ZTO Express: Market share gains offset by weak economic environment (NYSE: ZTO)

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Summary in seconds

I am reviewing ZTO Express (Cayman) Inc. (NYSE: ZTO) [2057:HK] shares in the form of Hold. ZTO advertises itself as “one of the leading express delivery companies in China” and “one of the largest” in the world on its corporate website.

ZTO Express’ recent financial performance in the second quarter of 2022 has been excellent, but the market still expects the company’s revenue growth to slow over the next three years. The negatives related to weak economic growth should offset the positives related to market share gains for ZTO in the near future. In this regard, I think a Hold investment rating for ZTO is fair.

Robust growth in revenue and net income for the second quarter of 2022

ZTO Express released a very strong set of financial results for the second quarter of 2022, as highlighted in its latest quarterly earnings press release issued on August 17, 2022, after market close.

ZTO’s revenue grew +18.2% year-on-year to RMB 8,657 million in Q2 2022, implying that ZTO Express’ annual revenue expansion accelerated from a lower revenue growth of +14.4% YoY recorded in the second quarter of 2021.

The company’s strong revenue growth in the second quarter of 2022 was driven by both price increases and higher volumes. Specifically, ZTO Express’ parcel volume and ASP (Average Selling Price) delivery increased by +7.5% YoY and +10.5% YoY, respectively, in the last quarter.

ZTO Express’ non-GAAP net profit jumped +38% year-on-year from RMB 1,272 million in Q2 2021 to RMB 1,759 million in Q2 2022. In addition to benefiting from a significant increase in its revenues, ZTO’s bottom line increased significantly thanks to better profit margins.

ZTO’s gross profit margin increased by +2.6 percentage points from 22.8% in the second quarter of 2021 to 25.4% in the last quarter. The company explained during its second quarter 2022 analyst briefing on August 17, 2022, that its ability to “sustain the price which has increased compared to last year” and the fact that the “competitive environment is stabilizing “have helped it improve its profitability. in Q2 gross margin.

The company’s operating margin also increased by +300 basis points, from 19.9% ​​in Q2 2021 to 22.9% in Q2 2022, as ZTO Express managed its costs well. This is evidenced by a decline in the company’s selling, general and administrative or SG&A expense to revenue ratio, from 5.4% in the prior year quarter to 5.3% in the second quarter of this year. .

Positive market share gains

The main positive takeaway from ZTO Express’ second quarter financial results is that the company is grabbing market share from competitors.

ZTO disclosed in its second quarter 2022 earnings press release that its share of the mainland China express delivery market by parcel volume fell from 21% in the first quarter of 2022 to 23% during the last trimestre. It is essential for ZTO Express to increase its market share for two main reasons. The first key reason is that express delivery is a high fixed cost business where economies of scale are important. The second key reason is that bargaining power with customers and suppliers is also a function of size.

Looking ahead, ZTO Express said in its recent Q2 2022 earnings briefing that the company is “very well positioned to reach 30% to 40% of the overall market over the next five to 10 years.” . ZTO’s long-term market share expectations do not appear to be overstated, looking at both short-term and long-term historical trends.

In its Q2 2022 results presentation slides, ZTO pointed out that its market share grew every year between 2017 and 2021. Specifically, ZTO Express’s share of China’s express delivery market grew from 15 .5% to 20.6% during this period. Ten years ago, ZTO’s market share was well below 7.6% in 2011.

Industry consolidation is a key driver of market share gains for ZTO Express and its larger peers.

A comparison of the competitive landscape of the China express delivery market in 2011 and 2021

A comparison of the competitive landscape of the China express delivery market in 2011 and 2021

ZTO Second Quarter 2022 Results Presentation

As shown in the chart above, the combined market share of the smallest players (excluding the six largest players, including ZTO) in China’s express delivery market contracted from 28.6 % in 2011 to 19.5% in 2021. There is still plenty of room for ZTO and its larger rivals to take more market share from subscale and smaller competitors in the foreseeable future.

Concerns about the weak economic environment in China

According to an August 5, 2022, South China Morning Post article, Chinese Premier Li Keqiang was quoted as saying at a business forum that the country “can ‘live’ with slightly lower GDP growth if inflation stays below 3.5 percent.” This can probably be interpreted as a signal of China’s recognition that economic conditions in the country are not good. Earlier, Reuters also reported on July 28, 2022 that “China fails to mention GDP growth target” during the country’s Politburo meeting.

The weak economic environment will naturally be negative for an economically sensitive industry like parcel delivery.

Based on sell-side consensus financial projections obtained from S&P Capital IQ, analysts expect ZTO Express revenue growth to rise from +20.6% in fiscal 2021 to +19.2%, +17.8% and +15.5 % for fiscal years 2022, 2023 and 2024, respectively. In other words, market share gains cannot fully offset the expected decline in parcel volume resulting from economic weakness, suggesting that decelerating revenue growth for ZTO in the near future is inevitable.

Final Thoughts

ZTO Express shares are rated as Hold. The company has the potential to expand its share of the Chinese express delivery market from 23% today to 30% to 40% over the next decade. On the other hand, ZTO will still be affected by slowing economic growth in China, as indicated by consensus numbers indicating moderating revenue growth.