scale and cost-cutting measures are beginning to bear more fruit, with unit cost falling to RMB1.6 from RMB1.64 during the same period last year, despite higher fuel cost increase. Revenue jumped 33.5% to RMB2.6 billion on the back of strong parcel volume growth which increased by almost 41.9% to 1.175 billion.

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 assess our performance. All percentage changes I'm going to give will be on that basis.

To start with, parcel volume during the quarter increased by 41.9% to 1.175 billion. Our number of self-owned trucks increased to over 3,000 as of March 31, 2017, from 2,930 as of December 31, 2016. The use of more self-owned, high-capacity trucks has enabled us to enhance transportation efficiency continuously and reduce unit transportation costs as we further increase our economies of scale.

Revenues increased by 33.5% to RMB2.6 billion, primarily due to an increase in parcel volume as a result of overall market growth and our expanding market share. Cost of revenues rose RMB1.9 billion, an increase of 38.8%, primarily due to increase in line haul transportation, sorting operating, and accessories cost, which were partially offset by a decrease in waybill material cost due to the increased use of digital waybills of our end-customers which have lower cost than paper waybills.

Going into further details, line haul transportation costs increased 43.3% to RMB1.1 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 include fuel cost, driver's compensation, depreciation and maintenance expenses.

This also includes RMB163.4 million in costs associated with outsourced transportation services. As a percentage of revenues, line haul transportation cost accounted for 42.8%, an increase from 39.9% in the same period of last year, mainly due to increases in fuel cost, depreciation and outsourced transportation cost.

Sorting hub operating cost rose 28.5% to RMB556.2 million, primarily due to increases in labor cost as a result of wage and headcount increases, depreciation expenses, and rental and related utility costs. As a percentage of revenues, sorting hub operating cost accounted for 21.3%, a decrease from 22.1% in the same period last year, as a result of greater economies of scale and improved sorting efficiency.

Cost of accessories increased 34.5% to RMB62.4 million, which was in line with growth in our revenue from the sale of accessories.

Other costs increased 50.6% to RMB145.2 million, primarily due to an increase in dispatching costs associated with serving enterprise customers, which were partially offset by a decrease in costs associated with the use of paper waybills.

Gross profit rose 21.5% to RMB730.6 million, while gross margin decreased to about 27.9% from 30.7% in the same period last year, mainly attributable to the downward adjustments to network transit fees we began charging our network partners in the second quarter of 2016 and the increase of line-haul transportation cost.

Total operating expenses declined 49.7% to RMB73.9 million. Taking a closer look, we see that SG&A expenses decreased slightly to RMB162 million, primarily due to the decreased share-based compensation expenses.

Income from operations was RMB656.7 million, an increase of 44.5% from the same quarter of last year. In the first quarter, net income rose to RMB502.9 million, compared with RMB338.8 million we made during the same period last year. Basic and diluted earnings per ADS were RMB0.70, compared to RMB0.47 during the same period last year.

Adjusted net income surged to RMB503.1 million, compared to RMB367.9 million during the same period last year, which was again -- demonstrates just how effective our initiatives are to increase operational efficiency and reduce costs.

EBITDA was RMB804.8 million, a significant increase from RMB520.2 million during the same period in 2016. Adjusted EBITDA was RMB805 million, an increase from RMB549.3 million during the same period last year.

Net cash provided by operating activities was RMB331.5 million, compared with RMB263.6 million during the same period last year.

As of March 31, 2017, the Company had RMB11.1 billion in cash and cash equivalents and time deposits, a slight decrease from RMB11.3 billion at the end of last year.

Now, turning to guidance. For the second quarter of 2017, we expect revenues to be in the range between RMB2.95 billion and RMB3.05 billion, or USD428.6 million to USD443.1 million, representing a year-over-year growth rate of approximately 29% to 33.4%. This represents Management's current and preliminary view, which is subject to change.

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

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

Thank you. We will now begin the question-and-answer session. (Operator Instructions).

And our first question will come from Baoying Zhai of Credit Suisse. Please go ahead with your question.

Pardon me, ladies and gentlemen. We have Ronald Keung from Goldman Sachs. Please go ahead.

Thank you for taking my question. (Spoken in Chinese)

We've been seeing quite a lot of expansion of businesses of express companies where they've now expanded to less-than-truckload, into warehousing, into supply chain. And so, would like to hear Management's view in each of these segments in express and trucking, and also strategies of the Company in expanding in the current trucking and express segments, and I mean further strategy of expanding it to other logistic segments. Thank you.

(Spoken in Chinese)

Yes, I will do the translation for the Chairman.

To put it simple, express delivery business is mainly a B2C business, whereas less-than-truckload business is mainly a B2B business. Currently, our LTL business is an operating entity independent from our listed company. It is an important component of the ZTO ecosystem.

We founded the LTL business in the second half of 2016, and the establishment of this business not only follows the development trend of more advanced manufacturing industry in China, but also provides a new service offering to our customers.

The LTL market in China has huge growth potential and is highly fragmented in the meantime. So, because of this, the LTL business has vast room for growth. Our LTL business adopts an operating model of distribution center ownership plus franchise network, focusing on establishing its competitive advantage through providing value-added services.

Aside from our core express delivery services, we are also looking into expanding our service value chain and ecosystem. Our current ecosystem includes the ZTO less-than-truckload business, the ZTO International business, the ZTO e-commerce, and ZTO Warehousing solution business. While improving this business, we will also explore opportunities in adjacent business areas such as ZTO Technology and ZTO Finance in the future. And this attrition business directly complements ZTO's core business and greatly enhance our overall ecosystem.

For the year of 2017 and 2018, our focus will remain on operating the main express business and building a bigger ecosystem.

Next question?

Our next question will come from Baoying Zhai of Credit Suisse.

Please go ahead with your question.

(Spoken in Chinese)

Baoying, do you want to ask the question in English yourself, or do you want us to translate it for you?

Okay, sorry, so I will translate that myself. So first of all, congratulations to the solid volume growth in the first quarter, especially the industry volume growth actually showing an [upper] view slowdown. And so regarding the first quarter results, I think it's very clear that one question I want to follow up is the government subsidy, so would you like to elaborate more what is the subsidy about and is this recurring? Because I see RMB71 million year-on-year increase.

So regarding the future, in terms of the second quarter guidance, to be honest, it's a little bit weaker than my expectation because I think last year, the second quarter ASP is already at a low rate, so this year, second quarter, ASP should be relatively resilient. So, is this because of volume growth is not that good? Especially YTO is fighting back aggressively in the second quarter. Do we see some impact from this?

And the second question regarding the future is CapEx, because in the first quarter, we only see about RMB100 million CapEx, but the previous guidance regarding the full year is a full price of about RMB4.5 billion. So do we spill maintain the same CapEx guidance or there will be some changes? Thank you so much.

(Spoken in Chinese)

I will do the translation for the chairman. First, the government subsidies are in substance, a tax rebate, and we believe that's sustainable in the future as long as we apply for that every year. And second, the expected revenue growth remain very strong and it may be less than expected because of the drop in the average weight in our parcel being shipped and also the increase adoption of the digital waybill.

We continue to believe that -- we continue to grow our parcel volume above the industry average. Third, it's about the competition in the marketplace, the initiative our peers took right now did not affect us very much, we are still an industry leader.

In the chairman's words, running an express delivery business is like running the marathon, we focus our development growth in a more sustainable and long-term manner by sticking to our strategic plan, we strategically deploy resources to ensure the stability of our network as well as improve service qualities and profitability of our network.

We would like to emphasize one more time that our network has always been the most -- more stable among the peers and this is why we are able to succeed. We believe that we will be able to maintain our advantage with stable, healthy growth in the future.

In terms of CapEx in the first quarter, yes, during the first quarter, we added more than 70 self-owned trucks and we also installed 6 sets of automated sorting equipment in the sorting hubs in 6 cities to improve the sorting efficiency. As of the end of March, we already installed a total of 18 sets of automated sorting equipment in 16 sorting centers.

In the first quarter, we deployed approximately RMB509 million in CapEx, and at this point in time, we have no plans to raise the annual CapEx target. The CapEx spend in the first Q is typically lower than the rest of the year.

(Spoken in Chinese)

Yes, the chairman also added that the drop in the average weight of the parcel volume is a result of a change in the product mix and also the increased adoption of the digital waybill won't have any impact on our profitability.

Next question.

Our next question will come from Ella Ji of China Renaissance. Please go ahead.

(Spoken in Mandarin) So I will do the translation myself. So first question, we understand that there are some smaller express delivery companies have recently waged a price war, we understand that they are much smaller than ZTO, but we still wonder if this has any impact on ZTO's business even on a regional basis, and how will ZTO -- how does ZTO plan to handle this type of price war?

The second question is we understand that there is still an increase in cost pressure at franchisee level including rent and last mile delivery guys salaries. We also saw that the whole industry rate, the last mile delivery fee recently, we are wondering how well ZTO bear this higher cost together with the franchisees and how will this impact ZTO's profitability in the long term?

Thank you very much.

(Spoken in Chinese).

It's a long answer, so let me answer your question one by one. The first -- the answer to the first question, about the price war by other smaller companies, the pricing war initiated by these smaller companies has very limited impact on us. We always closely monitor what is going on in the industry, we focus on increasing our market share and strengthening service quality and profitability to ensure a stable network. We believe when consumers choose express delivery services, they place more consideration on the value for money rather than just the price.

Currently, we focus more on improving service quality and providing more cost efficient and comprehensive products and services to our customers. The scale and the stability of our networks are much better than these small companies and therefore, our service is much more reliable.

The answer to the second question about the profitability of our service outlets, the chairman says we continuously monitor the profitability of our networks and outlets, including the rental fees. If the rental fees for an outlet is rising, we will give them subsidies and for our entire network based on basic delivery fee, we will adjust the lowest amount delivery rates based on market dynamics in different regions.

At the same time, we also care about the ability to compensate for the right employees as well as the operational and the profitability of our service outlets. To cope with different problems, we will provide different solutions to these service outlets. In the meantime, we will continue to strengthen our training program, provide more support to the outlets, and support the implementation of new technology to help increase efficiency at our outlets.

In the long run, we believe that we are striking a good balance in our marketshare, service quality, and profitability. And the chairman also says that we are focused on maintaining network stability, addressing everyone's interest and expand the capacity of our outlets to incentivize them, and also secure the interest of our outlets, and the network partners.

And that is the business philosophy that we have and the reason why we created the last mile delivery mechanism that is tailor made for our local conditions.

We continue to improve and optimize this mechanism as the market develops to better balance the interest of our network partners, we will also provide subsidies for our secondary network charging fees, we make specific adjustments on the last mile delivery fees based on the ratio of pickup versus delivery volume of the outlets, and also we provide subsidies to delivery outlets located in remote areas or offer extra rewards to the outlets if they beat their parcel volume targets we set for them.

We also subsidize our outlets that have high operating costs including those which are located in city centers. And yes, he says, in order to develop a stable network, it is key to empower the outlets and help them improve their operational efficiency.

On the one hand, we continue to increase our market share and enhance the influence of our brands, which helps our outlets expand their business volume. On the other hand, we also help our outlets improve their operational efficiency by providing them with training, developing IT system for them as well, and in addition, we will continue to lower our operating costs which also benefits the outlets.

By empowering our outlets, we help them improve their profitability and we believe improving the profitability of the outlets in ZTO as a group is not a zero-sum game, which means it's not the case that one's gain is offset by the other's equal loss. We create positive synergies between our service outlets and the Group and we can support and complement each other.

And currently, the overall profitability of our outlets is very good.

And the answer to the third question about the recent last mile fee increase, the chairman says that we raised the last mile delivery fee by about 0.6 -- RMB0.15 per parcel in our network. This can maintain the network stability, improving the benefits to the delivery personnel, minimize unhealthy competition through price war, and also promote sustainable development of the market.

In the ZTO network, last mile delivery fees are paid directly by the pickup outlets to the delivery outlets and therefore, it is borne by the pickup outlets. In the near term, the fee adjustment may have an adverse impact on pickup outlets, but in the longer term, the policy is conducive to a healthier and more sustainable growth of the industry.

And the Company has always focused on the stability and profitability of the network and our results demonstrate that our network is comprised of more stable and more efficient outlets in the industry and our relationship with network partners focuses more on shared services, at the same time, creating a win-win situation rather than just a zero-gain, zero-sum relationship that benefits only one party but at the cost of the other parties.

That summarizes the answers to the questions.

Okay, next question.

Our next question will come from Alex Yao of JPMorgan. Please go ahead.

(Spoken in Chinese)

So, I have two questions, one is regarding the comparable net (inaudible) rate we noticed that one of the key competitor only grew their revenue by 7% in the first quarter this year because of operational disruption as a result of low profitability of the network partners.

In such a competitive environment, what strategy do you accelerate market share gain?

The second question is about the ability and profitability of the network partners, what is your strategy to stabilize the network partners [logistical expense]. Would you consider some of the economic (inaudible) to show these network partners to help them with the profitability?

Thank you, I will stop here.

(Spoken in Chinese).

I will do the translation for the chairman, to answer your first question, Alex, the chairman says that we are glad to see the increase of the market share during the first quarter and also the continuous improvement of our industry-leading position. We closely monitor what is happening in the industry and we focus our resources more on the trends and factors that could cause industry-wide changes, and adjust our operating tactics based on the long-term strategic goals.

As an industry leader, we have always believed that quality services and stable networks are the basis for growing our market share. We always focus on making our strategy work to enhance the capability of our entire network.

I also ask that according to the statistics released by the State Post Bureau, the total parcel volume in China for the first quarter was about 7.59 billion, an increase of about 31.5% year-over-year, and our parcel volume was 1.175 billion for the first quarter, an increase of about 42% year-over-year, and our growth rate was much higher than the industry average.

As of the end of the first quarter, our market share was 15.5% in terms of parcel volume, an increase of 1.1 percentage point when compared to the 14.4% we had at the end of 2016. We believe that as long as we do the right thing, we will maintain healthy and sustainable growth in the future.

To answer your second question, anything special that we did in the first quarter to gain marketshare to ensure the network stability, the chairman says that we did nothing special in the first quarter to ensure our network stability. Actually, we have been constantly doing the same thing, doing the right thing in the past, and continue to do so in the future.

He says we provide subsidies for some of our network partners, service outlets, for example, we provide subsidies for secondary network transit fees and also provide subsidies to delivery outlets located in remote areas or offer a sort of rewards to these service outlets if they beat the parcel volume targets that we set for them.

He says we believe improving the profitability of our service outlets and ZTO as a group is not a zero-sum gain, he says that is not the case that one's gain is offset by another's equal loss. We create positive synergies between our service outlets in the group, and we can support and complement each other.

And he says that currently, the overall profitability of the service outlets in our network is very good.

Okay, last question.

Your next question will come from Edward Zhu from Morgan Stanley. Please go ahead.

(Spoken in Chinese)

So my first question is about your GP margin, we see that in the first quarter GP margin still declined, although the revenue increased dramatically and the net profit was pretty good. So, what's your target for the GP margin for this year? Specifically, what does the fuel cost account for your total cost, in your cost structure? And also, the increase of the last mile delivery fee, will that cost be borne by the headquarter? Would you be giving some subsidies for the first mile franchisees for this? First question.

Second question, about the first mile delivery stuff, because we see that a lot of network company, like Baidu, Maytuan, they are offering good compensation for these last mile guys, and which may poach some last mile stuff from the regular express companies. How are you going to deal with this? And do you see any significant loss of your last mile delivery stuff? Thank you.

(Spoken in Chinese)

So the first question is about the gross margin in Q1. The Chairman says -- first of all, I would like to point out that the gross margin in Q1 this year and last year are not directly comparable. The reason is that, during the second quarter of last year, we lowered the network transit fees we charge our network partners, and the change in the pricing has led to a reduction in transit fee revenue per package. So, because of this change, the quarterly revenue generated during the second quarter of last year is not comparable with that in the previous period.

And such pricing policy will change in April last year, so the apple-to-apple comparisons will begin during the second quarter of this year. And according to the data that we currently have for April 2017, our gross margin stabilized when compared with the same period of last year. In the long term, he believes that the gross margin will be stabilized and increase steadily.

In terms of the transportation cost control, we adopted a number of measures during the first quarter of 2017, which is gradually taking hold. These measures include, first, controlling the cost of third-party logistic vehicles. We increased the number of self-owned vehicles and optimized the transportation routes to replace third-party trucking companies.

The increase in the transportation cost during the fourth quarter of last year was because some one-off factors like higher fuel prices and some other seasonality, for example, the e-commerce sales promotion during the shopping festival, which require more third-party vehicles than expected. And also because of the imbalance between supply and demand of transportation capacity in the marketplace during that period, the third-party outsourcing cost increased quickly.

And while we have already bought more self-owned vehicles, we have not been able to recruit or no need to recruit or -- we have not been able to recruit and train enough qualified drivers in a timely manner. So, we have to rely more on third-party trucking capacity in Q4 last year. And this situation has significantly improved this year.

And second, we also control this Company's cost by adjusting the transportation routes. And third, we increase our vehicle capacity by effectively using our self-owned -- self-operated distribution centers where we can arrange pick-up and drop-off times ourselves.

In the meantime, we also improved the performance of (inaudible) system of our sorting personnel. We continue to increase investment in sorting equipment, especially automated, extensible belt conveyors and automated sorting equipment.

And the increase in the belt conveyors helps improve efficiency, which has effectively lowered our sorting cost in Q1. And the investment in the automated sorting equipment will have a much greater impact on us by the fourth quarter of 2017. By then we expect to have over 50 automated sorting equipment installed in the Company.

And the next question, about competition from the foot delivery industry for personnel to last mile delivery personnel. The Chairman said, based on our understanding, delivery personnel, especially frontline foot delivery personnel only accounted for a very small portion of total delivery personnel, perhaps less than 5%. So, the case that you just described that the foot delivery business is attracting more delivery staff to join their ranks doesn't exactly ring true to us. We don't see this happening. And there's no major impact on our business.

And our service outlets are very stable because of our unique shared success system and effective network partnerships with balanced interests, and our network partners are very loyal to us.

Yes, to reduce fuel cost, the Chairman adds that we'll continue to lower fuel cost by centralizing the sourcing of fuels. And that has started to pay off in March last -- this quarter.

And anything else? The last mile -- yes, the last mile fee adjustment, the Chairman mentions, and raising the last mile fee in the networks can maintain the stability of the network and improves the benefits to the delivery personnel and also promote sustainable development of the markets. And depending on the situation, we may provide more subsidies to some of these service outlets. But overall, the pick-up outlets will have to bear the last mile delivery fee adjustment on their own.

(Spoken in Chinese)

Yes. The Chairman also adds to the comments on the pricing adjustment in last Q2. And he says, what we actually did in last Q2 is actually we bundled smaller packages into bigger packages. And as a result of this, there are some minor impacts on the total pricing of the package.

And he believes that it is very important for us to strike the right balances among our market share, service quality, and profitability of the entire network. Only by doing this we can make sure that we can achieve long-term sustainable growth in the entire network.

Okay. Due to the time limit, we have to end the meeting now.

So, in closing on behalf of the entire ZTO Management Team, we'd 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 us today. This concludes the call. Thanks.

(Spoken in Chinese)

Yes, the Chairman adds, because of time constraint, we have to end the call right now. But for investors who have more questions about the business, about the Company, please feel free to reach out to us. We are open to answer your questions. And we are a company, we adopt a transparency culture. Thank you. Bye-bye.

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