ZTO Express (ZTO, BUY, TP: $21.00)

November 21, 2016 Initiation of Coverage ZTO Express (ZTO, BUY, TP: $21.00)

BUY HOLD SELL ZTO: Logistics Leader Stands Out from the Crowd; Initiate Buy with $21 Target Target Price: $21.00 Current Price: $16.30 52-Week High (MM) $18.45 We are initiating coverage of ZTO Express with a Buy rating and $21 price target, 52-Week Low (MM) $14.15 representing 30% upside. We are attracted to ZTO as one of the best managed express EV (MM) $10,342 delivery companies, whose sound growth strategy for sustainable share gain should Market Cap (MM) $12,098 Shares Outstanding (MM) 742 propel it to the forefront of a growing industry. The company owns and manages a high Average Daily Trading Volume (M) 7.3 % of core assets which has helped it earn the highest net profit per parcel among its Source: Factset Tongda peers. We think that these factors together with RMB 11bn net cash balance should help the company compete successfully in the ever-growing express delivery industry. Meanwhile, we think its investment in automated sorting lines and trucks Price Performance should help drive continuous cost structure improvement. Our $21 target is based on 18 32x our 2017 non-GAAP EPS estimate of $0.64, or 0.7x PEG. 17 Ready for Express 2.0. We think China's express delivery industry has entered 16 ▪ 2.0 after the initial explosive growth stage. The market likely remains highly 14 competitive, however, strategy, operations, execution, and precise management 13 of network partners should play a more essential role. We expect that the main Oct-16 Nov-16 players' market share will diverge more prominently in the next few years and ZTO eventually, large-scale M&A will consolidate the market. We expect ZTO to emerge as one of the winners. ▪ Greater Share of a Growing Market. We think ZTO's top-line growth will be primarily driven by parcel volume, i.e., ~30% industry growth coupled with gradual market share gain. This should be partially offset by continuous price declines, however, we anticipate the price decline trajectory will become flatter than in previous years. ▪ Strong Margins Despite Pricing Pressure. While we anticipate some mild price decline in the coming years, we believe ZTO can still realize margin improvement due to cost leverage, use of automated sorting lines, and more large-load trucks. ▪ Financial Estimates. We expect ZTO's top-line to grow at 37% 2015-2018 CAGR, while bottom-line non-GAAP net profit grows at over 55% 2015-2018 CAGR. We assume 53%, 46%, and 35% parcel volume growth in 2016, 2017, and 2018, respectively. We forecast that the adjusted net margin will reach 21.7%, 24.5% and 25.7%, respectively, over the next three years. Our adjusted diluted EPS is $0.41, $0.64, and $0.86 for 2016-2018, respectively. ▪ Risks include Cainiao's potential introduction of charges for its waybill services or direct involvement in order dispatch or delivery price-setting in the long term. Price competition is another concern. Per our sensitivity analysis, another RMB 5 cent (-3%) and 10 cent (-5%) decline in price would lead to 10% and 15% discounts in 2017 net profit, respectively, assuming all cost items remain unchanged. Summary financial data Research Team Ella Ji, CFA Highlights 2015A 2016E 2017E 2018E Head of TMT Research Revenue (MM) ($) 916 1,419 1,987 2,644 +1 212-554-2966 Operating Income (MM) ($) 230 391 613 866 [email protected] EPS ($) 0.29 0.41 0.64 0.86 Nicky Ge P/E 56.2x 39.8x 25.5x 19.0x Senior Associate, China Renaissance Securities (HK) Limited +852 2287 1661 EPS:Non-GAAP EPS excluding SBC [email protected] Source: China Renaissance Securities (US) Inc. ("CRSUS"), Company reports. China Renaissance Securities (US) Inc. 1

See Appendix A for Analyst Certification and Important Disclosures

November 21, 2016 Initiation of Coverage

KEY INVESTMENT THESIS 3

PEER VALUATION COMP TABLE 9

THE WORLD’S LARGEST EXPRESS MARKET, DRIVEN BY E-COMMERCE PROSPERITY 10

ENTERING THE 2.0 ERA WITH SOLID GROWTH 10 BEYOND ECOMMERCE: THE FASTER AND HIGHER MARGIN WORLD OF BUSINESS SOLUTIONS 12 LIMITED ROOM FOR FURTHER PRICE DECLINE 14 NETWORK PARTNER MODEL VS DIRECT OWNERSHIP: IN OUR VIEW, TONGDA OPERATORS CAPTURE THE BEST PROFITABILITY IN THE WHOLE CHAIN 16 REALITY CHECK ON NETWORK STATIONS AND TAOBAO MERCHANTS 18

ZTO, OUTPERFORMING THROUGH ITS STRONG NETWORK AND CONSISTENT QUALITY 21

EXPECTING ZTO TO STAND OUT FROM ITS TONGDA PEERS 21 KEY OPERATING ASSET OWNERSHIP IS VITAL FOR EFFICIENCY IMPROVEMENT 21 ZTO OUTPERFORMS IN PER PARCEL PROFIT 23 EXPRESS DELIVERY COMPANIES DUPONT ANALYSIS 25 STRONG BONDS WITH NETWORK PARTNERS 26

FINANCIAL ANALYSIS AND VALUATION 27

REVENUE AND COST OF REVENUE FORECAST 27 SENSITIVITY ANALYSIS (PRICE WAR, CAINIAO CHARGES, AND FUEL COST) 30 RISK 1: PRICE WAR 30 RISK 2: CAINIAO CHARGES 31 RISK 3: DIESEL PRICE HIKE 31 STRONG CASH FLOW GENERATION 32 VALUATION 32

FINANCIAL MODEL 33-35

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Key Investment Thesis

ZTO Is Well Poised for Sustainable Market Share Gain in the 2.0 Era

We think China’s express delivery industry has entered the 2.0 era after its initial explosive growth stage, fueled by demand for door-to-door pick-up and delivery of e-commerce purchases. Growth strategy, operations and execution, and finer management of network partners will play a more essential role going forward. We also think service quality will become more important to senders as opposed to price, since the market price is already at quite a low level, and we observe more willingness from end customers to pay for quality services. We like ZTO and view it as one of the best managed companies in the industry with a sound growth strategy for sustainable share gain opportunities.

Industry Outlook: Organic Development First, Consolidation Later

The industry has become more fragmented in the past few years. We think this is because robust market growth created plenty of business opportunities, and capital was abundant for new ventures. We think competition will likely remain the main theme in the industry in the next few years, as companies compete in execution, efficiency, and operations. A majority of the express delivery market is occupied by four companies—ZTO, YTO, STO, and Yunda—which all specialize in the intermediate segment of the parcel delivery chain and hire local “network partners” for last-mile services (see Exhibit 17). Currently, the major players each occupy 10%-15% market share, and they were all successfully funded via recent public listings. Thus, large scale M&A activities between them are not likely, in our view, although tuck-in acquisitions are possible. However, we think leading players, such as ZTO, will be able to gain more market share via better services and higher efficiency in the coming years.

As the larger companies grow even bigger, their cost advantage over the smaller players will likely become even more obvious. Then, it is likely that the industry will experience some consolidation and that there will be some large- scale M&A between the major players. We do not believe the Chinese express market will consolidate to the extent of markets like the US duopoly.

ZTO’s Growth Outlook: A Bigger Slice of a Bigger Pie

We think ZTO’s topline growth will be primarily driven by parcel volume, i.e., ~30% industry growth in 2015-2018 coupled with gradual market share gains fueled by ZTO’s industry-leading cost structure, capacity, and relationships with network partners. With a high net cash balance of more than RMB 11 billion post its recent IPO and with committed investment in core assets, we think ZTO is well positioned to take more market share in the coming years. Exhibit 1

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below illustrates our forecast of market share change in the following years, assuming no M&A activities.

Volume growth will be partially offset by mid-single digit price declines in the next few years. We anticipate the price decline trajectory will become much flatter than in previous years, per our analysis in the following sections.

Exhibit 1. Express Delivery Market Share Forecast

Source: CRSUS, Company reports

We identify ZTO’s key advantages as: 1) high direct ownership of key operating assets which should lead to attractive efficiency improvements; 2) flat, stable and balanced network partner structure, which should enable highly effective central management.

As the following table illustrates, ZTO has some of the best cost management in the industry and a high net profit per parcel. Its strength in those metrics does not stop here: we estimate its net profit per parcel will further improve to RMB 0.44 with its net margin at 20.5% in 2016. This should provide the company with a deeper pocket to withstand any potential price competition.

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Exhibit 2. ZTO Earned High Profits per Parcel among Network Partner Express Companies

2015 SF YTO STO Yunda ZTO Revenue per parcel 24.43 3.99 3.00 2.37 2.38 (Revenue net of last-mile delivery fee) 24.43 2.60 1.52 2.37 2.38 Unit waybill fees per parcel 0.91 0.72 0.93 1.08 Unit network transit fee per parcel 1.46 0.72 1.36 1.30 Unit last-mile delivery fee per parcel 1.39 1.48 0.00 0.00

COGS per parcel 19.60 3.44 2.50 1.63 1.60 (Cost net of last-mile delivery) 2.05 0.97 1.63 1.60

Gross profit per parcel 4.83 0.55 0.51 0.74 0.78 GM 20% 21% 33% 31% 33% We estimate ZTO net Operating profit per parcel 0.71 0.33 0.39 0.38 0.54 margin will OM 3% 13% 25% 16% 23% exceed 20% in 2016

Net profit per parcel 0.59 0.24 0.30 0.25 0.39 NM 2% 9% 20% 11% 16% Note:Note: we used 2015 pro pro forma forma data data for for ZTO ZTO Source:Source: CRSUSCRSUS and and SF, SF, YTO, YTO, STO, STO, ZTO, ZTO, and and Yunda Yunda company company reports reports

Profitability Outlook: Margin Gains Followed by Potential Long-Term Mix Shift

We think ZTO will be able to continue improving its margins in the next few years as express delivery companies have strong leverage in their cost structure. If the industry consolidates, we anticipate ZTO’s margin profile will become more attractive.

Longer term, i.e. in 5-10 years, ZTO may choose to expand into other areas such as cold chain, less-than-truckload delivery, etc. as the industry growth of its current business further slows down. In that case, the blended margin may come down due to the mix shift to less profitable business.

Financial Estimates and Valuation

We expect ZTO’s top-line to grow at 37% 2015-2018 CAGR, while bottom-line non-GAAP net profits should grow at over 55% 2015-2018 CAGR. We assume 53%, 46%, and 35% parcel volume growth in 2016, 2017, and 2018, respectively, partially offset by 10%, 4%, and 2% declines in revenue per parcel. We forecast the adjusted net margin to reach 21.7%, 24.5% and 25.7% in the next three years. Our adjusted diluted EPS is $0.41, $0.64, and $0.86 (USD) for 2016-2018, respectively.

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Per our sensitivity analysis below, if revenue per parcel drops another 10 cents (RMB), for example, it would impact revenue by 5% and net income by 15%, assuming all cost and expense items remain unchanged.

Exhibit 3. ZTO Net Income Price Discount Sensitivity Analysis

Current Estimates (RMB '000) 2016E 2017E 2018E

Revenue 9,646,085 13,510,544 17,979,126

Op Income (GAAP) 2,661,357 4,170,906 5,889,999 OPM 27.6% 30.9% 32.8%

Net Income (GAAP) 1,979,074 3,162,621 4,461,614

NM 20.5% 23.4% 24.8%

Valuation 35.1x 22.8x 16.9x

2017E Sensitivity Analysis

Discount to current ests -3% -5% -8% -10%

Delta in rev per parcel (0.06) (0.10) (0.16) (0.20) Revenue 13,105,228 12,835,017 12,429,701 12,159,490

Op Income (GAAP) 3,765,590 3,495,379 3,090,063 2,819,852 OPM 28.7% 27.2% 24.9% 23.2%

Net Income (GAAP) 2,862,383 2,659,725 2,355,738 2,153,080

NM 21.8% 20.7% 19.0% 17.7% Discount 91% 84% 74% 68% Source:Source: CompanyCRSUS estimates, reports, CRSUS Company estimates reports

ZTO is currently trading at 25.6x our 2017E EPS estimate. Our price target of $21 is based on 32x 2017E EPS, or 0.7x PEG based on 43% 2015-2018 EPS growth. This compares to 20x for the average of global express companies and 20x for the average of China e-commerce companies, despite the fact that ZTO is growing much faster than these comps and has a much higher margin. Other express delivery companies are trading at an average of 49x 2017E EPS on China’s local A share stock market.

We also use DCF valuation (Table on page 32) as a complementary methodology for ZTO. Our DCF derived TP of $20.73 implies 32.5x/24.0x 2017/2018 PE and 0.6x PEG.

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Risks to Our ZTO Price Target

 Alibaba Holdings (BABA, Buy, $115) owns a 47% stake in logistics company Cainiao Smart Logistics Network Limited (privately owned), which manages a software platform that offers the end-to-end tracking of packages, allowing packages to move smoothly through multiple delivery companies. Although Cainiao does not directly own sorting hubs or vehicles, it has access to all information along the parcel delivery process, and is thus able to monitor the performance of each delivery partner. Cainiao also owns the waybill system that ZTO currently uses to track and itemize 70%+ of its orders. If Cainiao starts to charge a higher fee for its waybill system, it will likely impact ZTO’s profitability.

 In addition, Cainiao has been establishing its own ground network of warehouses, and inviting the merchants on Alibaba platforms to use its warehouses. The current adoption rate is still relatively low. However, if it is able to convert most merchants to the use of its warehouses in future, Cainiao may become the express delivery companies’ single largest customer and may get directly involved in order dispatch or delivery price- setting, etc., bringing uncertainties to ZTO’s business and financial outlook.

 In the past, price competition has been one of the most efficient ways to gain market share for Express delivery companies, especially as their services are essentially of the same nature. Although we would not expect a significant ASP decline (we expect the $ amount drop and the % drop will both slowdown in the coming years), an intensified price war might dampen margins for the entire industry.

 According to its last year’s annual filing, Alibaba has 12% ownership in YTO express (600233 CH, not covered), a key competitor of ZTO. Although we have not noticed any change of policies yet, any potential preferential treatment to YTO may impact ZTO’s growth and financial outlook.

 Long term, if ZTO seeks to expand its business scope, its blended margin will likely be lower due to the mix shift to lower profitability businesses, such as less-than-truckload, cold chain, and fresh foods, etc.

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Company Description

ZTO is a leading express delivery company in China, home to the world’s largest delivery market (according to iResearch) with 27.9 billion parcels expected in 2016. As one of the best performing companies, ZTO managed to double its market share from 7% in 2011 to 14% in 2015. ZTO provides express delivery services through its nationwide network, and has developed one of the most extensive delivery networks covering over 96% of China’s cities and counties as of June, 2016.

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Peer Valuation Comp Table

Price Mkt Cap (USD Rev Growth EPS Growth 2015 EBIT P/E Multiples PEG PEG Company Name Ticker 11/18/2016 Mns) 2016E 2017E 2018E 2016E 2017E 2018E CAGR Margin 2017E 2018E 2017E 2018E

ZTO Express ZTO $16.30 $12,098 38% 40% 33% 41% 54% 35% 43% 22.6% 25.6x 18.9x 0.5x 0.5x

China E-commerce Alibaba Group Holding Ltd BABA $93.39 $233,758 32% 52% 30% 27% 25% 28% 27% 38.4% 23.4x 18.2x 0.9x 0.6x JD.com Inc JD $26.45 $36,557 43% 33% 25% NM NM 217% NM -2.1% 174.2x 54.9x NM 0.3x Vipshop Holdings Ltd VIPS $13.67 $8,046 44% 29% 20% 33% 28% 20% 27% 6.8% 16.1x 13.3x 0.6x 0.7x Baozun Inc BZUN $15.61 $776 34% 29% 28% 173% 170% 56% 126% 1.3% 21.6x 13.8x 0.1x 0.2x Suning Commerce Group Co Ltd 002024 CH ¥11.21 $15,123 18% 14% 14% -86% 386% 174% 24% -1.6% 329.7x 120.5x 0.9x 0.7x Group Average 35% 31% 23% 37% 152% 99% 51% 8.6% 113.0x 44.2x 0.6x 0.5x Excl JD and Suning 20.4x 15.1x 0.5x 0.5x

Global Express Delivery

FedEx Corp FDX $187.29 $49,755 5% 20% 5% 21% 13% 11% 15% 10.5% 15.4x 13.8x 1.1x 1.2x United Parcel Service Inc UPS $114.09 $99,561 4% 5% 4% 10% 6% 9% 8% 13.3% 18.5x 17.0x 3.2x 1.9x Singapore Post Ltd SPOST SGD 1.45 $3,138 19% 26% 11% 3% -12% 15% 1% 30.0% 21.6x 18.8x NM 1.3x Deutsche Post AG DPW GR 29.06 $39,633 -4% 4% 3% 28% 4% 6% 12% 0.0% 13.1x 12.4x 3.3x 2.0x Yamato Holdings Co Ltd 9064 JP 2,276 $9,153 1% 4% 3% 1% 6% 9% 5% 4.2% 21.8x 20.0x 3.4x 2.2x CJ Korea Express Corp 000120 KS 193,000 $3,914 19% 12% 10% 39% 64% 27% 43% 3.7% 28.6x 22.5x 0.4x 0.8x Group Average 8% 12% 6% 17% 14% 13% 14% 10.3% 19.8x 17.4x 2.3x 1.6x

Global Logistics

XPO Logistics Inc XPO $42.25 $4,683 98% 3% 6% NM 74% 59% NM -0.4% 24.7x 15.6x 0.3x 0.3x CH Robinson Worldwide Inc CHRW $74.40 $10,533 -4% 7% 5% 3% 3% 7% 4% 6.3% 20.1x 18.8x 6.8x 2.6x Landstar System Inc LSTR $81.30 $3,401 -6% 5% 4% -6% 9% 10% 4% 7.3% 23.6x 21.4x 2.6x 2.1x Expeditors International of Wa EXPD $51.50 $9,286 -10% 6% 8% -1% 6% 9% 4% 10.7% 20.7x 18.9x 3.7x 2.0x Group Average 19% 5% 6% -2% 23% 21% 4% 6.0% 22.3x 18.7x 3.3x 1.7x

China Express Delivery

鼎泰新材 SF 002352 CH ¥49.50 $35,210 NM 60% 23% 155% 25% 26% 59% 3.0% 70.7x 56.3x 2.8x 2.2x 大杨创世 YTO 600233 CH ¥38.03 $15,547 NM 30% 28% 81% 29% 21% 41% 13.0% 60.4x 50.0x 2.1x 2.4x 艾迪西 STO 002468 CH ¥32.95 $7,309 NM 23% 18% 66% 33% 15% 36% 25.0% 30.0x 26.2x 0.9x 1.8x 新海股份 Yunda 002120 CH ¥52.34 $7,688 NM 68% 31% 13% 23% 6% 14% 16.0% 33.3x 31.5x 1.5x 5.5x Group Average 45% 25% 79% 27% 17% 37% 14.3% 48.6x 41.0x 1.8x 3.0x

Note: All in USD except for stock price, which is in local currency Source: Bloomberg, Wind, China Renaissance Securities

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The World’s Largest Express Market, Driven by e-Commerce Prosperity

Entering the 2.0 era with Solid Growth

Riding on the robust growth of the e-commerce industry over the past ten years, we think China’s express delivery industry has entered the 2.0 era, which requires greater efficiency and finer operational expertise than the 1.0 era of explosive growth. iResearch expects express parcel volume in China to reach 45bn in 2018 from 21bn in 2015, representing a 30% 2015-2018 CAGR, as per the company’s IPO filing.

According to iResearch, China has the largest express delivery market in the world in terms of parcel volume. In 2015, China had 21bn parcels delivered vs. 13bn in the US. However, the average express delivery fee per parcel in China is relatively low vs. that of the US, due to fierce competition in China and declining costs per parcel along with the scalability leverage. We estimate that the average per parcel revenue for an e-commerce package ranges from RMB 5-7 in China (equivalent to $0.7-$1), compared to $7 in the US.

Exhibit 4. China express parcel volume Exhibit 5. Express market size of China and the US 2015

Source: CRSUS, iResearch, China State Postal Bureau Source: CRSUS, iResearch

ZTO and its three largest peers—YTO, STO (002468 CH, not covered), and Yunda (002120 CH, not covered) —together occupy nearly 60% of China’s express delivery market share. These four firms are collectively called the

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“Tongda companies” or “Tongda Operators” because their names include “three tongs and one da,” the Chinese words for transportation and delivery. The companies’ full names are Zhongtong (ZTO), Yuantong (YTO), Shentong (STO), and Yunda. The Tongda companies also share a business model. They outsource the local pick-up and drop-off portions of the delivery process and only manage the higher-margin central portion, which includes line-haul transportation of packages between large regional sorting hubs.

Like the express market as a whole, the Tongda companies are closely tied to China’s booming e-commerce sector. According to our estimates, 71% of express parcels are e-commerce related, 20% of parcels are commercial/business parcels (documents, receipts, etc.), and the remaining 9% are individually generated parcels including personal packages and apparel returns or exchanges. We also estimate that parcels from Alibaba platforms (Taobao and Tmall) accounted for 51% of China’s express parcel volume in 2015. Other e-commerce clients include JD Marketplace (JD US, not covered), Vipshop (VIPS US, not covered), Jumei (JMEI US, not covered), We-ecommerce (belongs to Tencent, 0700 HK, Buy, HKD 250), cross border e-commerce players, etc. Alibaba has been the largest e-commerce client for the Tongda Operators, accounting for ~80% of their parcel volumes, though this percentage has been declining.

Exhibit 6. China’s express parcel growth vs. e-commerce Exhibit 7. Express market composition (2015)

Source: CRSUS, iResearch Source: CRSUS, iResearch, Company information

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Despite the fact that BABA’s GMV growth is a key driver for the express industry, parcel volume is expected to outpace e-commerce GMV growth as e- commerce orders become smaller but more frequent. We identify the reasons behind this as follows:

1) Expansion of shopping categories from high ASP (home appliance, 3C, cosmetics, apparel) to low ASP (FMCG, food).

2) Increasing shopping frequency as user time spent becomes more fragmented in the mobile era, e.g. 2 items per order down from 5 previously

Exhibit 8. Average order size trend on BABA

Source: CRSUS, Alibaba company information

Beyond ecommerce: the faster and higher margin world of business solutions

While e-commerce comprises the bulk of express market volume, other commercial express (shipping between businesses) constitutes a distinct and sizeable market. We estimate commercial parcel volume reached 4.1bn in 2015. It typically requires delivery services to be faster, safer, and more reliable, and customers’ price sensitivity is relatively low.

Historically, the Tongda operators’ market share in the commercial express market has been low; major players in this market are SF (Shunfeng, 002352 CH, not covered), state-owned companies such as EMS, and international companies such as FedEX (FDX, not covered) and DHL (private company).

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For example, SF, an express delivery company operating on a direct ownership model, has successfully entered the commercial express market by leveraging what we view as outstanding quality. Unlike the Tongda Operators, which focus on the core part of the delivery chain, SF directly owns and operates its entire chain from end to end. In 2015, SF delivered 1.7 billion commercial parcels, accounting for 41% of the total market. The company has to date focused primarily on this sector, with revenues from commercial express (RMB45.5bn, pre discount) constituting nearly 95% of its total revenues in 2015.

Despite SF’s current strong performance, we wonder how much more revenue the company can generate in the commercial express market for the following reasons: 1) State-owned companies and international companies have occupied a large market share of 53% as of 2015, and have established long- term and intimate relationships with their commercial clients. Thus, those commercial companies have been hard for competitors to sign, and 2) The commercial express market growth has been lagging the general industry (28% versus 45% industry growth in 2015).

However, we think the commercial express business is a highly attractive market for the Tongda Operators, including ZTO, especially as their capacity has been improving significantly in the past few years and as their service quality has evolved to be more in line with commercial express companies like SF, while offering a much lower price. In fact, according to management, commercial parcel volume is already close to 4 million/day at ZTO, compared to 4.65 million for SF in 2015. We anticipate commercial parcels will grow at a faster rate than e-commerce orders at ZTO and will help drive the company’s top line and margin performance.

Exhibit 9. Commercial express market share (2015)

International Others companies 6% (FedEx, DHL, UPS) 4% SF 41%

State-owned companies (EMS, CAE, CRE) 49%

Source: CRSUS, EMS, iResearch, SF Express

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Limited room for further price decline

As the following charts show, delivery fee per parcel has been declining due to lower costs (scalability and waybill adoption, as well as operating leverage), competition, and smaller & lighter packages, especially for cross-town and international parcels. Shipping rates for intra-town delivery have been largely stable.

Exhibit 10. Express industry market size and charging rate Exhibit 11. Revenue break-down per parcel (RMB)

Source: CRSUS, China State Postal Bureau Source: CRSUS, iResearch

Exhibit 12. Parcel volume breakdown by distance Exhibit 13. Revenue breakdown by distance (RMB)

Source: CRSUS, China State Postal Bureau Source: CRSUS, China State Postal Bureau

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However, we think the price per parcel is stabilizing and anticipate that the trajectory of price declines will become much flatter in the coming years. This is because:

1. The past years’ price decline has been based on cost savings. As such, although average price per parcel keeps declining, the industry (including ZTO) actually achieved higher profitability. One of the main cost-saving drivers was the adoption of electronic waybills. Now that electronic waybills have reached 70%-80% penetration, further cost- saving in this area is limited;

2. It has become easier to pass on shipping costs to end customers, who have become less price sensitive when they want high quality and fast delivery services (especially since the charges in question are only about RMB .05 to .10 per parcel). For example, as we spoke with network partners, many mentioned that there is a growing % of customers who would select to use premium delivery services and are willing to pay for that. We think the e-commerce merchants (senders) will also become less sensitive to price but place increasing value on quality; and

3. Other Tongda Operators are listed on China’s local stock market (A share), which requires companies to be profitable to maintain a public listing. As Exhibit 2 shows, per parcel net profit was only RMB 0.24 for YTO and RMB 0.25 for Yunda in 2015. Their cushion for further price declines appears to be considerably restrained.

Exhibit 14. Monthly average price of express parcels (in RMB)

Source: CRSUS, State Post Bureau

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Network partner model vs direct ownership: In our view, Tongda Operators capture the best profitability in the whole chain

China’s express delivery companies mainly operate along two business models: the network partner model (which the Tongda Operators, including ZTO, follow) and the direct ownership model. In the network partner model, companies typically operate a logistics network by focusing on the operations of the core sorting hubs and line-haul transportation assets while outsourcing pickup and last-mile deliveries to local network partners. Network partners are business partners that own and operate pickup and delivery outlets and operate express delivery services under the company’s brand. For example, ZTO has 7,700 network partners nationwide, In the direct model, companies operate the entire chain and own almost all the assets and labor from end to end.

One key advantage of the network partner model is it allows the Tongda companies to rapidly scale up and expand their networks to meet the demands of the fast-growing e-commerce industry while limiting their capital expenditures. Secondly, this model delivers higher profitability, as shown in the charts below.

Exhibit 15. ROE comparison of the two models Exhibit 16. Net margin comparison between two models

120.0% Direct Operation Network Partner 25.0% Direct Operation Network Partner

97.4% 19.5% 100.0% 20.0% 16.5% 80.0% 15.0% 60.0% 10.5% 9.1% 10.0% 40.0% 31.0% 20.9% 3.9% 3.5% 12.3% 14.7% 5.0% 2.4% 20.0% 7.3% 8.4%

0.0% 0.0% FedEx EMS SF (2015) ZTO YTO STO Yunda FedEx EMS SF (2015) ZTO YTO STO Yunda Express (2011) (2015) (2015) (2015) (2015) Express (2011) (2015) (2015) (2015) (2015) (2015) (2015) Source: CRSUS, iResearch, Company information Source: CRSUS, iResearch, Company information

Based on our research, we estimate that the network partner business model has a 10%-15% profit margin for the entire delivery chain. Within that, line-haul and sorting (e.g. the Tongda Operators’ core business) have enjoyed robust profitability as they have become the vital part of the delivery process, providing the companies with more bargaining power over network partners.

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We think the net margin for network partners varies greatly from region to region and between collection and delivery. Parcel-collecting partners (first mile) likely enjoy a net margin of 10% for signing customers while parcel delivery (last mile) likely receives a 5% net margin on average, both far below the profit margin of sorting and line-haul players. The network partner industry is highly fragmented, with several local companies competing in both pickup and delivery within their areas. Assuming that franchise network partners pay full benefits and taxes, we think their adjusted net margin should be in the single-digits, which indicates the net margin for the entire chain is in the high single-digits.

The adjusted profit margin of the network partner model is still higher than that of the direct ownership model. For example, the net margin of international names and SF ranges from 0% to 8% depending on market conditions and geographic coverage. However, we do not think the two profit margins will align perfectly in the end, as the network partner business will still benefit from greater flexibility in business operations e.g. contract workers during peak season.

Exhibit 17. Express Delivery Industry Chain Economics Analysis

Source: CRSUS, Company information

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Reality check on network stations and Taobao merchants

We interviewed a number of network partners as well as Taobao merchants. We also visited more than 20 network stations and summarize our findings below.

Finding 1: More Tongda and less SF

According to our conversations with Taobao merchants, almost all of them set the Tongdas as their default express service providers, unless specific customers request to use SF express and pay the additional fee. Apparently, for Taobao merchants, the price difference between SF and Tongda is much more meaningful than the negligible difference between their qualities of service. Additionally, Cainiao’s Chengnuoda service, which uses ZTO and other express operators to ship priority parcels with guaranteed 1, 2, or 3 day delivery, will help enhance the Tongdas’ service quality at a low additional unit price for merchants. The Tongda operators’ improvements to their quality and range of services, while limiting price increases, will likely allow them to gain market share at SF’s expense.

Finding 2: The decreasing price trend may become much flatter

A consensus among E-commerce merchants is that the average express cost of Tongda has been steadily decreasing, especially for those merchants with large order volume and stable order frequency. For example, the starting price of Tongda could be as low as RMB 4 per parcel, according to our channel checks. Compared to two years ago, the price has dropped much, but only for merchants whose volume has increased. For merchants with small order volume, it seems that they have not enjoyed much of a price drop. According to an interview with a part-time merchant on Taobao, the price of Tongda remains unchanged at RMB 9-10. Notably, for SF express, we did not see any obvious price drop, and its price would always be standardized, no matter how much order volume a merchant could provide.

Finding 3: The non-standardized price structure

The official prices for express companies are all quite similar. For example, for a parcel weighing less than 1kg sent from Shenzhen to Guangzhou, the prices on the companies’ websites are shown as follows:

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Exhibit 18. The price for a parcel less than 1KG (in RMB)

Source: CRSUS, Company websites

However, according to our interviews with the Tongda operators’ network partners, they actually charge much lower prices than the above numbers when they collect parcels from customers. The price for offline walk-in customers is around RMB 7-8, while the price for e-commerce merchants with large and frequent parcel volumes could be as low as RMB 5-6. “It is all about competition,” says a network partner of Yunda. “We are just too similar for our customers, in terms of both service quality and physical distance. You see, there are five stations around such a small neighborhood. You won’t charge those residents high prices because they can transfer to other stations easily.”

The Tongda pricing structure leaves parcel collection partners the flexibility to charge senders based on individual situations, as long as it does not exceed the websites’ official price. E-commerce orders are typically the lowest in price, due to large volume and high price sensitivity.

Finding 4: Deliverers’ income and work status

During our reality check tour, we found that the widespread rumor of delivery drivers’ salaries reaching RMB10K does have some truth to it. However, the salary is highly floating, and a higher salary always comes with an even heavier workload. We note the following three points:

a) Long working hours: Deliverers have to work very long hours each day, normally from 8:30 am to as late as 10:00 pm. For example, for one network partner we interviewed, there are two waves of trucks from the regional sorting hubs to the local network stations, one at 9:30 A.M. and the other at 3:00 P.M. In order to coordinate with the truck schedule, morning parcels have to be delivered before 2:00 P.M. and the afternoon parcels before 10:00 P.M. “If I can’t finish my parcels today,” said a deliverer, “I have to rescan them one by one and report to management, which takes more time and would increase my workload the next day.”

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b) Floating income: Normally, a deliverer is offered an annual base salary of RMB 1000-3000, and RMB 0.8-1.0 commission for every parcel delivered, depending on the different regions and seasons (Q4 usually offers the best remuneration due to increased demand for deliverers in preparation for Singles’ Day on November 11th.) For parcel pickup service, there are two types of remuneration systems: the commission model and the bargaining model. Through the former model, the staff receives around a 10% commission from the pickup fee received, which usually encourages the staff to seek longer distance orders with higher ASPs. The latter model takes a cost-adding approach. A network station manager gives a base price to the staff, and the staff may charge customers any price, as long as it does not exceed Tongda’s official price on their website, and earn the differential. “For example, for parcels from Shenzhen to Guangzhou, my manager would charge me RMB 5.5,” said a deliverer, “company regulation says our price may not exceed RMB 10. So, if I charge my customer RMB 7.5, I can earn the RMB 2 difference.” Normally, for merchant customers with relatively larger order sizes, the franchisee manager would offer lower base prices. “For e-commerce merchants, the price we can charge is also quite low. Those customers usually know a lot of deliverers and they can easily transfer if your price is high.” Notably, the remuneration systems a company uses are never standardized. They are all “properly adjusted and decided” by different franchisee managers.

c) Support from network partners varies: We suspect that Tongda network partners do not provide great welfare to their delivery personnel. As for vehicles, Tongda network porters provide small trucks for some relatively bigger network stations, for carrying parcels between stations and sorting hubs, but smaller stations may need to share the capacity. “Most deliverers have their own motorcycles. You can rent a motorcycle from the company if you don’t want to buy one. But the rent is expensive and you must pay compensation if you damage it.” The only benefit is that Tongda gives him a monthly subsidy of RMB 100 to cover his mobile phone bill. “I did not expect that before. But later I found out our phone bills always exceed RMB 100, especially for deliverers in residential areas, like me.”

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November 21, 2016 Initiation of Coverage

ZTO, Outperforming through Its Strong Network and Consistent Quality

Expecting ZTO to stand out from its Tongda peers

We expect the express delivery market to start consolidating in the next two years as e-commerce enters a mature stage with CAGR of 30% in 2015-2018 (iResearch estimate). Although we do not think ASP would see further large declines, competition can still get fierce as every cent matters now. We expect STO, Yunda, SF, and EMS to continue losing market share, while we expect ZTO and YTO as the largest current players (Exhibit 19 below) to have a better chance to gain market share.

We expect ZTO to deliver 4.50bn, 6.56bn, and 8.84bn parcels in 2016, 2017 and 2018, respectively, increasing its market share to 16%, 18% and 19% accordingly.

Exhibit 19. Express industry market share trend

Source: CRSUS, Company reports, iResearch, China State Postal Bureau

Key operating asset ownership is vital for efficiency improvement

We believe core asset ownership is key to improving operating efficiency at the current stage, whereas big data, IT systems, and tech innovation will also become increasingly important for operating efficiency in the future. ZTO has a high percentage of ownership of its core assets: sorting hubs and trucks.

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For example, ZTO has 74 sorting hubs, and 68 of them are self-owned. ZTO’s 92% self-run ratio makes the company stand out in terms of sorting hub control.

Exhibit 20. Sorting hub ownership 2015 Exhibit 21. Sorting hub comparison

Source: CRSUS, iResearch, Company information Source: CRSUS, iResearch, Company information

The number of trucks for ZTO’s main line transportation was 3,300 in 2015, and about 2,000 units are self-owned. Moreover, among the 2,000 self-owned trucks, 590 units are large and heavy duty, providing ZTO with a larger capacity per truck and hence lower average transportation cost.

Exhibit 22. Truck ownership 2015 Exhibit 23. Self-owned transport vehicle mix

Source: CRSUS, iResearch, Company information Source: CRSUS, iResearch, Company information

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Under the Tongda network partnership business model, which has already outsourced parcel collection and delivery services to franchisees, we believe the self-owned ratio of core facilities for main line transportation is even more notable. On the one hand, it provides more potential for cost leverage; on the other, it enables the company to have greater control over the quality of service and prevents any of its network partners from growing too big.

ZTO outperforms in per parcel profit

In our analysis as shown in Exhibit 24, we found that ZTO has outperformed the network partner market in terms of net profit per each parcel in its network. We note that YTO and STO adopted different revenue recognition methods, which factor the last mile delivery fee into the revenue and then deducts it as a cost of goods sold. In the exhibit, we removed the last mile delivery fee for both companies and compared per parcel economics across the Tongda Operators on an apple-to-apple basis.

Exhibit 24. Per Parcel Economics Comparison

COGS per parcel 19.60 3.44 2.50 1.63 1.60 (Cost net of last-mile delivery) 2.05 0.97 1.63 1.60

Gross profit per parcel 4.83 0.55 0.51 0.74 0.78 GM 20% 21% 33% 31% 33% We estimate ZTO net Operating profit per parcel 0.71 0.33 0.39 0.38 0.54 margin will OM 3% 13% 25% 16% 23% exceed 20% in 2016

Net profit per parcel 0.59 0.24 0.30 0.25 0.39 NM 2% 9% 20% 11% 16%

Note: we used 2015 pro forma data for ZTO Source: CRSUS and SF, YTO, STO, ZTO, and Yunda company reports

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We also compared at the Tongda express companies’ cost structure in COGS in the following tables and charts. Overall, our conclusion is that ZTO has the best cost structure due to its better management and higher ownership of trucks and sorting hubs. Notably, although STO’s cost per parcel is lowest, this is because STO operates the fewest sorting centers and thus its revenue per parcel is also the smallest (40% below the average of its three peers).

Exhibit 25. Tongda Operators per parcel cost comparison, 2015

ZTO per parcel cost analysis YTO per parcel cost STO per parcel cost Yunda per parcel cost Transportation cost 0.93 Transportation cost 0.99 Truck Transport 0.37 Transport 0.96 Sorting hub cost 0.47 Sorting hub cost 0.47 Airline agency 0.11 Labor 0.28 Cost of accessories sold 0.05 Network partner cost 0.40 Direct labor 0.14 Terminal 0.06 Other costs (waybill, IT, overhead) 0.15 Waybill cost 0.07 Material 0.16 Operation and rent 0.09 Total 1.60 Other costs 0.13 Depreciation 0.04 Depreciation 0.04 Total 2.06 Others 0.14 Waybill 0.09 Total 0.97 Others 0.07 Non-express cost 0.05 Total 1.63 Source: CRSUS, company reports Source: CRSUS, Company reports

Source: CRSUS, Company reports Source: CRSUS, Company reports

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Express Delivery Companies Dupont Analysis

Profit Asset Equity ROE margin Turnover multiplier ZTO 15% 16% 0.7x 1.4x SF 8% 2% 1.4x 2.5x YTO 21% 9% 1.3x 1.8x STO 97% 20% 1.4x 3.6x Yunda 31% 11% 1.4x 2.2x Source: CRSUS, Company reports

ZTO’s ROE is not the highest among its competitors. Although its profitability is high, its asset turnover and leverage is not as high as those of its peers. For asset turnover, we think this is because ZTO has a relatively asset heavy model among the Tongda Operators. For example, the company made large investments such as purchasing self-owned trucks and sorting hubs in 2014 and 2015. We think eventually these investments will turn into a higher profit margin and parcel volume growth. ZTO’s equity multiplier in 2015 is low, indicating the company was operating under low leverage though it has a relatively healthy financial status, in our opinion.

Exhibit 26 Profit margin 2015 Exhibit 27 Asset turnover 2015 25% 160%

139% 138% 136% 20% 140% 20% 127% 16% 120% 15% 11% 100% 9% 10% 80% 66% 5% 2% 60%

0% 40% SF YTO STO Yunda ZTO SF YTO STO Yunda ZTO

Source: CRSUS, company disclosed information Source: CRSUS, company disclosed information

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Exhibit 28 Equity multiplier 2015 Exhibit 29 ROE comparison 2015 400% 120% 362% 350% 97% 100% 300% 252% 80% 250% 216% 200% 181% 60%

150% 135% 40% 31% 100% 21% 20% 15% 50% 8%

0% 0% SF YTO STO Yunda ZTO SF YTO STO Yunda ZTO

Source: CRSUS, company disclosed information Source: CRSUS, company disclosed information

Strong bonds with network partners

ZTO was among the first to acquire operating assets from network partners. In 2014 and 2015, the company acquired 8 and 16 sorting hubs, respectively, from its network partners. In return ZTO paid not only cash but also equity shares. In total, its network partners own 22% of its share of holdings, giving them an important stake in ZTO’s success. In addition, the founder/chairman owns nearly 30%, and four senior directors and executives collectively own 24% of the equity post the IPO.

Exhibit 30. ZTO shareholding structure

Source: CRSUS, Company reports

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Financial Analysis and Valuation

Revenue and Cost of Revenue Forecast

We expect revenue to grow to RMB9.6bn in 2016, RMB13.5bn in 2017, 18.0bn in 2018, and 23.3bn in 2019, representing a 34.1% CAGR. We expect ASP per parcel to drop slightly to RMB2.06, RMB2.03, and RMB2.01 in 2017, 2018 and 2019, while the number of ZTO parcels should reach 6.56bn, 8.84bn, and 11.57bn in 2017, 2018 and 2019, respectively.

Exhibit 31. ASP trend (RMB) Exhibit 32. Parcel volume trend (bn unit)

Source: CRSUS, Company information Source: CRSUS, Company information

Within ZTO’s cost structure, the largest component is labor, accounting for nearly 50% of the total cost of revenue. Fuel (diesel) represents 18% and highway tolls represent 12%. Truck and sorting hub depreciation and rental expenses together account for just 12% of the total cost. We thus think the company should invest in these assets to increase efficiency and lower labor intensity. For example, the automated sorting line is a great way to save costs in the coming years by replacing all parcel-sorting labor within a hub.

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Exhibit 33. ZTO’s Cost of Revenue Component

Source: CRSUS, Company information

We expect ZTO’s main cost-saving sources to be: 1) automated sorting lines; 2) more self-run, large-load trucks; 3) direct negotiation with Sinopec of a wholesale diesel price ~20% below the retail level; 4) continuous operating leverage.

We expect GM to improve from 32.6% in 2015 to 35.7% in 2016 and 37.3% in 2017. Transportation and sorting hub costs accounted for 58.8% and 24.4% of COGS in 2015. We forecast transportation cost per parcel to be RMB 0.81, RMB 0.78 and RMB 0.75 in 2016, 2017, 2018, respectively, as the fleet of ZTO self- owned trucks continues to increase. We forecast the sorting cost per parcel to be RMB 0.44, RMB 0.41 and RMB 0.40 in 2016, 2017, 2018. ZTO plans to add ~50 automated sorting lines, which will improve operating efficiency and reduce the company’s reliance on labor.

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Exhibit 34. Transportation cost mix and per parcel trend

Source: CRSUS, Company information Source: CRSUS, Company information

Exhibit 35. Sorting hub cost mix and per parcel trend

Source: CRSUS, Company information Source: CRSUS, Company information

We forecast that the operating margin should improve from 22.9% in 2015 (pro forma) to 27.6%, 30.9%, and 32.8% in 2016, 2017, and 2018, respectively. Our forecast of SG&A is 8.26%, 6.61% and 5.85% of total revenues in 2016, 2017 and 2018, reflecting operating efficiency and scalability.

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Exhibit 36. ZTO Operating and Net Margin Trend

Operating margin Net margin 35% 30% OP Margin ZTO 30% 32.8% 25% 30.9% 25% 24.8% 27.6% 20% 23.4% 20% 22.9% 20.5% 15% 15% 16.5% 10% 10% 13.4% 9.1% 5% 5%

0% 0% 2014 2015 2016E 2017E 2018E 2014 2015 2016E 2017E 2018E

Source: CRSUS, company reports

Sensitivity analysis (price war, Cainiao charges, and fuel cost)

Risk 1: Price war

We think a potential price war is possible because: 1) all Tongda Operators’ services and quality are largely similar to each other and the level of differentiation is low; 2) senders, especially ecommerce merchants, are price sensitive. Price is still their first consideration; 3) all of the major players are publicly listed and their future financing situations have greatly improved; 4) all of them currently earn decent margins. There is room for price reduction. Below is our sensitivity analysis for ZTO on potential price declines.

2017E Sensitivity Analysis: Price War (RMB '000)

Discount to current ests -3% -5% -8% -10%

Delta in rev per parcel (0.06) (0.10) (0.16) (0.20)

Revenue 13,105,228 12,835,017 12,429,701 12,159,490

Op Income (GAAP) 3,765,590 3,495,379 3,090,063 2,819,852

OPM 28.7% 27.2% 24.9% 23.2%

Net Income (GAAP) 2,862,383 2,659,725 2,355,738 2,153,080

NM 21.8% 20.7% 19.0% 17.7% Discount 91% 84% 74% 68% Source:Source: CRSUS, Company Company reports, CRSUS information estimates

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Risk 2: Cainiao Charges

One potential risk to ZTO’s net profit growth is that Cainiao may begin charging express companies for electronic waybills and data support, which it has been providing to the express industry at very low cost. A direct charge will increase ZTO’s cost and impact its profitability. Below is our sensitivity analysis on Cainiao’s potential charge.

2017E Sensitivity Analysis: Cainiao Charges (RMB '000)

Cainiao charge per parcel 0.05 0.10 0.15 0.20

Number of BABA parcels (bn) 5.90 5.90 5.90 5.90

Revenue 13,510,544 13,510,544 13,510,544 13,510,544

Op Income (GAAP) 3,875,802 3,580,699 3,285,595 2,990,491

OPM 28.7% 26.5% 24.3% 22.1%

Net Income (GAAP) 2,945,043 2,723,715 2,502,387 2,281,059

NM 21.8% 20.2% 18.5% 16.9% Discount 93% 86% 79% 72% Source:Source: CRSUS, Company Company reports, information CRSUS estimates

Risk 3: Diesel Price Hike

Diesel is about 18% of ZTO’s total cost of revenues. However, the diesel price tends to fluctuate and is typically out of the company’s control. In the past 2 years, the diesel price has been declining, which benefitted the company’s profitability. Below is our sensitivity analysis on a potential diesel price hike.

2017E Sensitivity Analysis: Diesel Price Hike (RMB '000)

Diesel price hike 5% 10% 20% 50%

Transportation cost per parcel 0.72 0.73 0.76 0.83

Revenue 13,510,544 13,510,544 13,510,544 13,510,544

Op Income (GAAP) 4,093,359 4,015,813 3,860,719 3,395,439

OPM 30.3% 29.7% 28.6% 25.1%

Net Income (GAAP) 3,108,210 3,050,050 2,933,730 2,584,770

NM 23.0% 22.5% 21.7% 19.1%

Discount 98% 96% 93% 82% Source:Source: CRSUS, Company Company reports, information CRSUS estimates

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Strong Cash Flow Generation

ZTO’s network partner business model generates impressive cash flow. The company usually requires its network partners to have a minimal deposit at ZTO. For each parcel ZTO delivers, it deducts its earned revenue from the deposit balance. Both ZTO and network partners monitor the balance on a daily basis.

We expect the company’s operating cash flow will continue to exceed its net income, and the OCF to net income ratio should be sustained at ~1.5x in the coming years. ZTO is expected to incur ~RMB 2.5 billion of capex in 2016 and 2017, mainly for its sorting hubs and warehouses, automated sorting lines, and large load trucks. Still, we anticipate RMB 0.3 billion and 2.4 billion of free cash flow for both years.

Valuation

ZTO is currently trading at 25.6x our 2017E EPS estimate. Our price target of $21 is based on 32x 2017E EPS, or 0.7x PEG based on 43% 2015-2018 EPS growth. This compares to 20x for the average of global express companies and 20x for the average of China e-commerce companies, despite that ZTO is growing much faster than these comps and has a much higher margin. Other express deliveries are trading at an average of 49x 2017E EPS on China’s local A share stock market, where restrictions on capital outflows and short selling tend to keep valuations high.

We also use DCF valuation as a complementary methodology for ZTO. Our DCF derived a target price of $20.73, which implies 32.5x/24.0x 2017/2018 PE and 0.6x PEG.

Year to Dec (RMB'000) 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E Terminal EBIT 2,783,357 4,320,906 6,039,999 8,574,541 10,957,763 13,775,824 15,632,167 17,632,785 19,053,013 20,384,207 20,384,207 NOPAT 2,042,174 3,240,680 4,529,999 6,430,906 8,218,322 10,331,868 11,724,125 13,224,589 14,289,760 15,288,155 15,288,155 Capex, net (2,604,443) (2,702,109) (2,157,495) (1,977,488) (1,847,759) (2,225,977) (2,517,715) (2,787,704) (3,011,583) (3,219,076) (3,219,076) Depreciation & amortization 432,630 855,912 1,207,450 1,372,590 1,495,514 1,565,131 1,693,643 1,852,921 2,032,818 2,220,496 2,220,496 Change in working capital 404,937 990,404 630,951 1,349,225 547,663 1,624,680 (25,077) 1,528,715 (295,201) 1,449,576 1,449,576 Free operating CF (FoCF) 275,298 2,384,887 4,210,905 7,175,233 8,413,740 11,295,703 10,874,976 13,818,521 13,015,794 15,739,151 15,739,151 DCF Parameters Target Interest-bearing liabilities as a % of EV 0% Common parameters WACC 12.6% Terminal FCF growth 3.0% NPV of FoCF 102,183,121 + Net cash (debt), current 2,418,762 = Equity value 104,601,883 15,382,630 (USD'000) / Number of shares('000) 742,221 RMB/US exchange rate 6.80 = NPV per share (US$) 20.73 Source: company reports, CRSUS

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ZTO Express Income Statement RMB'000 except for per share data 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16E 4Q16E 2014 2015 2016E 2017E 2018E Net Revenues 1,128,295 1,357,765 1,412,422 2,187,973 1,958,548 2,286,629 2,309,691 3,091,218 3,903,572 6,086,455 9,646,085 13,510,544 17,979,126 Y-Y (%) na na na na 73.6% 68.4% 63.5% 41.3% na 55.9% 37.9% 40.1% 33.1% Q-Q (%) na 20.3% 4.0% 54.9% (10.5%) 16.8% 1.0% 33.8%

Cost of Goods Sold (779,863) (891,416) (972,723) (1,354,735) (1,357,100) (1,458,810) (1,480,512) (1,910,373) (2,770,530) (3,998,737) (6,206,794) (8,473,579) (11,076,129) % of revenues (69.1%) (65.7%) (68.9%) (61.9%) (69.3%) (63.8%) (64.1%) (61.8%) (71.0%) (65.7%) (64.3%) (62.7%) (61.6%)

Gross Profit 348,432 466,349 439,699 833,238 601,448 827,819 829,179 1,180,845 1,133,042 2,087,718 3,439,291 5,036,965 6,902,997 Margins (%) 30.88% 34.35% 31.13% 38.08% 30.71% 36.20% 35.90% 38.20% 29.0% 34.3% 35.7% 37.3% 38.4% Y-Y (%) na na na na -0.6% 5.4% 15.3% 0.3% na 84.3% 51.0% 46.5% 37.0% Q-Q (%) na 11.2% (9.4%) 22.3% (19.4%) 17.9% (0.8%) 6.4%

Selling, general and administrative (115,678) (133,505) (156,171) (186,384) (162,631) (218,097) (202,439) (214,059) (534,537) (591,738) (797,226) (893,080) (1,048,956) TOTAL ASSETS 10.3% 9.8% 11.1% 8.5% 8.3% 9.5% 7.5% 6.9% 13.69% 9.72% 8.26% 6.61% 5.83% Y-Y (%) na na na na 40.6% 63.4% 29.6% 14.8% na 10.7% 34.7% 12.0% 17.5% Other operating income, net 3,100 11,193 20,245 (1,289) 15,640 (7,617) 5,635 5,635 1,796 33,249 19,292 27,021 35,958 % of revenue -0.3% -0.8% -1.4% 0.1% -0.8% 0.3% -0.2% -0.2% 0.05% 0.55% 0.20% 0.20% 0.20% Total operating expenses (112,578) (122,312) (135,926) (187,673) (146,991) (225,714) (196,804) (208,425) (532,741) (558,489) (777,934) (866,059) (1,012,998)

Total Share-based compensation 21,652 26,056 27,105 41,988 24,771 28,920 29,212 39,097 - 116,800 122,000 150,000 150,000 Operating income (Non-GAAP) 257,506 370,093 330,878 687,553 479,228 631,025 661,587 1,011,517 600,301 1,646,029 2,783,357 4,320,906 6,039,999 Margins, pre-SBC operating (%) 22.8% 27.3% 23.4% 31.4% 24.5% 27.6% 28.6% 32.7% 15.4% 27.0% 28.9% 32.0% 33.6% Operating income (GAAP) 235,854 344,037 303,773 645,565 454,457 602,105 632,375 972,421 600,301 1,529,229 2,661,357 4,170,906 5,889,999 Margins, post-SBC operating (%) 20.9% 25.3% 21.5% 29.5% 23.2% 26.3% 27.4% 31.5% 15.4% 25.1% 27.6% 30.9% 32.8%

Earnings before Taxes 232,843 341,782 301,779 875,672 469,421 609,117 638,038 978,084 602,911 1,752,076 2,694,660 4,221,827 5,953,834

Tax (65,836) (97,626) (90,323) (166,214) (122,018) (171,954) (159,510) (264,083) (202,486) (419,999) (717,564) (1,055,457) (1,488,458) Effective tax rate (28.3%) (28.6%) (29.9%) (19.0%) (26.0%) (28.2%) (25.0%) (27.0%) 33.6% 24.0% 26.6% 25.0% 25.0%

Net income to ZTO shareholders (GAAP) 167,168 244,581 211,653 679,578 347,364 439,180 478,529 714,001 406,426 1,302,980 1,979,074 3,166,371 4,465,375 Net income to ZTO's shareholders (Non-GAAP) 188,820 270,637 238,758 721,566 372,135 468,100 507,741 753,098 406,426 1,195,632 2,091,523 3,316,371 4,615,375 Margins (%) 16.7% 19.9% 16.9% 33.0% 19.0% 20.5% 22.0% 24.4% 10.4% 19.6% 21.7% 24.5% 25.7% Y-Y (%) na na na na 97.1% 73.0% 112.7% 4.4% 194.2% 74.9% 58.6% 39.2% Q-Q (%) na 43.3% (11.8%) 202.2% (48.4%) 25.8% 8.5% 48.3%

Basic Weighted Average ADS('000) 731,406 731,406 731,406 731,406 731,406 731,406 731,406 731,406 597,883 599,373 731,406 753,349 775,949 Diluted Weighted Average ADS('000) 742,221 742,221 742,221 742,221 742,221 742,221 742,221 742,221 597,883 599,373 742,221 764,488 787,423

Diluted EPS per ADS 0.23 0.33 0.29 0.92 0.47 0.59 0.64 0.96 0.68 2.17 2.67 4.14 5.67 Diluted EPS per ADS (Non-GAAP) 0.25 0.36 0.32 0.97 0.5 0.63 0.68 1.01 0.68 1.99 2.82 4.34 5.86

USD'000 except for per share data Revenue $165,926 $199,671 $207,709 $321,761 $288,022 $336,269 $339,660 $454,591 $574,055 $895,067 $1,418,542 $1,986,845 $2,643,989 Operating Income (GAAP) $34,684 $50,594 $44,673 $94,936 $66,832 $88,545 $92,996 $143,003 $88,280 $224,887 $391,376 $613,369 $866,176 Operating Income (Non-GAAP) $37,869 $54,425 $48,658 $101,111 $70,475 $92,798 $97,292 $148,753 $88,280 $242,063 $409,317 $635,427 $888,235 Net Income (GAAP) $24,584 $35,968 $31,125 $99,938 $51,083 $64,585 $70,372 $105,000 $59,769 $191,615 $291,040 $465,643 $656,673 Net Income (Non-GAAP) $27,768 $39,800 $35,111 $106,113 $54,726 $68,838 $74,668 $110,750 $59,769 $175,828 $307,577 $487,702 $678,732 Diluted EPS (Non-GAAP) $0.04 $0.05 $0.05 $0.14 $0.07 $0.09 $0.10 $0.15 $0.10 $0.29 $0.41 $0.64 $0.86

Note: For y/y comparison, we used 2014 and 2015 pro-forma number Source: Company reports, CRSUS estimates

China Renaissance Securities (US) Inc. 33 November 21, 2016 Initiation of Coverage

ZTO Express Balance Sheet

RMB'000 2014 2015 2016E 2017E 2018E ASSETS CURRENT ASSETS Cash and cash equivalents 163,359 2,452,359 11,575,006 13,885,584 18,031,865 Restricted deposits - 266,403 366,403 466,403 566,403 Accounts receivable 49,164 58,494 92,704 129,843 172,789 Inventories 4,950 15,720 33,081 33,543 53,543 Advance to suppliers 178,671 347,680 731,650 741,862 1,184,220 Prepaid expenses 126,800 211,724 445,547 451,766 721,145 Amounts due from related parties 229,670 85,740 135,885 190,323 253,272 Total current assets 752,614 3,438,120 13,380,275 15,899,325 20,983,238

NON-CURRENT ASSETS Investments in equity investees 389,557 377,431 377,431 377,431 377,431 Property and equipment, net 925,868 1,752,586 3,813,590 5,482,770 6,184,129 Land use rights 416,283 821,131 931,940 1,108,957 1,357,643 Goodwill 2,379,182 4,091,219 4,091,219 4,091,219 4,091,219 Deferred tax assets 87,259 81,006 81,006 81,006 81,006 Other non-current assets 23,362 20,730 70,730 120,730 170,730

Total non-current assets 4,221,511 7,144,103 9,365,916 11,262,113 12,262,158

TOTAL ASSETS 4,974,125 10,582,223 22,746,191 27,161,437 33,245,396

LIABILITIES AND EQUITY CURRENT LIABILITIES Bank borrowings 250,000 300,000 - - - Accounts payable 152,059 294,199 398,478 547,172 688,921 Advance from customers 220,247 298,865 523,847 628,464 904,971 Income tax payable 218,215 301,932 522,420 632,188 904,304 Amounts due to related parties respectively 100,819 103,267 348,461 268,243 537,873 Acquisition consideration payable 50,697 87,766 87,766 87,766 87,766 Other current liabilities 539,257 1,264,914 1,594,417 2,410,432 2,919,011 Total current liabilities 1,531,294 2,650,943 3,475,388 4,574,264 6,042,847 Deferred tax liability 47,128 85,059 85,059 85,059 85,059

Total liabilities 1,578,422 2,736,002 3,560,447 4,659,323 6,127,906

EQUITY Ordinary shares 390 390 390 390 390 Series A Preferred Shares - 1,976,855 1,976,855 1,976,855 1,976,855 Additional paid-in capital 2,966,980 4,281,321 13,529,321 13,529,321 13,529,321 Retained earnings 401,440 1,589,420 3,678,965 6,995,336 11,610,711 Accumulated other comprehensive income - (13,749) (13,749) (13,749) (13,749) Non-controlling interests 26,893 11,984 13,962 13,962 13,962 Total equity 3,395,703 7,846,221 19,185,744 22,502,115 27,117,490

TOTAL LIABILITIES AND EQUITY 4,974,125 10,582,223 22,746,191 27,161,437 33,245,396

Source: Company reports, CRSUS estimates

China Renaissance Securities (US) Inc. 34 November 21, 2016 Initiation of Coverage

ZTO Express Cash Flow Statement

RMB'000 2014 2015 2016E 2017E 2018E CASH FLOW FROM OPERATING ACTIVITIES: Net income 406,003 1,331,618 1,979,074 3,166,371 4,465,375 Adjustments to reconcile net income to net cash by operating activities: Share-based compensation expenses 0 116,800 122,000 150,000 150,000 Depreciation of property and equipment 64,014 158,056 432,630 855,912 1,207,450 Loss on disposal of property and equipment 3,132 7,293 (9,551) 0 0 Allowance for doubtful debts 0 2,588 0 0 0 Deferred income tax (80,309) 5,047 0 0 0 Gain on deemed disposal of equity method investments 0 (224,148) 0 0 0 Share of profit/loss in equity method investmens (5,578) 459 0 0 0 Changes in working capital: 684,489 469,825 404,937 990,404 630,951 Net cash (used in) from operating activities 1,071,751 1,867,538 2,929,090 5,162,687 6,453,776

CASH FLOW FROM INVESTING ACTIVITIES: 2.5b 2.4 1.8 Purchase of property and equipment (618,571) (1,062,302) (2,411,521) (2,431,898) (1,797,913) Purchase of land use rights (171,510) (413,562) (192,922) (270,211) (359,583) Payment of amounts due from related parties (228,509) (15,000) 0 0 0 Repayment of amounts due from related parties 0 228,509 0 0 0 Cash paid for business acquisition (13,793) (20,604) (50,000) (50,000) (50,000) Others (83,916) (166,787) (100,000) (100,000) (100,000) Net cash in investing activities (1,116,299) (1,449,746) (2,754,443) (2,852,109) (2,307,495) TOTAL ASSETS CASH FLOW FROM FINACING ACTIVITIES: Issuance of Series A Preferred shares (a) - 1,934,331 0 0 0 Loans from shareholders 509,800 - 0 0 0 Proceeds from bank borrowings 300,000 350,000 0 0 0 Repayment to bank borrowings (50,000) (300,000) (300,000) 0 0 Payment of dividends - (115,000) 0 0 0 Issuance of ordinary shares - - 9,248,000 0 0 other cash flow from financing (404,736) - 0 0 0 Repurchase of ordinary shares (184,000) - 0 0 0 Issurance of convertible bonds - - 0 0 0 Net cash provided by financing activities 171,064 1,869,331 8,948,000 - - Effect of exchange rate changes - 1,877 0 0 0

Net increase in cash and cash equivalents 126,516 2,289,000 9,122,647 2,310,578 4,146,281 Cash and cash equivalents at beginning of the year 36,843 163,359 2,452,359 11,575,006 13,885,584 Cash and cash equivalents at end of the year 163,359 2,452,359 11,575,006 13,885,584 18,031,865

Free operating cash flow 281,670 391,674 324,647 2,460,578 4,296,281

Operating cash flow-net profit ratio 264% 140% 148% 163% 145%

Source: Company reports, CRSUS estimates

China Renaissance Securities (US) Inc. 35 November 21, 2016 Initiation of Coverage Appendix A

Analyst Certification I, Ella Ji, CFA, certify that the views expressed in this research report accurately reflect my personal views about any and all of the subject securities or issuers featured in this report. Furthermore, no part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed in this report. Important Disclosures

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China Renaissance Securities (US) Inc. 36 November 21, 2016 Initiation of Coverage The research analyst(s) or his/her associate does not serve as an officer of the issuer that the research analyst(s) review in this report. The research analyst(s) or his/her associate does not have any financial interest in any of the issuer that the research analyst(s) review in this report. CRSHK does not have any financial interests in relation to the issuer the securities in respect of which are reviewed in this research report where the aggregate of such interests amount to 1% or more of the issuer's market capitalization as at the date of publication of the report. CRSHK is not a market maker of in the securities of the issuer that the research analyst(s) review in this report. CRSHK does not have any individual employed by or associated with itself serving as an officer of the issuer. The terms "analyst", "associate", "financial interests", "individual employed by or associated with", "issuer" and "securities" referred to in this paragraph means such terms as defined in paragraph 16 of the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission ("SFC Code of Conduct"). As per paragraph 16.5(d) of the SFC Code of Conduct, CRSHK does not have any investment banking relationship with the issuer. Global product, jurisdiction and distribution The research group of China Renaissance produces and distributes research products for clients of China Renaissance on a global basis. Analysts based in China Renaissance offices around the world produce equity research on industries and companies. This research is disseminated in Hong Kong by CRSHK; and in the United States of America by CRSUS. CRSUS has approved and and agreed to take responsibility for any research prepared by CRSHK if and to the extent CRSUS distributes it in the United States. This report and the securities and financial instruments discussed herein may not be eligible for distribution or sale in all jurisdictions and/or to all types of investors. This report is provided for information purposes only and does not represent an offer or solicitation in any jurisdiction where such offer would be prohibited. No part of this report may be reproduced or distributed in any manner without the written permission of CRSUS. CRSUS specifically prohibits the re-distribution of this report, via the Internet or otherwise, and accepts no liability whatsoever for the actions of third parties in this respect. The following are additional required disclosures: Ownership and material conflicts of interest: China Renaissance’s policy prohibits its analysts, professionals reporting to analysts and members of their households from owning positions in securities of any company in the analyst's area of coverage. Analyst compensation: Analysts are paid in part based on overall revenues of China Renaissance, which includes investment banking revenues. Analyst as officer or director: China Renaissance’s policy prohibits its analysts, persons reporting to analysts or members of their households from serving as an officer, director, advisory board member or employee of any company in the analyst's area of coverage. Non-U.S. Analysts: Non-U.S. analysts are not registered or qualified as research analysts with FINRA. They may not be associated persons of CRSUS and therefore may not be subject to FINRA Rule 2241 or FINRA Rule 2242 restrictions on communications with subject company, public appearances and trading securities held by the analysts. Potential Conflicts of Interest Analyst Conflict of Interest: The research analyst(s) responsible for the preparation of this report receives compensation based upon a variety of factors, including the quality and accuracy of research, internal/client feedback, and overall firm revenues, which include investment banking revenues. Research analysts do not receive compensation based upon revenues from specific investment banking transactions. China Renaissance Conflicts of Interest:

China Renaissance Securities (US) Inc. 37 November 21, 2016 Initiation of Coverage China Renaissance has managed or co-managed a public offering of the securities for ZTO Express in the past twelve months. China Renaissance has received compensation for investment banking services from ZTO Express in the past 12 months. China Renaissance expects to receive or intends to seek compensation for investment banking services from ZTO Express and Alibaba Group Holding in the next three months. Distribution of Ratings and Investment Banking Below is the distribution of research recommendations as of November 22, 2016 Rating Count Percent IB Count IB% Buy 4 44.44% 4 100.00% Hold 4 44.44% 4 100.00% Sell 1 11.11% 1 100.00% China Renaissance Ratings as of May 10, 2016: Ratings of Buy, Hold and Sell have a time horizon of twelve to eighteen months from the date of publishing the initiation or subsequent rating/price target change report issued for the subject company. The ratings are as follows: Buy – The expected return on the subject company’s stock price should outperform the typical benchmark market index for the subject company's primary listing exchange (e.g. the S&P 500 for US-listed stocks) over the above-defined time horizon from the publishing date of the initiation of coverage or subsequent report announcing a rating change. Hold – The stock price of the subject company is not expected to either appreciate or depreciate meaningfully from the typical benchmark market index for the subject company's primary listing exchange (e.g. the S&P 500 for US-listed stocks) during the above-stated time horizon. Sell – The expected return on the subject company’s stock price should underperform the typical benchmark market index for the subject company's primary listing exchange (e.g. the S&P 500 for US-listed stocks) over the above-defined time horizon from the publishing date of the initiation of coverage or subsequent report announcing a rating change. Not Rated – China Renaissance has removed the rating and, if applicable, the price target, for the subject company's stock because of either a lack of a sufficient fundamental basis or for legal, regulatory or policy reasons. The previous rating and, if applicable, the price target, should no longer be relied upon. An NR designation is not a recommendation or a rating. Not Covered – a company for which China Renaissance research has not been published. Valuation Methodology ZTO: Our $21 target is based on 32x our 2017 non-GAAP EPS estimate of $0.64, or 0.7x PEG. General Disclosures This research is for institutional investors only, and intended for our clients only. Other than disclosures relating to China Renaissance, this research is based on current public information that we consider reliable, but we do not represent it is accurate or complete, and it should not be relied on as such. The information, opinions, estimates

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China Renaissance Securities (US) Inc. 40