3Q23 results miss our expectations

Deppon Logistics announced its 3Q23 results: Revenue rose 22% YoY and 18% QoQ to Rmb9.75bn. Gross profit fell 33% YoY and 4% QoQ to Rmb785mn. Net profit attributable to shareholders fell 6% YoY but rose 34% QoQ to Rmb228mn. The 3Q23 profit missed our expectations, mainly due to weak freight delivery demand, YoY decline in unit price of large- parcel express delivery, and increased costs from network integration. However, the firm raised its 2023 guidance for revenue from connected- party transactions with JD.com by 60%, and its revenue integration with JD Express Freight is progressing faster than we expected.

By business: In 3Q23, revenue from large-parcel express delivery fell 9% YoY and 5% QoQ to Rmb4.84bn, with parcel volume at 184mn units (+1% YoY and -8% QoQ), and revenue per parcel at Rmb26.3 (-9% YoY and +3% QoQ). The unit price of express delivery remained under pressure YoY, but the decline narrowed QoQ. In 3Q23, revenue from road freight business surged 88% YoY and 58% QoQ to Rmb4.59bn, mainly driven by progress in the project of network integration with JD Express Freight and the continued upgrading of less-than-truckload (LTL) and full truckload (FTL) businesses since 2Q23.

Trends to watch

The firm raised its 2023 guidance for revenue from connected-party transactions with JD.com by 60%, with the revenue growth beating our expectations amid the progress of network integration. Deppon Logistics began integrating 83 sorting hubs acquired from JD Express Freight in July. The firm announced that JD Express Freight contributed incremental revenue of Rmb1.45bn from connected-party transactions over January-September 2023, and the firm expects the incremental revenue from connected-party transactions to reach Rmb3.64bn in 2023 (60% higher than the upper limit of Rmb2.28bn in the firm's previous announcement), implying faster revenue growth from network integration than we expected.

Network integration leads to increased costs; short-term profit under pressure; watch earnings growth as integration accelerates. In 3Q23,　gross margin fell 6.5ppt YoY and 1.8ppt QoQ to 8.1%. Labor costs, transportation costs, rents, and depreciation and amortization costs rose 10%, 70%, 28%, and 2% YoY to Rmb3.85bn, Rmb3.88bn, Rmb471mn, and Rmb296mn. Transportation costs increased notably, mainly due to changes in product mix brought by network integration and the growing size of the FTL business, and partly due to the firm's initiative to increase investment in resources to ensure services. We estimate that network integration may contribute revenue of Rmb2.19bn in 4Q23. Costs may marginally stabilize as network integration matures, and we are optimistic that network integration will contribute incremental earnings in the future.

Financials and valuation

Given accelerated integration with JD Express Freight's network and higher short-term costs, we lower our 2023 net profit forecast 6.7% to Rmb842mn and raise our 2024 net profit forecast 2.1% to Rmb1,156mn. The stock is trading at 18.2x 2023e and 13.2x 2024e P/E. We are upbeat on the firm's long-term steady earnings growth after the completion of integration, and maintain OUTPERFORM rating and target price of Rmb20.00, implying 24.4x 2023e and 17.8x 2024e P/E, offering 34.4% upside.

Risks

Intensifying price competition; economic downturn; disappointing earnings contribution from network integration.