AI Costs, Slowing Industrial Demand, And Private Label Risks Will Challenge Margins Yet Improve Resilience

Catalysts

About ZKH Group

ZKH Group operates a professional one stop MRO procurement platform focused on industrial grade products, AI driven efficiency and integrated supply chain services.

What are the underlying business or industry changes driving this perspective?

• Although customer count and weekday order value are recovering and are expected to support mid teen GMV growth, the transition from loss making to sustained profitability could stall if industrial demand in China softens again. This could limit revenue scale benefits and slow operating leverage on margins.
• Despite plans to expand private label from roughly 8 percent of GMV toward 30 percent, intensifying competition in MRO and possible pushback from OEM suppliers could cap mix improvement. This may constrain gross margin expansion and delay meaningful uplift in net margins.
• While AI tools like Expert Linglong are already lifting worker productivity and generating incremental sales, ongoing model development and deployment costs may rise faster than expected. This could compress earnings even as AI driven efficiencies gradually improve operating margin.
• Although ZKH is building out specialized chemical logistics and last mile capabilities that differentiate its one stop offering, higher regulatory and safety compliance costs in hazardous materials handling may offset scale efficiencies. This may limit contribution to gross profit and operating income.
• While international and cross border MRO demand from Chinese manufacturers expanding overseas offers a long runway for revenue diversification, slower than expected breakeven in overseas operations and a cautious investment pace could dilute group level earnings and delay net margin improvement.

Assumptions

This narrative explores a more pessimistic perspective on ZKH Group compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming ZKH Group's revenue will grow by 10.3% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from -2.0% today to 1.5% in 3 years time.
• The bearish analysts expect earnings to reach CN¥176.4 million (and earnings per share of CN¥1.09) by about December 2028, up from CN¥-173.6 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as CN¥775.3 million.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 32.2x on those 2028 earnings, up from -20.9x today. This future PE is greater than the current PE for the US Trade Distributors industry at 19.9x.
• The bearish analysts expect the number of shares outstanding to grow by 1.33% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.85%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Industrial activity in China may slow again over the long term, which would undermine ZKH Group's expectation that GMV can grow 15 percent to 20 percent per year and could cap revenue growth.
• Rising competition from scaled players such as JD Industrial and other MRO platforms could erode ZKH Group's one stop positioning and take rate advantages, placing pressure on gross margins and overall earnings.
• The strategic push to grow private label from about 8 percent of GMV toward 30 percent may face resistance from OEM suppliers or customers concerned about quality, which could limit mix improvement and delay net margin expansion.
• Sustained heavy investment in AI infrastructure, overseas expansion and specialized logistics, including hazardous chemical warehouses, may keep operating expenses elevated for longer than planned, preventing a durable inflection from narrowing losses to consistently positive earnings.
• Overseas initiatives, particularly in the United States and Europe, could take longer than expected to reach breakeven beyond the 2026 target, which would dilute consolidated profitability and weigh on net margins.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for ZKH Group is $3.72, which represents up to two standard deviations below the consensus price target of $4.53. This valuation is based on what can be assumed as the expectations of ZKH Group's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $6.1, and the most bearish reporting a price target of just $3.72.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be CN¥11.8 billion, earnings will come to CN¥176.4 million, and it would be trading on a PE ratio of 32.2x, assuming you use a discount rate of 8.8%.
  
• Given the current share price of $3.22, the analyst price target of $3.72 is 13.3% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.