GreenTree Hospitality Group Ltd. Q2 FY2020 Earnings Call

Good day, and welcome to the GreenTree Second Quarter 2020 Earnings Conference Call. I would now like to turn the conference over to Rene Vanguestaine. Please go ahead.

Thank you, Rachel. Hello, everyone, and thank you for joining us. GreenTree's earnings release was distributed earlier today and is available on our IR website at ir.998.com as well as on PR Newswire services. As a reminder, we also posted a PowerPoint presentation that accompanies our comments to the same IR website. On this call, we are going to refer to this presentation, so please make sure you open it now. Thank you. On the call from GreenTree are Mr. Alex Xu, Chairman and Chief Executive Officer; Ms. Selina Yang, Chief Financial Officer; Ms. Megan Huang, Vice President of Sales and Marketing; and Mr. Nicky Zheng, our IR manager. Mr. Xu will present the company's Q2 2020 performance overview, followed by Ms. Huang, who will discuss business operations, and Ms. Yang will then discuss financials and guidance. They will be available to answer your questions during the Q&A session that will follow. Before we begin, I'd like to remind you that this conference call contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended and as defined in the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements can be identified by terminology such as may, will, expects, anticipates, aims, future, intends, plans, believes, estimates, continue, target, is or are likely to, going forward, confident, outlook and similar statements. Any statements that are not historical facts, including statements about the company and its industry, are forward-looking statements. Such statements are based upon management's current expectations and current market and operating conditions and relate to events that involve known and unknown risks, uncertainties and other factors, all of which are difficult to predict and many of which are beyond the company's control, which may cause the company's actual results, performance or achievements to differ materially from those in the forward-looking statements. You should not place undue reliance on these forward-looking statements. Further information regarding these and other risks, uncertainties or factors is included in the company's filings with the U.S. Securities and Exchange Commission. All information provided, including the forward-looking statements made during this call, are current as of today's date. The company does not undertake any obligation to update any forward-looking statement as a result of new information, future events or otherwise, except as required under applicable law. It is now my pleasure to introduce our Chairman and Chief Executive Officer, Mr. Alex Xu. Mr. Xu, please go ahead.

Thank you, Rene, and thanks, everyone, for joining our second quarter earnings call today. Let's start with Slide 5. During the quarter, our performance, as that of the hospitality industry as a whole, continued to be impacted by COVID-19 with reductions in both business and leisure travel. Overall, though, and despite some local resurgence of infections in June, our business continued to recover. Our blended ADR decreased 17.4% year-over-year to RMB142. Our occupancy rate dropped to 63.4%, and RevPAR decreased 35.4% to RMB90. If we exclude hotels under requisition, temporary closures and the impact from consolidated entities, RevPAR for same-hotel decreased 2.2% to RMB112. Nonetheless, we continued to expand our market presence across China. By the end of the quarter, we had grown our geographic coverage to 343 cities across China with 111 new hotels opened and reached a new milestone, exceeding the 4,000 mark with 4,066 hotels in operation. We ended the quarter with 1,087 hotels in our pipeline, up 82.4% year-over-year. Total revenues were RMB216 million, a 21.4% decrease compared to the second quarter of 2019. Gross profit decreased 38.2% to RMB121.1 million. Net income decreased 26.3% to RMB93.7 million. Non-GAAP adjusted EBITDA decreased 47.2% to RMB91.4 million. Net income per ADS decreased 19.7% to RMB1.01, and the core net income per ADS decreased 40.9% to RMB0.72. Let's now turn to Slide 7 for further update on the impact of COVID-19. China effectively contained the spread of COVID by the second quarter of 2020, albeit with some restrictions on certain consumer-related activities. So our business was inevitably affected by some business closures and travel restrictions imposed by governments that continued throughout the second quarter, especially during June. As COVID-19 came under control and restrictions were gradually lifted, we saw a return of domestic tourism and business travelers. According to the STR data, occupancy rate, ADR and RevPAR of hotels in China improved steadily during the second quarter, partially offsetting the decline observed in the first quarter. Once again, GreenTree's overall performance was better than the average performance across the hospitality industry in China, i.e., around 20% less decrease of RevPAR. This is thanks to the tireless work and dedication of our hotel staff and franchisees and the strong support of our loyal individual and corporate members. During June and July, new COVID-19 cases were reported in several cities, including Beijing and Dalian. Total measures, including strict travel restrictions, temporary closure of entertainment places and many other leisure places, were reimposed, helping to bring the resurgence of COVID-19 quickly under control. Now let's turn to Slide 8. We continue to act quickly and strategically to ensure that we are providing as much support as possible to all our franchisees and employees to protect the long-term health of our business. With the resumption of business travel and domestic tourism, we increased our cooperation with our corporate clients and provided additional sales support to our franchisees. During the quarter, we expanded our cooperation with a number of travel management companies to attract more corporate clients and business travelers. Also, every one of our hotels is expanding joint promotion programs and cooperation with local merchants. With all these efforts and assistance from GreenTree's central office, the performance of our hotels quickly improved even with the slight dip in June due to the resurgence. Our occupancy rate increased from a low of 21.5% at the end of January to averaging 65% during the second half of May to exceed 75% on the second half of July and to exceed 82% further during the first 2 weeks of August. With these encouraging trends, we are confident that we can achieve our revenue target during the third quarter of 2020. I am proud of the Q2 result we achieved, especially considering the difficult environment that we operated under as a result of the COVID-19. Through it all, our business remained resilient and highly adaptable. We quickly adjusted our operation and marketing campaigns to meet evolving consumer preferences and weaker market conditions. We protected our margins, thanks to our flexible cost structure and the measures we implemented over recent quarters and that we will continue to implement for the rest of 2020. As a result, our sales recovered, and we returned to profitability for this quarter. With the Chinese government's efforts to bring the spread of COVID-19 under control, domestic tourism and business is gradually bouncing back. On July 15, 2020, the Ministry of Culture and Tourism lifted restrictions on interprovincial travel. The lifting of these restrictions is stimulating business travel and summer travel and helping the hospitality sector to deliver steady and improved performance. After the lifting of the restrictions, we have observed another 10% increase in our occupancy. With assistance and support from the government and our business partners, together with our core strengths such as our large, loyal membership base and the strong operational capabilities and our proprietary technologies, we are well-positioned to deliver another year of outstanding service to our guests, strong performance to our franchisees and sustainable growth to our shareholders. I will now pass the call to Megan Huang. Megan, please go ahead.

Thank you, Alex. Moving to Slide 10. At the end of the second quarter, we had 4,066 hotels in operation, 37.6% higher than a year ago. 35 of these hotels were leased-and-operated or L&O hotels, and 4,031 were franchised-and-managed or F&M hotels. While the mid-scale segment remains the core of our business with almost 64.2% of all local hotels, last year, we expanded more into both the higher-end and economy segments. As a result, by the end of the second quarter, the number of hotels in the mid-to-upscale and luxury segments increased to 7.8% of the total portfolio, and the economy segment grew to 28%. Our entry into these segments will enhance our ability to cross-market our different brands. We have also increased our dominant position in tier 3 and smaller cities. As a result, 66.8% of our hotels were in these cities at the end of the second quarter. On Slide 11, you can see that we opened 111 hotels compared to 134 in the second quarter of 2019, a 17.2% drop. 1 hotel was in the luxury segment. 28 were in the mid-to-upscale segment, 50 in the mid-scale segment and 32 in the economy segment. 5 were in tier 1 cities, 34 in tier 2 cities, and the remaining 72 were in tier 3 and smaller cities in China. More than 26% of newly opened hotels were luxury and mid-to-upscale hotels. Meanwhile, we closed 43 hotels, 5 due to brand upgrades, 20 due to noncompliance with our brand and operating standards, and 18 due to property-related issues. So net-net, we added 68 hotels to our portfolio in the second quarter. Slide 12 shows the growth in our pipeline of new hotels. Despite COVID-19, our pipeline increased from 1,025 on March 31, 2020, to 1,087 on June 30, 2020. Around 40% of these hotels are in the mid-scale segment, about 35% in the economy sector, and around 25% in the mid-to-upscale and luxury segments. Slide 14 summarizes the impact of COVID-19 on our second quarter operating performance. The RevPAR decreased year-over-year due to COVID-19 to RMB90. However, excluding the impact of Argyle and Urban, our RevPAR was RMB95. Our F&M hotels' ADR decreased 17.4% to RMB142. The occupancy rate dipped 17.6% to 64%, and the RevPAR decreased 35.2% to RMB90. While our L&O hotels' ADR decreased 19.7% to RMB173, the occupancy rate dipped 24% to 47%, and RevPAR decreased 47.1% to RMB80. The L&O hotels' performance was impacted by both COVID and also by recent and ongoing renovations that were delayed due to COVID. Two of them will be completed this quarter. Slide 15 shows the quarterly RevPAR change. As you can see, RevPAR for our L&O hotels decreased 47.1% year-over-year to RMB80, and the RevPAR for our F&M hotels decreased 35.2% to RMB90. But RevPAR is rebounding from the first quarter level. Slide 16. We now have about 49 million loyal individual members and 1.56 million corporate members, up from approximately 46 million and 1.52 million as of March 31. During the quarter, around 93.7% of all room nights were sold directly, primarily due to our individual and corporate members. With that, I'll pass the call over to our CFO, Selina Yang.

Thank you, Megan. Please turn to Slide 17. Total revenues decreased 21.4% year-over-year to RMB216 million. Total revenue from F&M hotels decreased 22.7% to RMB165.7 million, while total revenue from L&O hotels decreased 16.8% to RMB50.3 million. The decrease was primarily due to the impact of COVID-19, which resulted in declined RevPAR of L&O hotels and F&M hotels, renovation of 5 L&O hotels, delay in new hotel openings, as well as partial reduction and extension of sublease income recognition. Slide 18 shows that hotel operating costs were RMB94.9 million, up 20.2% year-over-year. The increase was mainly attributable to higher rents, higher depreciation and amortization, and the consolidation of operation costs for Argyle and Urban. Argyle's costs increased compared to a year ago, primarily due to rents for 2 L&O hotels in development. Excluding the impact from acquired entities, hotel operating costs for this quarter decreased 6.2%, which was primarily due to a decrease in salaries of hotel staff and regional general managers and decreases in utilities, consumable, food and beverage, which resulted from the lower occupancy rate. Selling and market expenses were RMB12 million, a decrease of 26.6% year-over-year. The decrease was mainly attributable to sustainable reduction in costs for advertising and meals. Excluding Argyle's and Urban's expenses, selling and marketing expenses in this quarter decreased 37.6%. General and administrative expenses were RMB48.1 million, up 21.1% year-over-year. The increase was primarily attributable to higher depreciation and amortization for our property and equipment, increased consulting fees, and the consolidation of expenses from Argyle and Urban. Additionally, a one-time bad debt regarding accounts receivable due to COVID-19 was accrued. Excluding the impact from acquired entities and accrued bad debt, our G&A expenses decreased by 21.6%. Overall, total operating costs and expenses grew 14.8% year-over-year to RMB155.1 million. Excluding impacts from acquired entities, our total operating costs and expenses decreased 6.4% compared with a year ago. On Slide 20, you see that gross profit decreased 38.2% year-over-year to RMB121.1 million in this quarter. Gross margin decreased from 71.3% to 56.1%. Net income decreased 26.3% to RMB93.7 million, and net margin decreased from 46.2% to 43.4%. These year-over-year decreases were primarily due to the impact of COVID-19. On Slide 21, we can see that adjusted EBITDA decreased 47.2% year-over-year to RMB91.4 million. Adjusted EBITDA margin decreased to 42.3%. Core net income decreased 40.2% to RMB74.6 million, and core net margin was 34.6%. Please turn to Slide 22. Net income per ADS decreased 19.7% to RMB1.01. That's equal to $0.14, while our core net income per ADS basic and diluted non-GAAP decreased 40.9% to RMB0.72. That's equal to $0.10. Let's now look at Slide 23. As of June 30, 2020, the company had a total balance of cash and cash equivalents, restricted cash, short-term investments, investments in equity securities and time deposits of RMB1.7 billion as compared to RMB1.6 billion as of March 31, 2020. The increase from the first quarter was primarily attributable to cash inflow from operating activities, changes in fair value of equity securities, proceeds from disposal of investments and offset by loans to franchisees and investment on upgrade decoration. The cash and cash equivalents provide us with ample resources as we continue to evaluate potential investments and to support our franchisees. On Slide 24, as Alex mentioned, COVID-19 had a significant impact on our business. As a result, we expect a decline in total revenues of 10% to 15% for the full year 2020 as compared to 2019. This concludes our prepared remarks. Operator, we are now ready to begin the Q&A session. Thank you.

Your first question comes from Justin Kwok from Goldman Sachs.

I have three broader questions. First, regarding your guidance for the third quarter and the full year, can you provide a comparison of your RevPAR for the third and fourth quarters in relation to 2019? How much recovery are you seeing? Second, what is the level of competition in the market, particularly concerning the signing of new franchisees? It's encouraging to note that your pipeline has grown to over 1,000 hotels. Are you gaining more market share, and how competitive do you find the landscape? Lastly, I want to ask about the potential for a secondary listing in Hong Kong or other markets. What are your thoughts and considerations on this topic?

Thank you, Justin. This is Alex. I'm going to answer as much as I can, and Selina and Megan can add to it as well. Regarding the guidance for the like-for-like RevPAR for the third and fourth quarters, we are very optimistic and encouraged by the lifting of restrictions on July 15 for interprovincial travel. While we believe that travel is primarily focused on essential business travel at this time, leisure travel remains cautious compared to last year's levels. Our business model is resilient, supported by a loyal base of corporate members. In fact, our occupancy for the first two weeks of August reached 82%. However, we are noticing increased competition from various hotel classes, which may pressure the ADR, particularly from luxury segments, resorts, and 4- or 5-star hotels. Their demand is weaker than ours, and many higher-end hotels are lowering their rates to attract business. Consequently, we foresee ADR pressure in the third quarter. We believe ADR will lag behind occupancy, which will continue to improve even at slightly lower ADRs. Our internal expectation for the third quarter is a 10% to 15% increase in like-for-like RevPAR compared to the same period last year. For the fourth quarter, we anticipate being about 5% to 10% below last year, although optimistically we may achieve the same RevPAR as last year. That's my response to the first question, and I’d like to give Selina and Megan the chance to add their thoughts, as our CFO knows the numbers better than I do.

Okay. Thank you, Alex. Thank you, Justin, for the question. Indeed, during the first two weeks, we have observed a quick recovery, especially in our occupancy rate. So with this encouraging trend, we expect our revenues for our third quarter to be down 8% to 13% year-over-year. If we talk about like-to-like RevPAR, we think our ADR decrease will be in the range below 10%. So if there are no major COVID cases happening during the second half of 2020, hopefully, we will see in the fourth quarter our revenue recovering gradually to last year's level. So at least our year-over-year decrease will be less than 5%. And hopefully, our RevPAR decrease will be in the range of around 5% as well. So in line with this, we expect a decline in total revenue of 10% to 15%.

Thank you, Selina. To answer the second question about our pipeline and market share, we noticed during the second quarter that our rate of contract additions remained consistent. Given that our business developers still face travel restrictions in areas of China, particularly Xinjiang, we experienced limitations. Despite these challenges, we added 173 contracts in the second quarter, equivalent to around 700 new hotels annually. However, it seems our franchisees have not fully leveraged this opportunity to grow and are approaching new hotel openings with caution. They are taking extra time to prepare for openings due to the lengthy ramp-up period associated with COVID, which leads to higher costs. While many franchisees are eager to grow, they have been more reserved in the first two quarters. I am optimistic that we will see significant growth in contract signings in the third and fourth quarters, as our franchisees gain experience and confidence. Additionally, GreenTree’s business model has proven resilient, as shown in the previous quarters. We have also supported our franchisees with minimal fees and costs, which has contributed to our low hotel closure rates. Nearly all of our franchisees remain confident in operating profitably. With the lifting of restrictions on July 15 and a notable rise in occupancy rates, we expect our franchisees and developers to secure better deals in the market. This could lead to an increase in conversions from independent or local branded hotels that are struggling. Overall, we remain positive about our pipeline and growth potential. I will now pass the floor to Selina and Megan to see if they have any additional insights.

Thank you, Alex. Yes, I'd like to share some thoughts from our discussions with franchisees. We observed that our existing franchisees are currently capturing good opportunities to open more hotels, targeting different customer tastes, especially since they have overcome COVID-19 and can find more cost-effective properties with sale rents. As for our potential franchisees, they are more focused on the return on investments. They are more cautious about decoration costs, operational capabilities, customer resources, and the system efficiency, which are all related to their cost control. We believe these are all strengths of GreenTree. So that's why we have confidence that as the industry recovers, we may face more opportunities, and we can capture these opportunities. Thank you, Alex.

So Justin, regarding the third question, we understand the potential risk there and that we're trying to comply with the regulation from both countries. On the other side, we're also talking with our adviser evaluating options for us. I believe there are probably more options available for us because 2 years ago, when we first got our IPO, as everybody knows, our liquidity was limited. We only offered 10%, and our parent company held 90%, and we never really, I think, sold one share. But if there is a dual listing, then we can increase our liquidity and complete our first round and fulfill our obligations. Second, it gives the company a little bit more freedom and financial resources to explore further opportunities available in the marketplace. Additionally, we see, as you mentioned, that there may be more individual hotel availabilities in the third and fourth quarters. Some local hotel chains, smaller- to medium-sized hotel companies may be ready for joint ventures or consolidation. We have a bit more resource in that end. We are evaluating this situation, and our advisers are working on that. We are confident that we can find a solution that's satisfactory to everyone, benefiting both the company and shareholders.

Maybe just one very quick follow-up. Any color on the prebooking status for the upcoming October 1 Golden Week?

Right now, the prebooking for October 1 is a little bit less than the prebooking of last year for a couple of reasons. One is that there are ample hotels available at that time. Secondly, people are still a little concerned about the dynamics and conditions at that time. However, from the information we received, we still have strong demand in the pipeline that is very close to last year's figures. Megan and Selina, do you have anything to add?

Yes. Typically, our guests start booking hotels for October around the middle of August. We are happy to observe that the booking rate around the autumn festival and the National Day is now nearly double the normal level. This is what I can share with everyone. Thank you, Justin. Thank you, Alex.

Your next question comes from Dan Xu from Morgan Stanley.

Can you hear me?

Very clear. Thank you.

Yes. Thank you.

I have two questions. The first is a follow-up regarding competition from a different perspective. Some hotel companies have mentioned expanding into lower-tier cities, while GreenTree has a significant presence with 70% of its hotels in tier three cities and below. Are you noticing any increase in competition, or have any of these companies entered into dealings with our current or potential franchisees? My second question concerns the bad debt accrual of CNY 9.1 million. Could you provide more details about this? Is it related to the franchisee loan as well?

Regarding the competition, because I'm involved with the development on a daily to weekly basis, I can provide a clear observation there. At this moment, what we see is less competition in third and fourth-tier cities because of many constraints. Last year, competition was fierce, but many hotel companies, including some OTAs that sponsored soft brands, exited from the industry this year. We see them either closing their businesses or seriously reducing staff. So we actually see that competition has become healthier this year compared to last year. This year's main negative factor was COVID-19, but we believe that we now have a better market presence than before. Regarding the bad debt provision, in July, we typically bill our full-year system service fees and that provision for bad debt accounts for one-time yearly service fees. This is to address uncertainties concerning our franchisees' financial difficulties, which could impact their ability to pay.

Thank you, Alex. Regarding the competition in lower-tier cities, we believe that for each single market, earlier entry into these markets presents more opportunities. Additionally, management capabilities, including remote control and the quality of general managers, play a significant role. At GreenTree, we can train a team of general managers to qualify them for those cities, resulting in better performance in tier 3 and smaller cities.

Your next question is from Billy Ng from Bank of America.

I have one question. Just wonder, maybe Alex and Selina, have you noticed any change in terms of business clients and business demand? I guess, like, as you mentioned, the recovery is largely led by business travelers. Initially, there might have been a lot of pent-up demand due to many not having seen their clients for some time. But have any companies or corporates indicated that they may travel less in the medium to long term? Or have they changed the way they travel, or are they demanding lower corporate rates? Also, in terms of distribution to these clients, are there any major changes? I'm just thinking about the next 6 to 12 months and trying to see what kind of business demand will be out there eventually.

Billy, thank you so much for the question. That's a great question, applicable to China, Asia Pacific, and other regions. We are observing long-term impacts due to the short-term COVID pandemic on corporate travel trends, and associated factors drive corporate travel decision-making. We are fortunate that we have positioned our hotels in a price segment that captures hard-core travel needs, such as construction, engineering, sales, and marketing. These essential travelers must conduct business in person. Corporates are also very budget-conscious, and they have lower budgets overall and concerns regarding health and potential quarantines. However, we see strong demand in our segment, and we have achieved over 80% occupancy post-July 15 after interprovincial restrictions were lifted. The leisure travel segment will take longer to fully recover; in particular, pent-up demand for nearby suburban or weekend travel will precede the recovery of longer interprovincial leisure travel.

Yes, and Megan has some comments.

Yes. During this quarter, we expanded our cooperation with a number of travel companies to attract more corporate clients and business travelers.

Yes. Indeed, because we observed the contribution from corporate members increased by 1% every month since COVID-19. Our total contribution from individual and corporate members has exceeded 80%. It's a positive trend.

I have other questions regarding ADR. And so right now, I think we are about 15% or 17% below the level of last year in terms of ADR. Occupancy seems to have recovered quite well. But regarding ADR, can you elaborate more on what drives the ADR? Is it because there are many promotional packages out there, or are regular room rates genuinely coming down? My follow-up question on that is, how long does it take to get back to the normal level? Do we need to see like a 15% decline? Looking at other downturns, it can take a few years to return to where it was. But do you think there’s a chance to recover quickly once demand returns, or is a gradual approach more likely?

Billy, that's a great question we've studied closely. As you can see on PPT, Page 7, the numbers are interesting. We had the worst quarter in Q1, yet the ADR for Q1 dropped only 17%. In Q2, the entire industry saw an ADR drop of almost 30%. This is common for the hospitality industry as managers may not respond quickly by adjusting their ADRs to attract customers. The adjustment of ADR as a competitive tool can be slow. As we see recovery, we observe that demand is elastic; occasionally, when demand drops by about 40%, the ADR can drop 10%. Our industry struggles with this tradition of price competition, leading to pressure on ADR in Q2. However, our ADR compression is lower than the industry average. The ADR issue really poses a dilemma for us, and we hope the industry reacts. We believe, when overall occupancy approaches last year’s levels, ADR will follow suit.

Yes, during the down cycle, hotels are more likely to reduce room rates to attract guests due to supply and demand economics. Our GreenTree hotels are affected by this rule, but our ADR decreases were less than the average industry level due to a few factors. First, our individual and corporate members contribute over 80% of our room sales, leading to stable and low room rates for them. Additionally, when hotel operating costs remain high, there is limited room to adjust room rates. GreenTree's cost competitiveness allows us to reduce room rates slightly while still remaining profitable. Finally, as occupancy recovers faster, room rates may follow suit as well.

Your next question comes from Bruce Mi from UBS.

I only have one question about numbers. So could you please give us a breakdown of the RevPAR growth by city tiers and different hotel segments?

Yes, Bruce. In terms of city tiers, we observed hotels in tier 3 and smaller cities resumed faster than others in the second quarter, which we think is due mainly to two reasons. First, different from big cities whose major guests are cross-provincial business travelers, hotels in smaller cities accommodate more local and short-distance guests, who were affected the least during COVID-19. Second, impacted by new cases in mid-June, operating performance in large cities was affected. The RevPAR change in tier 3 cities was a 27% year-over-year decrease, while in tier 2 cities, it was a 42% decrease, and in tier 1 cities, it was a 50% decrease. Sure. For RevPAR growth by hotel segment, for the economy segment, year-over-year decrease was 39%. The mid-scale segment decreased by 30%, the mid-to-upscale segment decreased by 29%, and the luxury hotel segment decreased by 54%.

This concludes our question-and-answer session. I would like to turn the conference back over to Selina Yang for any closing remarks.

Thank you, operator. In closing, on behalf of the entire GreenTree management team, we thank you for your interest and participation in today's call. If you require any further information or have plans to visit us, please contact us. Thank you, everyone.

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.