ZTO Express (Cayman) Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

ZTO Express is a leading express delivery company in China, providing a wide range of logistics services primarily centered around express delivery and freight forwarding solutions.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

ZTO Express (ZTO) operates primarily in the People’s Republic of China, it is a Chinese delivery services company that connects businesses with their clients.

Business Overview

ZTO Express operates in the Chinese express delivery market, the largest express delivery market in the world and accounts for 20% of total volume in the world. The company utilizes a network model, which relies heavily on its network partners, for operations. ZTO’s network model focuses on building scale, optimizing costs, and delivering high levels of customer service to its express delivery service. They have a wide scale of operations in China with about 30k pickup and service outlets, roughly 4,800 transit hubs, and more than 5,000 transportation routes. They have a diverse customer base, primarily including merchants, customers of online retailers, and individual customers. ZTO has strategically invested in technology to improve the efficiency and performance of their express delivery services and operations. ZTO also focuses on improving operational and network efficiency in order to maintain profitability.

Revenue Distribution

ZTO’s revenue is derived primarily from providing express delivery and freight forwarding services within China. Their express delivery service is categorized into domestic express, cross-border express, and other delivery related services. They also have the freight business, where they provide services that include LTL, or Less-Than-Truckload freight transportation.

The company does not disaggregate revenues in the reports and earnings releases in a detailed way, we can only infer which parts of their business contributes the most to revenues based on the management commentary. Based on that, we can assume that the domestic express delivery segment makes up a majority of revenues. As said in the report, they are focusing on expanding into new geographies and providing more differentiated service in order to increase revenues.

The express delivery market is a vast and growing market driven by e-commerce growth. However, at the same time, prices in the express delivery industry has been declining and is expected to continue. This is partly because it is easy to have competition in a service based industry where the price is the only differentiating factor. So, smaller entrants have a greater chance to disrupt the bigger players through undercutting prices. The industry is highly sensitive to economic downturns, especially those related to consumer discretionary spending. The industry is undergoing consolidation to achieve economies of scale, reduce costs, and improve efficiency.

In general, the market is getting more competitive and ZTO is trying to maintain its position by improving its service quality, increasing market coverage, and investing in technology.

Margins and Profitability

ZTO’s margins and profitability are also affected by the competitive nature of their business, high volumes, and costs related to transportation. The operating margins and net profit margins are usually in the single digit range. Given the current financial outlook, these numbers are expected to be in the lower single digit percentages. But there was a mention of improving the gross profit, so better margins may be expected in the coming quarters.

ZTO is trying to maintain profitability and margins by focusing on better cost control and improving the overall operating efficiency.

Competitive Landscape

The express delivery market in China is very competitive with other giants competing against ZTO. They include SF Express, JD Logistics, and other regional players. Many global e-commerce marketplaces have their own in-house logistics solutions to reduce costs. Competition in the industry results in significant pressure on pricing, and companies are required to constantly focus on cutting prices to attract and retain customers. ZTO’s management continues to leverage its scale, its technology, and its customer base to compete effectively against its competitors and to defend itself from them.

What Makes ZTO Different

ZTO Express has a vast network in China, that operates with scale to bring costs down. The company is investing a lot in new technology like automation to reduce labor costs in the long run, and to improve operational efficiency. ZTO also has a strong customer base, built up over years of service.

ZTO aims to leverage its network capabilities to attract new customers, expand to new regions, and to capture higher market share.

Financials

ZTO has decent financials. They have revenue growth, but their profitability is low. While the company was doing well before the COVID related downturn, they haven’t been able to reach those margins again. The growth in the top line doesn’t mean that the company is able to make good profit. The balance sheet is decent, with large assets and reasonably low debt. The current ratio of the company is at 2.3 which is a healthy number, and they are likely to have no issues paying their debts. Based on these factors, I give the company a balance sheet rating of 4 out of 5.

Moat Assessment

ZTO has a very vast and wide delivery network, which gives it a competitive advantage against its competitors, it makes it incredibly tough to compete with ZTO’s large distribution system. Also, it has been operating for a long time in the space and has some scale advantages that help in reducing its costs. Also, the e-commerce business continues to grow at a rapid pace in China, giving ZTO an industry tailwind. The only major downside of this business model is its easy replicability. If a company is capable of creating similar network scale, that could challenge the position of ZTO, as well as the fact that margins are quite thin, making the company susceptible to new entrants. These limitations lead me to give ZTO a moat rating of 2 out of 5.

Understandability

ZTO’s business operations are easily understandable to an average person. A logistics business where they transport goods is not at all complex to comprehend. Even the way they generate revenues through transportation and logistics is easy to comprehend. However, given the complex and highly regulated operating environment in China, it can sometimes be difficult to understand all the nuances of the company. For these reasons, I give an understandability rating of 3 out of 5.

Legitmate Risks

  • Intense Competition: The Chinese express delivery market is highly competitive, with a lot of well established players vying for market share. High competition puts a strong pressure on pricing. Competitors can easily copy ZTO’s business model if they wanted. And also, this can result in a decline in profitability, if ZTO loses its pricing power, or cannot compete on price.
  • Dependence on Network Partners: Since the company is built on a network model, relying heavily on its network partners, if those network partners are unable to operate effectively, that would have a negative impact on ZTO’s business.
  • Regulatory Risks: The company is subject to complex regulations in China. Any change in those regulations may cause negative impact on the business.
  • Exposure to Commodity Prices: The company’s operations are dependent on fuel prices and other commodities, which are highly volatile and can affect the cost of doing business.
  • Economic Downturns: The Chinese economy could enter into an economical recession. And since ZTO does a lot of business related to consumer discretionary spending, economic downturns could lead to a steep drop in revenues.

Recent Concerns and Management Outlook

There have been issues with declining unit revenue in recent times. Also, the COVID related restrictions in China had disrupted a lot of supply chains, which also impacted ZTO. However, ZTO has been trying to take measures to improve profitability, including optimizing their cost structure, enhancing its quality of service, and expanding into new areas like smaller cities and cross-border business. The management expressed confidence that they will be able to see better growth in the upcoming quarters, through operational improvements and by capturing higher market share. Also, the e-commerce business continues to be the source of growth for ZTO, and with China expected to continue as a leading e-commerce market in the world, this should give an opportunity for growth.