ZTO - ZTO Express: Staying On The Sidelines

2023-08-08 07:30:56 ET

Summary

• ZTO Express' fiscal 2023 outlook is pretty good, with the company expected to report strong revenue growth and significant operating margin expansion this year.
• But ZTO's long-term prospects are more murky, considering the competitive threats posed by new entrants, and existing players that are engaged in fund raising.
• I keep my Hold rating for ZTO Express stock unchanged, after considering how the company could potentially perform in both the short term and long run.

Elevator Pitch

I still rate ZTO Express (Cayman) Inc. ( ZTO ) [2057:HK] shares as a Hold. With my previous May 30, 2023 write-up , I reviewed recent data relating to China's express delivery sector and touched on ZTO's volume guidance.

My attention turns to ZTO Express' short term financial prospects and the long term competitive landscape for the Chinese express delivery industry in the current article. ZTO's FY 2023 financial outlook is decent, but the company's medium to long term performance might be negatively affected by competitors' fund raising plans and new entrants. I am staying on the sidelines with a Hold rating for ZTO, until I am convinced that the company can stay as the market leader despite new competitive threats.

Favorable Short-Term Financial Outlook

ZTO Express is expected to report a pretty good set of financial results for full-year fiscal 2023.

In the past six months, the sell-side analysts' consensus FY 2023 top line forecast for ZTO was revised upwards by +1.5% (source: S&P Capital IQ ) from RMB41,308 million to RMB41,907 billion. During the same time period, ZTO Express' consensus EBIT estimate for this year was raised by +7.9% from RMB9,627 million to RMB10,385 million. This means that the market's current consensus financial projections point to ZTO's revenue and EBIT expanding by +18.5% and +34.2%, respectively in local currency or RMB terms in FY 2023.

In my opinion, the bullish expectations regarding ZTO Express's expected financial performance for the current year are justified.

The recovery in China's express delivery sector and market share gains are likely to be the main drivers of ZTO's top line growth for 2023. The number of parcel deliveries in China grew by a reasonably strong +17% YoY in the first half of the year, according to a July 13, 2023 China Daily news article . Separately, ZTO Express' management sees the company's share of the express delivery market in terms of volume increasing from 22.1% last year to a minimum of 23.6% this year as per its Q1 2023 results call commentary .

With respect to the potential improvement in profitability, ZTO Express' current consensus FY 2023 EBIT forecast of RMB10,385 million implies that the company's EBIT margin is projected to expand by +290 basis points to 24.8% in this fiscal year. In Q1 2023, ZTO's revenue in domestic currency terms rose by +13.7% YoY. But the company's cost of revenue increased by a mere +2.8% YoY for the first quarter of the year, which it attributed to operating "leverage, and meaningful productivity gain" driven by "digitization" at its quarterly results briefing. Going forward, I see greater economies of scale and improved operating efficiency as positive factors supportive of ZTO's profit margin expansion for 2023.

Competitive Landscape For China's Express Delivery Market In The Long Term

The key pillar of ZTO Express' investment thesis is that the company is expected to be a share gainer in the Chinese express delivery industry for the long run. But investors need to consider how the competitive landscape could potentially change in the future.

As it stands now, ZTO is the largest player in China's express delivery market with a 22.1% share in 2022 as highlighted in the company's May 2023 corporate presentation . The six biggest Chinese express delivery companies, including ZTO Express, have a combined 86.3% market share in the domestic express delivery sector in the previous year.

There is no guarantee that the Chinese express delivery market will continue to consolidate in the hands of the largest players and that ZTO Express will stay as the market leader judging by recent developments.

Cainiao Group, the logistics business of Chinese internet giant Alibaba ( BABA ), started its own express delivery service branded as "Cainiao Express" in June this year. By early August, Cainiao Group has already rolled out the company's express delivery services in eight Chinese cities and it has plans to expand the scope of its express delivery services to another seven cities in China soon. With the backing of its parent BABA which has significant financial resources as one of the largest internet businesses in China, Cainiao Group could pose a serious threat to the leading Chinese express delivery players such as ZTO in time to come.

Also, J&T Express, China's fifth biggest express delivery company with a 10.8% volume share in 2022, is planning to have its shares listed on the Hong Kong Stock Exchange and it could potentially "raise $500 million to $1 billion" based on a June 20, 2023 Deal Street Asia report . Assuming that J&T Express successfully complete its public listing in Hong Kong, the company might potentially utilize its IPO proceeds to fund its expansion in Mainland China.

In a nutshell, the process of industry consolidation for China's express delivery market might take a longer time with the entry of new players like Cainiao Group and the fund raising efforts of established companies such as J&T Express. Therefore, ZTO could find it hard to realize meaningful market share gains going forward. Also, a greater level of competitive intensity in the Chinese express delivery sector is also likely to translate into price wars and lower profit margins for ZTO Express in the long run.

Concluding Thoughts

ZTO's near term prospects are good, but there is uncertainty about the company's long term growth outlook. One of ZTO Express' key competitor, J&T Express is proposing to raise funds with an IPO, while a new player, Cainiao Group, has recently ventured into the Chinese express delivery market. Considering the potential changes to the competitive landscape in China's express delivery industry, I am currently sticking with my Hold rating for ZTO.

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