Earnings Call Transcript - GHG Q1 2020

Operator, Operator

Good day and welcome to the GreenTree Hospitality Group Ltd.’s First Quarter 2020 Financial Results Release Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note that this event is being recorded. I would now like to turn the conference over to Rene Vanguestaine of Christensen GreenTree Investor Relations firm. Please go ahead, sir.

Rene Vanguestaine, Investor Relations

Thank you, Chuck. 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 today to the same IR website. On the call today from GreenTree are Mr. Alex Xu, Chairman and Chief Executive Officer; Ms. Selina Yang, Chief Financial Officer; Ms. Megan Huang, Director of IT Department; and Mr. Nicky Zheng, IR Manager. Mr. Xu will present the company's first quarter 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 which follows. 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 terminologies 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. Future 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 conference 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.

Alex Xu, CEO

Thank you, Rene, and thanks everyone for joining our first quarter earnings call today. Let's start with slide five. In the first quarter, our operating performance was severely impacted by COVID-19. Our blended ADR decreased 7.8% year-over-year to RMB 150. Our occupancy rate dropped to 47.3%, and RevPAR decreased 44.1% to RMB 71. Nonetheless, we continued to expand our market presence across China. During the first quarter, we opened 62 hotels, mainly in the first part of January 2020, and we ended the quarter with 1,025 hotels in our pipeline, and that is up 113.1% year-over-year. By the end of the quarter, we had grown our geographic coverage to 342 cities across China, with 3,998 hotels in operation, up 41.3% over the prior year. Total revenues were RMB 157.4 million, a 33.1% decrease compared to the first quarter of 2019. Gross profit decreased 56.4% to RMB 67.6 million. Non-GAAP adjusted EBITDA decreased 64.5% to RMB 47.6 million, and the core net income per ADS, that is basic and diluted non-GAAP decreased 70.3% to RMB 0.27. Let's now turn to slide seven for an update on the impact of COVID-19. Thanks to the government's efforts, the outbreak has largely come under control in China. Inevitably, our operating performance declined due to the lockdown of a number of cities, business closures, and travel restrictions imposed by governments around China. However, GreenTree's overall performance was better than the average performance across the hospitality industry in China, due to the strong dedication and hard work of our staff, franchisees, and partners in the food and beverages business as well as our strong positioning in Tier 3 and the smaller cities. Now, please turn to slide eight. The COVID-19 outbreak created new needs, which we together with our franchisees at GreenTree answered immediately. We responded promptly to the government's call and provided rooms to house medical staff, volunteers, and travelers that needed to be quarantined. Anticipating the resumption of the business, we worked with our corporate clients to provide quarantine rooms for workers who were returning to work. We provided fee waivers and other meaningful financial support to our franchisees, and we implemented new precautionary measures to reinforce our already stringent health, safety, and hygiene standards and protocols. With this assistance from GreenTree, our franchisees have gradually managed to resume business operations, resulting in our occupancy rate rebounding and exceeding 65% on average in the second half of May, up from a low of 21.5% at the end of January. Since March 9, our individual or corporate members have accounted for more than 80% of all of our guests. Despite these encouraging trends, we expect revenues for our second quarter to be down 18% to 23% year-over-year. I cannot thank enough all our employees, franchisees, and guests, as well as the medical professionals, police, firefighters, and community leaders for their support and dedication in helping us resume our business rapidly. Despite these extremely challenging times, we are well-positioned to deliver our multiple missions: to serve our guests, support our franchisees and employees, and create long-term, sustainable growth for our shareholders. I will now pass the call over to Megan Huang, who is also in charge of our sales and marketing. Megan, please go ahead.

Megan Huang, Director of IT Department

Thank you, Alex. Moving to slide 10, at the end of this third quarter, we had 3,998 hotels in operation, 41.3% higher than a year ago. 35 of these hotels were leased and operated, or L&O hotels, and 3,963 were Franchise and Managed, or F&M hotels. The mid-scale segment remains the core of our business with almost 64.6% of all our hotels. Last year, we expanded more into both the higher end and economy segment of the market. As a result, by the end of this quarter, the number of hotels in the mid-to-upscale and luxury segments increased to 7.3% of the total portfolio, and the economy segment grew to 28.1%. 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 located in these cities at the end of this first quarter. Industry data, such as STR, indicates that hotels in these cities are recovering faster and are performing better than hotels in Tier 1 and Tier 2 cities. On slide 11, you can see that we opened 62 hotels compared to 102 in the first quarter of 2019, a 39.2% drop; 7 of these were in the mid-to-upscale segment; 37 in the mid-scale segment, and 18 in the economy segment; 3 were in Tier 1 cities; 13 in Tier 2 cities, and the remaining 46 were in Tier 3 and smaller cities in China. Meanwhile, we closed 21 hotels; 5 due to brand upgrade; 8 due to non-compliance with our brand and operating standards; and 8 due to property-related issues. So net-net, we added 41 hotels to our portfolio in the first quarter. Slide 12 shows the growth in our pipeline of new hotels. Our pipeline increased from 949 on December 31, 2019, to 1,025 on March 31, 2020. Around 39% of these hotels are in the mid-scale segment, about 36% in the economy sector, and around 25% in the mid-to-upscale segment. Slide 14 summarizes the impact of COVID-19 on our first-quarter operating performance. Our F&M Hotels ADR decreased 7.6% to RMB 149. Occupancy rate dipped from 78.4% to 47.7%, and the RevPAR decreased 43.8% to RMB 71. While our L&O Hotels ADR decreased 15.4% to 169, occupancy rate dipped from 59.6% to 32.7%, and the RevPAR decreased 53.6% to RMB 55. Slide 15 shows the quarterly RevPAR change. As you can see, RevPAR for our L&O Hotels decreased 53.6% year-over-year to RMB 55, and the RevPAR for our F&M hotels decreased 43.8% to RMB 71.

Selina Yang, CFO

Thank you, Megan. Please turn to slide 17. Total revenues decreased 33.1% year-over-year to RMB 157.4 million. Total revenue from F&M Hotels decreased to 32.6% to RMB 123.6 million, while total revenue from L&O Hotels decreased 34.8% to RMB 33.8 million. The decrease was almost entirely due to the impact of COVID-19, which resulted in declined RevPAR, cancellations, closures in compliance with local government requirements, delays in new hotel openings, as well as partial reductions and extensions of net income. In support of our franchisees, from February 1st to March 31st, we reduced both franchisee management fees and central reservation fees by 50%. Slide 18 shows that hotel operating costs were RMB 89.8 million, up 12.2% year-over-year. This increased cost was mainly attributable to higher depreciation and amortization and the consolidation of Argyle and Urban. Excluding Argyle and Urban, hotel operating costs decreased 3.9%, which was primarily due to the decrease in salaries of regional general managers and a decrease in utilities, consumables, food, and beverage costs that resulted from the declined occupancy rate. Selling and marketing expenses were RMB 17.8 million, a decrease of 27.7% year-over-year. The decrease was mainly attributable to decreases in advertising, travel, and meals because of the measures taken to control the spread of COVID-19, including the lockdown of certain cities, business closures, and restrictions on travel. General and administrative expenses were RMB 28.7 million, up 11.7% year-over-year. The increase was primarily attributable to increased legal and accounting consulting fees and the consolidation of expenses from Argyle and Urban. Excluding Argyle and Urban, G&A expenses decreased by 15.5%, mainly due to a decrease in staff-related costs and compensation expenses. Overall, total operating costs and expenses grew 5.4% year-over-year to RMB 107.5 million. Excluding Argyle and Urban, total operating costs and expenses decreased 11.0% compared with one year ago. On Slide 19, you’ll see that gross profit decreased by 56.4% year-over-year to RMB 67.6 million. Gross margin decreased from 66% to 43%. Net income decreased from 110.6% to RMB 14.1 million, and net margin decreased from 56.9% to negative 9%. These year-over-year decreases were primarily due to the impact of COVID-19. On Slide 20, you can see that adjusted EBITDA decreased 64.5% year-over-year to RMB 47.6 million. Adjusted EBITDA margin decreased to 30.2%. Core net income decreased 69.9% to RMB 27.7 million, and core net margin was 17.6%. Please turn to Slide 21; net income per ADS, basic and diluted, increased from negative RMB 0.11, that's equal to negative US$0.02. Core net income per ADS, basic and diluted non-GAAP decreased by 70.3% to RMB 1.27, equal to $0.04. Let’s now look at slide 22. Our operating net cash outflow was RMB 48.4 million as a result of an operation net income loss caused by COVID-19. As of March 31, 2020, we have cash and cash equivalents of RMB 1.6 billion as compared to RMB 1.8 billion as of December 31, 2019, primarily due to loans to franchisees, loan losses from the investment in equity securities, and investments to upgrade hotel decorations. The cash and cash equivalents provide us with ample resources as we continue to evaluate potential investment and support our franchisees. Our long-term top-region collaborations with several banks in China and our strong financial provision operational performance have allowed us to obtain unutilized bank facilities of RMB 330 million. On slide 23, as Alex mentioned, COVID-19 had a significant impact on our business results. As a result, we expect revenues to decline by 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.

Operator, Operator

Thank you. We will now begin the question-and-answer session. And our first question will come from Justin Kwok with Goldman Sachs. Please go ahead.

Justin Kwok, Analyst

Hi, morning, Alex and team. Thanks for taking my question. Perhaps, I'll start with two questions, more broadly. One is on the M&A side. I think, as you've just mentioned, immediately you got RMB 1.6 billion worth of cash and cash equivalents now. What are you seeing in the market post-COVID-19? Are you actually seeing more opportunities coming out or not? Because I think when I talked to a lot of the industry participants, it seems that this time around the disruption was pretty short and then there was still quite ample liquidity, so they are not seeing a lot of deals happening? So, that's the first one. And the second one regarding your revenue growth guidance for the second quarter, can I get a sense on what broadly you are assuming in terms of your occupancy level, in terms of your room rate level, and also are you assuming any further discount or help to the franchisees through the franchise fees cuts or rebates as well? Thank you.

Alex Xu, CEO

Thanks, Justin. Selina, I'll address the two questions and you can add any additional comments. Justin, those are excellent questions. In terms of the M&A landscape since the start of COVID-19, various measures have been implemented by the government, companies, and employees as well as hotel owners. Most hotel companies are currently managing to withstand the shock. Although the financial performance of the hotel industry has been significantly impacted, it takes time for companies to recognize that forming a strategic partnership with GreenTree would benefit their hotel owners. We have received interest from certain small and medium-sized and regional segments regarding potential strategic investments. We expect that by the third and fourth quarters, there will be more opportunities due to the rapid recovery, although we will need to see just how quickly that recovery progresses. Right now, our occupancy recovery, starting in the second half of May, has reached 65%, which is somewhat lower than industry expectations. Overall, the industry is recovering a bit more slowly than GreenTree. Thus, we anticipate that M&A opportunities will increase in the latter half of the year, and we will be ready to assess them. GreenTree has consistently sought to create win-win situations for all parties involved and aims to leverage this situation to benefit everyone. This explains why we have accessed these credit lines, and we plan to secure more from our lenders if necessary. Regarding your second question about revenue coverage in the second quarter, our revenue comprises several components: amortized income from hotel openings, system fees, and franchise fees. We have set a range of 18% to 23%, contingent on the recovery pace through June. The government is actively facilitating business recovery, so our projections depend on how quickly things rebound in June. We expect RevPAR to decline by about 20% to 30% compared to Q2 2019, or roughly 25% either way. Selina can correct me if I am mistaken. We anticipate that the recovery in the third quarter will surpass that of the second quarter. Currently, we do not foresee the need to reduce franchise, system, or regulatory fees. However, if there is another downturn or setback, we are prepared to provide support to our franchisees. At this time, we don't see a pressing need for cuts other than potentially continuing to offer financial assistance to franchisees looking to open more hotels during this period, as market capital is not as readily available as before.

Selina Yang, CFO

I think yes. Regarding Justin's question, I want to comment that we observed our operational performance has resumed since the middle of May. I mean they resumed more quickly than ever before. As we have discussed, our RevPAR decrease in the first quarter was 44%. Now we observe our decrease in RevPAR was about 30% to 35%. If everything goes smoothly, then we're likely to see the decrease in the RevPAR narrow in the coming second quarter. Thank you.

Justin Kwok, Analyst

Thanks both. May I just have one more question? Obviously, the current discussion on ADR relisting or delisting to the Hong Kong market is something very hot in the market in a way. How would management see this in terms of the opportunities or in terms of the considerations that you are looking at? If you can just hopefully provide some overall feedback?

Alex Xu, CEO

Sure, Justin. I will also address this question. We take all risk factors very seriously because our mission is to protect the financial health of our franchisees and maintain a stable platform for our employees while ensuring long-term stable returns for our shareholders. The recent HFCAA initiative by the Senate has raised significant concerns for us. We are uncertain about its potential impact, the speed of implementation, or if it will be implemented at all. However, we have already engaged our adviser to analyze the situation under 19C to prepare for securing an alternative, essentially a backup plan, to better manage risks associated with this potential legislation. We are committed to safeguarding our shareholders' long-term interests and will keep our investors updated on our progress.

Operator, Operator

And our next question will come from Praveen Choudhary with Morgan Stanley. Please go ahead.

Praveen Choudhary, Analyst

Thank you very much for taking my question. This is Praveen. Two questions for me, Alex and Selina. The first one is, I'm trying to understand the demand side of the equation. There are two parts to that question. One is in the new normal considering the social distancing, what part of the business is not yet coming back? For example, leisure probably is coming back slower. I'm just trying to understand whether it will come back at all or if it will not come back, at least in Q3 or Q4 this year? What percentage of your business comes from that segment? The second related question is, what you mentioned that 80% of your customers were members. I wanted to understand what percentage of that was corporate versus individual? And then I have a third question, which is not related to demand, which is about the equity portfolio, which has seen some losses in Q1, which is understandable. But I just wanted to know whether you have either bought new shares or sold any of those existing shares? Thank you.

Alex Xu, CEO

Praveen, thank you so much for those two wonderful questions. I will take the first part, and Selina and Megan, you guys can complete the supplement. Regarding the demand side, we are particularly concerned about the long-term impact of COVID-19 on leisure and group meetings to conventions, because conventions and leisure provide strong support during certain months for the entire hospitality industry. For the time being, I believe the companies are concerned about the risk to employees, and so are we. So, in terms of conventions, large group gatherings, and long-distance domestic travelers, Praveen, we think those will come back slowly. It also depends on our government’s initiatives, as Chinese business communities can be mobilized to do certain things. However, as a worldwide observation, we see that travelers are not quickly coming back. The sectors that are impacted the most are not the main focus of our business. Our business always has been focused on providing essential services to business travelers. They include traveling medical professionals, key logistics suppliers, engineers, and key support people. So, those guests are the types that we see right now, and we are also monitoring our high-end hotels and how to solve the lack of group reservations. Until we have either an effective vaccine or some kind of remedy, we believe that demand will be subdued. The leisure travel will come back slower than expected. Regarding the 80% you mentioned, our individual and corporate membership breakdown is more than 50-60% from local corporate and then 30-40% are individual members. While they also travel for business, more and more toward the latter part of May, I think we see a half and half balance. We are optimistic as this strategy has paid off; our business is well positioned to cater to these groups. Regarding the equity portfolio, we only invest in shares that we report to our shareholders. The key strategic positions we have include SBC and some investments in leading hotel groups. We have not made changes; we neither bought nor sold shares. We will likely see a rebound in the second quarter.

Selina Yang, CFO

Thank you, Alex. We are also observing that our contributions from property members and individual members are increasing in the second quarter. Comparing their contribution from the first quarter to May and April, we can see that the percentage of our individual members increased by 5%, and the percentage of corporate members increased by 2%, while the percentage from OTA decreased by nearly 2%. Thank you.

Operator, Operator

And our next question will come from Jisheng Liu with CLSA. Please go ahead.

Jisheng Liu, Analyst

Hey, hi. Good morning and good evening, Alex, Selina and Megan and Nicky for taking my question. I have maybe two to three questions. I will go maybe one by one. Number one is about hotel closures. In the first quarter of 2020, we recorded even fewer hotel closures than in the first quarter of 2019 or any quarters previously. I was trying to understand if we anticipate more hotel closures in the quarters to come, given the COVID situation? And maybe there are more to come that will impact our revenue going forward? I’d like some clarifications on this. Many thanks.

Alex Xu, CEO

Okay. Selina, I remember we had the closure of about one-third of the hotels due to upgrades, which is why we had a renewal. The hotel closures occurring primarily due to non-compliance and property lease expirations. Overall, we have not seen a major trend of more closures in the horizon. If any major closures occur, it will likely be in the second quarter. Many of the hotel closures we see are expiration of leases and those unable to maintain their hotel standards due to cash needs. However, we don’t expect large numbers of closures moving forward. Selina, do you have anything to add?

Selina Yang, CFO

No. You have explained very clearly. Thank you.

Alex Xu, CEO

We don’t expect any significant closures, and we continuously support our franchisees. We've worked hard through COVID-19 to ensure this.

Jisheng Liu, Analyst

Thanks, Alex and Selina. My second question is on the general ADR trend. We've seen some data indicating that in Tier 1 cities, for example, the general ADR decline year-over-year has been larger than it was in March. I'm wondering if Tier 3 to 4 cities have experienced a similar trend, or whether we've seen a less impact there? As presented, we have recorded much less than industry ADR decline in the first quarter. So, I'm curious if we expect similar resilience in the quarters to come.

Selina Yang, CFO

Sure. Thank you, Jisheng, for the question. Just like you said, we have observed the year-over-year decrease of ADR in Tier 1 cities has not been good. We observed a similar trend; the year-over-year decrease of ADR in Tier 3 cities was better than that of the Tier 1 cities. If we compare performance in Tier 1, Tier 2, and Tier 3 cities, the ADR decrease in Tier 3 cities was less than that of Tier 2 and was less than that of Tier 1.

Alex Xu, CEO

To add to that, Jisheng, the Tier 3 cities have many local travelers that are in small groups, while Tier 1 cities lack those key drivers, especially as international tourism remains low. Hence, the Tier 1 cities are facing a sharper drop in both ADR and occupancy rates. However, we hope to see improvements in both areas soon.

Jisheng Liu, Analyst

Thank you. My last question is about government subsidies. In the first quarter, I noticed you've already reported some government subsidies at the adjusted EBITDA level. Were these related to requisition hotels during the COVID peak outbreak or not? If not, how many hotels were requisitioned in the first quarter? And what estimates do we have for subsidies in the second and third quarters? Will they be similar to what we have seen in the first quarter?

Selina Yang, CFO

Hello. Yes, the subsidies were mainly attributable to tax subsidiaries coming from the government. There has been nearly 3% of our hotels requisitioned by the government, although now nearly all our hotels are open.

Alex Xu, CEO

Jisheng, one of the factors you’re asking about are primarily some payroll-related taxes, which is part of the reduction in tax that came from the government.

Jisheng Liu, Analyst

Thank you. So, just a quick follow-up on this. If the government subsidy in the first quarter was not at all related to requisition hotels, would the future requisition hotel subsidies, accounting-wise, be recorded in revenue or simply below the line?

Alex Xu, CEO

We will record income as revenue if we receive it. We do not specifically record the subsidies from the government.

Jisheng Liu, Analyst

Yeah, that's very clear. Thank you for answering my questions.

Alex Xu, CEO

Great. Thank you.

Operator, Operator

And our next question will come from Bruce Mai with UBS. Please go ahead.

Unidentified Analyst, Analyst

Good morning. Thanks, Alex, Selina and Megan for taking my questions. I just have one small question. Could you please share with us about your hotel decline for this year and next year? And also could you give us a rough breakdown by city tiers and hotel segments? Thanks.

Alex Xu, CEO

So, Bruce, I'd say we have a strong pipeline historically right now, a record pipeline of more than 1,025. Even in the first quarter in light of COVID, we still developed more than 100 hotels; we opened 62. We plan to open initially 700 this year. However, we understand that we are sensitive to the concerns of our franchisees regarding occupancy and demand in the second quarter. We are careful about encouraging openings. Originally, we expected to develop about 700, but we may come short by about 100 if we can’t catch up, so we are tentatively estimating 600 plus minus. We plan to continue our organic development approach, focusing on opportunities that arise without compromising our principles. In terms of city tiers, we continue to see significant growth across all segments, aiming to keep our portfolio diverse. We also anticipate that next year will be more robust as our operational divisions, like Argyle and Urban, are actively working on accelerating openings.

Operator, Operator

And our next question will come from Lydia Ling with Citibank. Please go ahead.

Lydia Ling, Analyst

Hi, management. Thanks for taking my questions. My first question, I want to follow-up on the store opening. Can we get some idea on the store opening pace so far for the second quarter to date? We also want to get a better insight into how our franchisees are feeling as we recover versus the first quarter. What kind of further support can we provide to them? My second question goes toward consolidation in the industry. We expect more consolidation to occur in the second quarter. I think larger platforms in the hotel segment will be keen on attracting independent players for consolidation. Are there any plans from our side to provide more attractive terms to those independent players to join our team? Thank you.

Alex Xu, CEO

Selina, I'll pick up the questions, and then you supplement. Lydia, thank you for those questions. For the openings in the second quarter, I would estimate in the range of 100 to 150 openings, as we are mindful to ensure that our franchisees feel comfortable and prepared. Regarding franchisee sentiment, while it’s not as bullish as before, we have seen that our GreenTree franchisees are in much better financial conditions due to our support in the past two years. Many are exploring opportunities, actively signing leases or purchase agreements. While sentiment overall is not as bright, we are better positioned than many competitors. Regarding consolidation, there will definitely be interest in smaller to medium players. We anticipate that many smaller hotel chains may seek partnerships. We ensure that consolidation occurs responsibly and aligns with our core values. We strive for quality and consistency among management teams during these processes. If you have leads, feel free to suggest potential candidates. Those are my answers; Selina can follow up.

Selina Yang, CFO

No further comments. Thank you, Alex.

Operator, Operator

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

Selina Yang, CFO

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 any interest in visiting us in China, please don't hesitate to contact us. Thank you all.

Operator, Operator

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

Alex Xu, CEO

Thank you, operator. Thank you, Chuck.