H World Group Ltd Q2 FY2021 Earnings Call

Good day, and thank you for standing by. Welcome to the Huazhu Group Limited Q2 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would like to hand the conference over to your first speaker today. Jason, please go ahead.

Thank you, Karenna. Good morning, and good evening, everyone. Thanks for joining us today. Welcome to Huazhu Group's 2021 second quarter and interim earnings conference call. Joining us today is our Founder and CEO, Mr. Qi Ji; our President, Mr. Jin Hui; our Chief Digital Officer, Ms. Liu Xinxin; our CFO, Ms. Chen Hui; our Deputy CFO, Ms. Ye Fei, and Mr. Li Dong. Following their prepared remarks, management will be available to answer your questions. Before we continue, please note that the discussion today will include forward-looking statements made under the safe harbor provision of the United States Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, our results may be materially different from the views expressed today. A number of potential risks and uncertainties are outlined in our public filings with the SEC. Huazhu Group does not undertake any obligations to update any forward-looking statements, except as required by applicable laws. On the call today, we will also mention adjusted financial measures during the discussion of our performance. Reconciliation of those measures to comparable GAAP information can be found in our earnings release that was distributed yesterday. As a reminder, this conference call is being recorded. The webcast of this conference call, as well as a supplementary slide presentation is available on Huazhu Group's website.

Good morning, and good evening, everyone. Thank you for joining us today. I would like to give you an overview of our business. In the second quarter, our China RevPAR recovered to 102% of the same period of 2019, supported by strong leisure traveling demand in May, but offset by relatively weak RevPAR recovery in June due to a COVID-19 resurgence in Guangdong Province and traffic control in Beijing. Unfortunately, the Delta variant of COVID-19 was again detected in Nanjing since late July, with further spread into many other provinces and cities. The Delta variant prompted the Chinese government to impose another round of strict traveling restrictions, which seriously affected our performance in August. Our European business saw some positive trend with RevPAR recovering to 50% to 60% of 2019 levels during the summer holidays, mainly due to the continued progress of vaccination and easing restrictions. However, we remain cautious about future recovery as European governments, especially the German government, are still carefully monitoring the situation regarding the Delta variant and its potential impact. Looking ahead, uncertainties brought by the pandemic may exist for a longer-than-expected time, and we expect to be well-prepared to overcome any business turbulences in the near term. Nevertheless, in the long term, we have high confidence in China’s future economic growth and believe the upward trend of the China lodging industry remains intact. Therefore, we will implement our strategies such as further penetration of lower-tier cities, speeding up upper-midscale and upscale segments, organizational upgrades, talent acquisition, and concentrating on high-quality hotel expansions to support our sustainable growth. With that, I will turn the call to Jin Hui to update our recent business development. Thank you.

Thank you, Ji Qi. As usual, I'll discuss our recent business recovery trend in detail. For the second quarter, our RevPAR recovery shows upward trends with RevPAR in April and May recovering to 100% and 106%, respectively. However, as mentioned earlier, due to the COVID-19 resurgence in Guangdong and traffic control in Beijing since late May, our RevPAR recovery in June slowed down. If we exclude the impacts from Guangdong and Beijing, our RevPAR recovery for the remaining areas was on track in June. Unfortunately, since late July, a new wave of Delta variants of COVID-19 was detected again in Nanjing and spreading into many other cities in China. Following that, the government imposed another round of strict traveling restrictions, which negatively affected travel demand and significantly impacted our business as August is typically a peak season for travel; therefore, due to the impacts from the Delta variant and the historical high base as of August 23, our RevPAR only recovered to 46% of the 2019 level. However, we saw that the recent wave of Delta variants has been largely contained given the good prevention measures imposed by the government, and the newly confirmed cases declined significantly from the peak. For hotel development, we achieved a record high number of new signings at 1,502 for the first half of this year, an increase of nearly 50% year-over-year. At the same time, our penetration into lower-tier cities is further accelerating, with lower-tier cities accounting for over 50% of both our current hotel pipelines and new signings. Moreover, we have already penetrated over 1,000 cities as of June, including both hotels in operation and in the pipeline, having added 200 cities compared to the same period last year. However, please note that, given the travel restrictions due to the Delta variants of COVID-19 mentioned above, our recent new signings and construction progress were also negatively affected. For our upper-middle hotel segment, we will use a multi-brand strategy to further explore market opportunities. Our upper-middle hotel brand portfolio includes Crystal Orange, Intercity, Mercure, Madison, and Novotel. As of June 2021, we had a total of 404 upper-middle hotels in operation and 248 in the pipeline. We are targeting to achieve over 1,000 upper-middle hotels in operation and in the pipeline by the end of 2023. On July 9, we announced a license agreement between Steigenberger and Porsche Design Group to establish a joint hotel brand, marking another breakthrough into the upscale and luxury hotel segment globally. We are planning to open at least eight hotels in the next 10 years, allocated in prime areas of international metropolises. Similar to other international hotel brands cooperating with luxury brands, our cooperation with the Porsche Design brand will further enhance Steigenberger’s brand positioning and awareness globally. It will help us catch more opportunities in the upscale and luxury segment in the future. Along with our lower-tier cities penetration, our membership program synergies to lower-tier cities and ability on traffic generation to hotels are the most concerning factors. We are very pleased to report that our CRS contribution in lower-tier cities achieved 56%, very close to that of higher-tier cities, thus demonstrating our ability to penetrate further into the lower-tier market.

Thank you, Jin Hui. Good morning and good evening to everyone, wherever you are. Let's move on to our operational and financial review for the second quarter of 2021. Our hotel network expanded by 15% in the second quarter to 692,000 rooms compared to 599,000 rooms in the second quarter of last year. Excluding Deutsche Hospitality, the legacy Huazhu hotel network expanded by 16% year-on-year to roughly 668,000 rooms in the second quarter. For our hotel turnover in the second quarter, our total turnover grew by 98% year-on-year to RMB13 billion, mainly due to our continuous network expansion in China and the initial recovery of Deutsche Hospitality's operation, as well as the low base for both China and the European business last year. Excluding Deutsche Hospitality, the legacy Huazhu’s hotel turnover grew 95% year-on-year to RMB12.7 billion in the second quarter and recorded a 45% increase compared to the second quarter of 2019. The growth was primarily driven by the hotel network expansion under the asset-light model. Legacy Huazhu’s blended RevPAR for the second quarter grew 2% from 2019 to RMB210. The ADR in the second quarter grew by 8% to RMB255 compared to 2019, while the occupancy in the second quarter was down 5 percentage points compared to 2019, mainly caused by the COVID-19 situation, particularly the resurgence in Guangdong Province and traffic control in Beijing in June. Our legacy Deutsche Hospitality business saw initial recovery in the second quarter since the German government imposed a lockdown from last November, thanks to the continued progress of vaccination and the easing of restrictions. Our legacy Deutsche Hospitality blended RevPAR for the second quarter grew 26% to €20 compared to the second quarter of 2020. The occupancy improved by six percentage points compared to the second quarter last year, while the ADR dropped by 6% to €82. Please see our financial results. Total net revenues grew by 84% year-on-year to RMB3.6 billion in the second quarter of 2021, and excluding Deutsche Hospitality, legacy Huazhu recorded an 85% year-on-year growth to RMB3.4 billion. The revenue was slightly below our previous guidance, mainly due to the COVID-19 resurgence in Guangdong Province and traffic control in Beijing as mentioned before.

Excluding the impact from the above-mentioned areas, the revenue growth was actually in line with our previous guidance. Breaking down the revenue of the second quarter, leased and owned revenue increased by 85% year-on-year to RMB2.3 billion. Excluding Deutsche Hospitality, the leased and owned revenue of legacy Huazhu grew by 84% year-on-year to RMB2.1 billion. Net revenue from managed and franchised hotels grew by 89% to RMB1.2 billion, mainly driven by the 89% year-on-year growth of legacy Huazhu. Due to further expanding hotel networks with the asset-light model, managed and franchised revenue contribution enlarged to 36% in the second quarter compared with 35% in the second quarter of 2020 at the group level. For legacy Huazhu, the managed and franchised model also expanded to 38% in the second quarter of 2021 compared with 37% a year ago. Moving on to the cost and profitability section. In the second quarter of 2021, the reported operating income turned positive to RMB629 million compared to a loss of RMB494 million last year and a loss of RMB575 million a quarter ago, mainly due to business recovery in both China and Europe. Excluding Deutsche Hospitality, legacy Huazhu’s operating income in the second quarter of 2021 was RMB763 million compared to a loss of RMB207 million last year and a loss of RMB172 million a quarter ago. The hotel operating costs and other operating costs for the second quarter of 2021 were RMB2.8 billion, up 28% year-on-year. The increase was primarily driven by legacy Huazhu, which recorded RMB2.2 billion in hotel operating costs, indicating a 29% year-on-year growth. The increase was mainly attributable to the higher rental cost of new upscale hotels, higher hotel-level personnel costs as we rapidly grow our hotel networks, and higher depreciation and amortization costs related to opening upscale hotels and upgrading existing ones. We previously mentioned that our future expansion of upscale hotels will primarily use the asset-light model; therefore, our pre-opening costs declined by 84% year-on-year and 20% quarter-on-quarter to only RMB16 million in the second quarter of 2021. Our SG&A in the second quarter of 2021 increased by 49% year-on-year to RMB553 million, mainly driven by the increase in legacy Huazhu. Excluding Deutsche Hospitality, SG&A for Huazhu increased by 71% year-on-year to RMB423 million, mainly due to increased selling and marketing expenses resulting from revenue recovery, the increase in headcount for our business development team to support penetration into lower-tier cities, increased personnel costs for the upscale business unit, and increased IT investment. Other operating income in the second quarter of 2021 increased by 121% to RMB362 million, mainly due to €38 million in subsidies received from the German government related to the 2020 lockdown period.

Our adjusted EBITDA income turned positive to RMB1 billion compared to a loss of RMB97 million a year ago. Deutsche Hospitality's EBITDA loss in the second quarter was RMB73 million, narrowed from RMB235 million last year, mainly due to government subsidies. Excluding Deutsche Hospitality, legacy Huazhu recorded adjusted EBITDA income of RMB1.1 billion, representing a 709% growth from the second quarter of 2020. We reported adjusted net income of RMB464 million compared to a loss of RMB476 million a year ago. Excluding Deutsche Hospitality, legacy Huazhu recorded an adjusted net income of RMB579 million compared to a loss of RMB253 million in the second quarter of 2020. The non-GAAP pro forma adjustment mentioned on this page excluded unrealized gains or losses from the fair value change of equities related to some of our investments. Regarding our cash position, we further lowered our net debt to RMB4.4 billion by the end of the second quarter compared to RMB5.2 billion by the end of the first quarter, and there is no risk of breaching the financial covenants of the US$1 billion syndication loan. Our cash balance was RMB6.2 billion, and the unutilized bank facilities amounted to RMB6.8 billion. This cash and bank facilities will allow us to pay down Huazhu’s bank debt in 2021 as well as in 2022 and will also be used to weather any unforeseen circumstances.

Turning to Deutsche Hospitality updates, the recovery is heading in the right direction although the path is bumpy. Vaccination commenced in December 2020 and sped up in the second quarter of 2021. Restrictions ease especially for people who recovered from COVID-19 infection and for those who either completed their injections or have negative test results. As of August 23, about 64% of the German population has received at least one shot and 59% of the whole population was fully vaccinated. DH’s occupancy rate increased from about 19% in Q1 to 24% in Q2 and now is around 50% during the August summertime. The recovery ratio compared to 2019 is about 54% in July and 67% in August month-to-date. DH is also taking further actions to reduce costs and preserve cash, including negotiating lease waivers and streamlining overhead at both hotel and headquarters levels. The impact of extending the lockdown would be also partially offset by short-term worker allowance and also the special government subsidy of which €38 million has been successfully received and recorded in Q2 related to the 2020 lockdown. The company's cash position is sufficient, and there is another €12 million credit line available.

Concerning guidance, given the impact of COVID-19 resurgence in Guangdong and traffic control in Beijing since late May as well as Delta variant spreading from Nanjing to several cities in China recently, we have lowered our Q3 and full-year revenue guidance. For the third quarter of 2021, Huazhu expects net revenue growth in the range of 8% to 12% compared to the third quarter of 2020, and 4% to 8% excluding Deutsche Hospitality. To provide more meaningful guidance excluding the impact of COVID-19, we expect net revenue growth in the range of 12% to 16% compared to pre-COVID-19 results in the third quarter of 2019, while anticipating a net revenue reduction in the range of 3% to 7% if excluding Deutsche Hospitality. For the full year of 2021, we now expect net revenue growth to range from 29% to 33%, or from 34% to 38% if excluding Deutsche Hospitality. To provide more meaningful guidance excluding the impact of COVID-19, we expect net revenue growth in the range of 17% to 21% compared with the pre-COVID-19 results of 2019, or in the range from 2% to 6% if excluding Deutsche Hospitality. Please note that our current revenue guidance is based on the expectation that the recent Delta variant of COVID-19 resurgence can be well contained by the beginning of September. However, given the future situation remains uncertain and unpredictable, we may need to adjust our guidance accordingly. We also keep our gross opening targets of 1,600 to 1,800 hotels unchanged, but expect the signing speed of the new pipeline and the construction of new hotels in the next few months will be affected as well.

Your first question comes from the line of Tian Hou from T.H. Capital. Please ask your question.

Yes. Good morning, management. I have two questions. Will you please give us some color on the member saturation? In Q2, how many new members were added and what is your channel for member acquisition? So that is question one. Number two, regarding your Q3 guidance, what do you see in China in terms of traveling, hotel demands, as well as COVID? It seems like COVID here and there always pops up. So I just wonder how much do you already see in your guidance? What's the base for your Q3 guidance – domestic guidance? Thank you.

Let me answer the first question. In Q2, the number of new memberships recruited was 6 million. We continue to utilize best practices to develop member recruitment, such as hotel-based recruitment, and also with local sales teams, corporate sales teams, and innovative partnerships through B2B and B2C channels like Alipay and WeChat.

For our Q3 revenue guidance, we acknowledge that the Chinese government has imposed very strict travel restrictions and control measures, significantly affecting our business performance. For the Q3 guidance and full-year guidance, we expect the RevPAR recovery for the third quarter to be around 70% to 75% of the 2019 level and 90% to 95% in the fourth quarter of 2019. As I mentioned earlier, our current revenue guidance is primarily based on the expectation that there will be no massive COVID-19 resurgence in the remainder of the year.

Thank you. That’s all my questions.

Your next question comes from the line of Praveen Choudhary from Morgan Stanley. Please ask your question.

Hi. Thanks so much for taking my call. I have two questions. The first one is about lower-tier cities. I just wanted to understand what challenges you are facing in lower-tier cities. It seems like it’s going very well based on the pipeline, but could you elaborate on any challenges facing you in the future? And the second question relates to the upscale strategy. I wanted to understand what portion of upscale hotel openings would be on leased and operating versus franchised and managed. The reason for asking this is to understand how long it will take before you can have a good size of these hotels and what costs you would incur. I remember previously that you had significant pre-opening expenses. Should we anticipate similar expenses going forward? Thank you.

For lower-tier cities, penetration is progressing well. However, we face challenges, particularly in local sales and aligning with local demand. We are continuously adjusting strategies in this area, especially focusing on improving local sales teams and building localized staff support to penetrate further. For Huazhu, we divide the hotel segment into four categories: economic, middle scale, upper-middle scale, and upscale. Within these segments, we see the most attractive opportunities in the upper-middle and upscale markets. For upscale, the construction and new hotel development is not driven by market dynamics; we are focusing on partnerships and brand consolidation, with a preference for a franchised management contract instead of leasing.

Your next question comes from the line of Yulin Zhong from Haitong International. Please ask your question.

Hello. Good morning, management. Thank you for taking my question. My question is regarding the Deutsche Hospitality hotel. I was wondering to what extent you can enhance the profile of the Deutsche Hospitality hotel side through digitalization, as you just mentioned. Thank you.

For the Deutsche Hospitality program, we have fulfilled one global digital platform ready and have launched a massive rollout across all hotels. This digital platform focuses not only on business operational efficiency but also on loyalty and CRS contribution. We aim to improve CRS contribution from the current 1% to around 20% in the coming year. Additionally, we pay considerable attention to the global loyalty platform, planning to officially launch the new global loyalty program called H Rewards in October.

I just wanted to add on Ji Qi’s point that it's still early to determine the margin improvement from digitalization, as we're in the first phase of setting up infrastructure and preparing for rollout. The company is focused on refining brand operations and bringing the brand back to Asia. However, introducing digital equipment and solutions can strongly support the company in streamlining its organization, targeting a reduction of 20% to 30% of staff through our multiple-year program, which should enhance margins significantly.

Hi. Thanks for the presentation. I have two questions. I remember in the first quarter, you mentioned something related to the cleanup of the hotel, particularly regarding Elan and some of the lower branded hotels. Could you provide an update on that? It’s great to see that you maintain your full-year growth guidance at 1.6 to 1.8. I wanted to get a sense of how the trend looks, perhaps quarter-to-date in the third quarter, and your confidence in achieving that target. What assumptions are you applying to reach that guidance? That's the first question. The second question refers to your forward guidance and development guidance, excluding or not excluding Deutsche Hospitality. It seems you are expecting the revenue for Deutsche Hospitality to jump to around RMB600 million in the fourth quarter. Would you expect your EBITDA to be breaking even for your Deutsche Hospitality operation individually at that level?

For the Elan brand, we recognize it as our softer brand and are continuously engaged in quality control and eliminating unqualified Elan hotels from operations and pipeline. For our growth outlook, we remain confident in our guidance for new hotel openings; however, the performance of our properties will indeed depend on the variable conditions such as COVID-19 trends.

Regarding the Deutsche Hospitality revenue queries, we remain generally positive about occupancy improvement in the fourth quarter. However, we are cautious yet optimistic due to potential fourth-wave risks related to COVID-19. While the revenue for the fourth quarter will likely be the highest among all quarters, I don’t think we can expect to reach breakeven yet. The company is working diligently towards obtaining further governmental subsidies related to the 2021 lockdown to assist.

Your next question comes from the line of Bruce Mi from UBS. Please ask your question.

Hi, management. Thanks for taking my question. I have two small questions. The first one is, as you mentioned, one of the challenges while penetrating into lower-tier cities is to meet different franchisees’ brand demands. Currently, how much of the hotels in the pipeline and new signs in lower-tier cities come from core brands like HanTing and JI Hotel, and how much from soft brands? My second question is, how does the take rate in lower-tier cities compare with that in tier 1 and tier 2 cities for the same brand?

In our current lower-tier city penetration, the new signings from JI Hotel and HanTing brands still account for roughly 70% to 75% of the new signings—other brands such as Starway, Orange, and Ni Hao are also progressing well. Regarding the take rate for HanTing and JI Hotel brands, the rates in lower-tier cities are very similar to those in higher-tier cities, demonstrating our CRS contribution in lower-tier cities closely resembles that of higher-tier cities. Thank you, everyone, for taking the time to join us today. We look forward to connecting with you again in the upcoming quarter. Thank you and goodbye.

This concludes today's conference call. Thank you for participating. You may now disconnect.