ZTO - ZTO Express: Best-In-Class And Trading At Significant Discount

2023-11-20 02:27:50 ET

Summary

• ZTO Express is a top player in China's express delivery industry and has consistently gained market share due to its competitive advantages.
• China's express delivery industry has outperformed GDP and e-commerce growth due to factors such as the rise of e-commerce platforms and increased demand for parcel delivery services.
• ZTO Express has the highest operating efficiency, lowest cost, and highest profit margin among major players, giving it a competitive edge in the market.

ZTO Express (ZTO) is one of the top express delivery companies in China. Having established itself as one of the top players in the industry, the company has also expanded into adjacent markets in recent years.

ZTO Express has benefited from China's rapid growing e-commerce market. Unlike its competitors such as YTO and STO, ZTO has consistently gained market share due to ZTO's competitive advantages against its competitors, as a result of ZTO's best-in-class management team.

After COVID, China's express delivery industry is likely to continue to benefit from faster-than-GDP growth of China's e-commerce market. As the most efficient and lowest cost player with the most stable franchisee partner network, ZTO Express will continue to take market share from its competitors and achieve above average growth. Furthermore, as industry price war subsides, ZTO's profitability will also improve. At today's price, ZTO Express is tremendously undervalued.

China's Fast Growing Express Delivery Industry

During the past 5 years, China's GDP growth has slowed dramatically mostly due to COVID, the burst of the real estate bubble, and local government debt problems. China's e-commerce growth is faster than GDP growth but has also come down because internet penetration has peaked. On the other hand, China's express delivery industry has outperformed both GDP growth and e-commerce growth by a large margin.

There are at least three reasons why China's express delivery industry has achieved stellar growth during difficult times. First of all, China's e-commerce has experienced decent growth due to the rise of PDD and ByteDance. Demand for parcel delivery service grew with the e-commerce market. Secondly, major China's express delivery players have penetrated to lower tier cities and rural areas. Previously these areas only had limited delivery services. Thirdly, there are more light-weight parcels as Chinese consumers bought more value products when the economy is faltering.

China's express delivery market can be further divided into two markets, namely the premium market and the value market. The premium market is a duopoly between SF Express and JD Logistics. Both use a self-operate business model.

In the value market, currently there are 5 major players after JT Express bought Best Inc. JT Express is a relatively new player. ZTO, STO, YTO and Yunda are traditional players with similar business models. They all use a franchise model, under which the headquarter operates parts or all of the line-haul transportation and sorting and transfer network, while the franchisee partners operate the first-mile pickup and last-mile delivery services.

Of all the major players, only ZTO has consistently gained market share due to its competitive advantages.

Market share change of major express delivery players

ZTO Express's Competitive Advantages

In the value segment of the express delivery market, service reliability and quality, cost advantages due to scale and operational efficiency are the most important competitive advantages.

Among the major players, ZTO has the highest operating efficiency, the lowest cost, and the highest profit margin. ZTO's profitability is so high that according to the company's investor presentation deck , ZTO accounted for between 50% and 80% of the Tongda (STO, YTO,ZTO, and Yunda) profit, with only 35% of the parcel volume.

ZTO's superior profitability is achieve mainly through a little bit premium pricing and cost advantages. ZTO's pricing in Yiwu City, which is the largest express delivery market in China, is higher than STO, Yunda and YTO by 3-10% depending on market conditions. ZTO's premium pricing power is built over the years by achieving industry leading on-time delivery rate and best-in-class service.

On the cost side, ZTO's cost advantage over its competitors mainly results from three factors.

First of all, unlike other major competitors which rely on outsourced line-haul vehicles, ZTO owns more than 90% of its line-haul vehicles. Furthermore, ZTO's line-haul trailers are 15% larger in size and have higher capacity. According to the company , the unit cost of transportation using its own line-haul trailer vehicle is lower than its competitors.

Secondly, ZTO also directly owns more sorting centers than its competitors, and ZTO's sorting centers are more automated than its competitors. According to the company's filing , " as of December 31, 2022, ZTO's network infrastructure consists of 98 sorting hubs with 458 automation lines ." A higher percentage of self-operated sorting centers means ZTO can better optimize routing, improve delivery efficiency and service quality.

Last but not least, ZTO has more direct point-to-point routes than its competitors. This is achieved through incentivizing ZTO's franchisee partners to directly deliver parcels to end-customers instead of sending the parcels to sorting centers first, which add another layer of cost. According to ZTO's 2022 annual report , ZTO has "approximate 5,900 direct network partners operating over 31,000 pickup/delivery outlets and over 80,000 last-mile posts. ZTO's network covers over 99% of cities and counties in China."

Income Model And Valuation

In my model, I assume that the Chinese express delivery market will continue to grow at 12-18% a year. This growth rate is consistent with the trend line of the industry growth rate. I also assume that ZTO will continue to increase its market share, in line with ZTO's historical rate of market share gain. If there's no further price war, ZTO can easily expand its gross margin to 27.6% and net margin to 21.5%. Combining these assumptions, I arrive at my own estimate of ZTO's 2025 net income of 14 billion yuan.

On the valuation side, comparing to FedEx and UPS, ZTO will grow faster. But at the same time a geopolitical discount seems to be appropriate given ZTO's stock is a Chinese ADR. Therefore, I applied a 16 times TTM P/E multiple, which is in line with the TTM P/E multiple of FedEx and UPS.

Based on my assumptions, ZTO Express's stock price has a 57% upside in two years from today's price.

Risks to consider

The biggest risk facing ZTO is another price war. China's express delivery industry has gone through multiple price wars. The government had to step in during COVID to stop irrational pricing. While the government's effort has temporarily halted the price war, there's no guarantee that there won't be another prolonged industry price war.

Another risk is the key man risk. ZTO's success has largely resulted from its founder and CEO, Meisong Lai's personal charisma and competency. If something unfortunately happen to Mr. Lai, or if he loses his passion and motivation, it will be a big blow to ZTO Express.

Lastly, as with all other Chinese ADRs, ZTO's stock is very volatile due to geopolitical tensions.

Conclusion

ZTO Express is the best-in-class operator in China's fast growing express delivery industry. After COVID, the industry is poised to grow faster than China's GDP. ZTO will benefit from the industry growth and further improve its operating efficiency. At the current market price, ZTO's stock has almost 60% upside in two years. Therefore, I give ZTO Express stock a "buy" rating.

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