ZTO Express: Still Undervalued Despite Unexpected Market Share Loss (NYSE:ZTO)

Kathrin Ziegler/DigitalVision via Getty ImagesI published my investment thesis on ZTO Express in November of last year and wrote an update to the business in March of this year after the company released its FY2024 earnings. The stock has risen a little bit since my write-ups. I believe ZTO is still undervalued based on my financial projections and valuations. However, recently, there have been some negative developments that are not in-line with my expectations. Therefore, while I will maintain my “buy” rating for ZTO Express, I have cut my target price to reflect the negative fundamental changes. Unexpected market share decline I have pointed out in my initial write-up of ZTO Express, of all the major players in China’s express delivery industry, only ZTO has consistently gained market share due to its competitive advantages. As a recap, from 2015 to 2023, ZTO has gained market share for 9 consecutive years, which is a remarkable achievement given the brutally competitive nature of China’s express delivery market. However, during the first five months of 2024, ZTO Express’s market share unexpectedly dropped significantly compared to its major competitors. ZTO ExpressThe market share loss was mainly due to ZTO’s below-average volume growth rate from the beginning of the year. Industry statistics are not available for Q2 yet, but for Q1 of 2024 parcel volumes for China’s express delivery industry grew 25.2%. Among the major players, ZTO’s parcel volume growth was the slowest at 13.9%, while YTO grew 24.9%, Yunda grew 29% and STO grew 36.7%. It is extremely rare that ZTO’s growth rate was the slowest in the industry. ZTO’s Chairman and CEO Meisong Lai explained why ZTO’s market share declined during ZTO’s Q1 FY2024 earnings call. Lai said that the industry’s faster-than-expected growth was due to “frequent promotions by new live-streaming e-commerce and social networks retailing. On the other hand, it also contributed to an increase in the proportion of low-priced e-commerce parcels. ZTO insisted on healthy and a sustainable growth and chose to let go unprofitable parcel volume on the premise of base level volume necessary for scale leverage.” I am a bit skeptical of Lai’s explanation because China’s express delivery industry has gone through many rounds of price wars. In the previous price wars, ZTO actually gained market share most of the time. Why is this time different? The price war continues During the first five months of 2024, China’s express delivery continued the brutal price war due to fierce competition in low-priced e-commerce and live-streaming markets. Average price per parcel declined for all major players. However, ZTO’s price declined the least with only 2.5%, followed by YTO’s 4.9% price decline. STO and Yunda were very aggressive with pricing, as their average price per parcel both declined double digits. It is impossible to predict when this round of price war will end, but eventually, it will. First of all, the government can step in and order the major industry players to stop the price war. This has happened before. Secondly, the franchisee networks of the major players are already unstable, as many franchisees are losing money at this price level. If the price continues to decline at this speed, I would imagine that a large portion of the franchisee partners of STO and Yunda will exit the network. Thirdly, if China’s economy recovers in the future, there won’t be so many low-priced parcels from the e-commerce market. In this case, industry volume growth might slow down, but pricing will improve. However, as long as the price war continues, ZTO may still lose market share. I will keep track of the market share changes for the remaining quarters of FY 2024. Financial projections and valuation In terms of financial projections, I’ve updated my ZTO’s model to incorporate the market share change for FY2024 and FY2025. This resulted in lower revenue and net income projections as well. author’s estimate author’s estimateAs for valuation, I am still applying 16 times TTM PE multiple for ZTO Express. This valuation multiple still reflects a 40% discount to the sector median of 25 times to account for the fact that ZTO Express is a Chinese ADR. At today’s valuation, ZTO’s stock price is still fairly cheap as the stock has almost 46% upside from my 2025 fair value estimate. Risks to consider In the short term, the biggest risk to ZTO continues to be a prolonged price war. In the previous price wars, ZTO has managed to increase its market share. However, ZTO’s market share declined unexpectedly during the first five months of FY 2024. It remains to be seen whether ZTO can maintain its market share going forward. In the long term, the biggest risk is the key man risk, as ZTO’s success so far can be mostly attributed to the business acumen of its Chairman and CEO Meisong Lai. Lastly, ZTO’s stock doesn’t get much attention and can be very volatile, like all Chinese ADRs. Conclusion ZTO’s recent market share loss is dis-confirming evidence to my initial thesis. I will closely monitor the price war in the industry as well as ZTO’s market share change. I still expect ZTO to continue to improve its operating efficiency and profitability in the next few years. Meanwhile, ZTO’s dividends and share repurchases will enhance shareholder returns. At the current market price, ZTO’s stock has almost 46% upside in two years. Therefore, I maintain my “buy” rating for ZTO Express.

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