ZTO - ZTO Express: A Good Company In A Tough Industry

2023-10-17 10:28:55 ET

Summary

• Price competition in the Chinese express delivery market remains intense based on an analysis of recent pricing data.
• ZTO Express has performed well in key areas such as service quality and cost control.
• I retain my Hold rating for ZTO, taking into account both company- and industry-specific factors.

Elevator Pitch

My investment rating for ZTO Express (Cayman) Inc. ( ZTO ) [2057:HK] stock stays as a Hold.

I evaluated the competitive dynamics for China's express delivery market and ZTO Express' near term outlook in my earlier article published on August 8, 2023.

In this current write-up, my focus is on industry headwinds and the company's differentiating factors. ZTO Express' service quality and cost management are outstanding, but it is still affected by negative industry factors like price wars and regulatory headwinds. In a nutshell, ZTO Express is a good company operating in a tough industry, which means that a Hold rating for the stock is fair.

Industry Headwinds

There are headwinds for companies operating in China's express delivery industry relating to price competition and unfavorable regulatory developments.

In my prior early August update, I warned that "the entry of new players like Cainiao Group and the fund raising efforts of established companies such as J&T Express" might "translate into price wars." The recent metrics disclosed by ZTO Express and its Mainland Chinese peers suggest that price competition could have intensified in the Chinese express delivery sector.

The Average Selling Prices or ASPs for Yunda Holding Co. Ltd. [002120:CH], YTO Express Group Co. Ltd. [600233:CH], and STO Express Co. Ltd. [002468:CH] decreased by -3.5%, -4.6%, and -5.9%, respectively in 1H 2023 on a HoH (Half-on-Half) basis as per my review of these listed companies' disclosures.

ZTO Express revealed in the company's Q2 2023 results press release that its "core express ASP decreased 7.8%" YoY in the most recent quarter. In this announcement, the company attributed the lower ASP to the "mix impact of KA (Key Accounts) volume decrease, pricing adjustments to attract lighter or smaller packages and volume incentives." The larger-than-expected decline in ASP resulted in ZTO Express' actual Q2 2023 top line of RMB9,740 million missing the market's consensus revenue forecast of RMB10,244 million (source: S&P Capital IQ ) by -4.9%.

ZTO Express acknowledged at its second quarter earnings briefing that "price-for-volume behavior" (i.e. reducing prices in exchange for an increase in delivery volumes) is "still present", and shared its observations that "the price fluctuation (in the industry) became extremely volatile" in Q2.

This trend of declining industry ASPs are reflected in the sell-side analysts' financial estimates for ZTO Express. The company's gross profit margin is projected to contract from 33.9% in the second quarter of this year to 31.7% and 30.6% for Q3 2023 and Q4 2023, respectively based on S&P Capital IQ's consensus data.

Separately, the Chinese regulatory authorities appear to be taking a tougher stance on domestic express delivery companies based on recent news flow.

An October 12, 2023, news article published on Chinese financial news portal AASTOCKS highlighted that the country's State Post Bureau "convened a meeting" on "the regulation of market order and governance of outstanding issues for the express delivery industry", requiring industry players to "accelerate the pace of development, transformation and upgrading."

In other words, ZTO Express and its peers are likely to increase their investments in specific areas to comply with guidelines set by the regulators. For example, express delivery services in China's rural areas might be less profitable than similar services in the country's urban areas due to a lack of scale, but companies will have to invest in improving the quality of delivery services in these rural areas to satisfy the regulators' demands.

ZTO Is A Good Company

As one of the players in China's express delivery market, ZTO Express is inevitably exposed to price wars and regulatory headwinds. But the company stands out among its peers for its service quality and cost management.

In its investor presentation slides , ZTO Express cited data from the State Post Bureau highlighting that it holds the "leading position of customer satisfaction" in the Chinese express delivery industry between 2014 and the first half of 2023. The company also disclosed in its investor presentation that its "monthly average effective complaint rate" for the last three years was less than "1 per million."

ZTO Express' good service quality as evidenced by the metrics presented above explains why the company's market share in China's express delivery market has continued to expand despite intense price competition. The market share for ZTO Express, as measured by industry parcel volume, went up from 22.1% last year to 23.5% in the most recent Q2 2023.

Also, ZTO Express is managing its expenses very well, which will help to partially offset the negative effects of price competition.

The cost per parcel for ZTO Express decreased by -18% YoY to RMB0.81 in the second quarter of this year. The company explained at its Q2 results call that "increased level of automation, improved standardization in operating procedures, and optimized performance evaluation systems" have allowed it to achieve a meaningful decline in the cost per parcel metric.

Closing Thoughts

I maintain a Hold rating for ZTO Express. I appreciate the company's strengths relating to expense optimization and service quality, but I am worried about unfavorable industry issues such as unfavorable policies and price competition.

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