H World Group Ltd Q1 FY2022 Earnings Call

Good day and thank you for standing by. Welcome to Huazhu Group Limited First Quarter 2022 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. And now, I’d like to hand the conference over to Mr. Jason Chen, IR Director of Huazhu Group Limited. Thank you, please go ahead sir.

Thank you, Amber. Good morning and good evening everyone. Thanks for joining us today. Welcome to Huazhu Group's first quarter 2022 earnings conference call. Joining us today is our Founder and Chairman, Mr. Ji Qi; our CEO, Mr. Jin Hui; our President, Ms. Liu Xinxin; our CFO, Ms. Chen Hui; our Deputy CFO, Ms. Ye Fei; and our CEO of International Business, Ms. He Jihong. 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 provisions 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 the 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 supplementary slide presentation is available on Huazhu Group's website at ir.huazhu.com. With that, now I will turn the call over to Mr. Qi Ji.

Good morning and good evening, everyone. And you may have noticed that the Omicron variant has been spreading widely in China in the past two to three months. The pandemic came suddenly and lasted a very long period this time. Its development trend and the impacts are far over people's expectations. The pandemic outbreak and the tactical control once again brought huge challenges and difficulties to our China business operations. The first thing we should consider is how to overcome the current difficulties on the premise of ensuring the safety and health of our customers and the employees, as well as adhering to government requirements. We initiated cost optimization, rental waiving negotiations, and marketing and sales strategic adjustments to navigate this period. More importantly, our franchisees are facing more difficulty and pressure due to the pandemic. As they are our important hotel partners, we need to provide support to help them through this tough period together. Obviously, we are currently experiencing a long and cold winter. However, I always believe that every cold winter will bring a golden harvest. Over the past decade, Huazhu faced many crises that made us stronger after each one. Additionally, every coin has two sides. Although the winter is cold, it provides us a good opportunity to review what we have done and rethink what we should do in the future. First, we need to build our long-term core competency by focusing the company’s limited resources on core strategies. Furthermore, we should take this opportunity to improve our internal skills through culture building, organizational upgrades, talent training, customer experience improvements, technology upgrades, and product development. By doing so, we can be well prepared for the warmer season after the current cold winter. The impacts and uncertainties from the pandemic, war, and global macro factors are unavoidable. We need to remain focused on our belief that, in the long term, we will center on customers, franchisees, and employees to implement our sustainable quality growth strategy and build our capability to navigate through economic cycles in the long run. With that, I will turn the call to Jin Hui to discuss our recent developments in detail.

Our RevPAR recovery was on track and in an upward trend in January and February. However, it was seriously interrupted since March. The recovery declined to only 67% of the 2019 level and further lowered to 53% in April. May saw a slightly better RevPAR recovery than April with the month-to-date RevPAR recovering to roughly 58% of the 2019 level. The RevPAR numbers mentioned only reflect our hotels in normal operations. If we included those hotels in requisition, our April and May RevPAR recovery would be roughly at 65% for both months, indicating roughly 7 to 12 percentage points better performance than hotels in normal operations. Since May, we have seen the normal hotels gradually improving in terms of performance, and the impacts of the requisition are diminishing. Under the strict COVID prohibition control, we are implementing several mitigation measures to overcome the difficulties. Firstly, we have started our reinforcement of cost control for domestic operations. The cost control will focus on three specific aspects: streamlining headcounts and expenses, concentrating resources on key strategies while reducing unnecessary expenditures, and negotiating lease waivers or reductions due to the pandemic. We have formed a special team internally to conduct lease waiver or reduction negotiations for both our leased and owned hotels as well as managed and franchised hotels to reduce operational costs. As one of the leading companies in the industry, we are also undertaking corporate social responsibilities during the pandemic by providing many requisition hotels. Since early March, our number of hotels in requisition increased massively from just over 200 to the peak of more than 1,800 hotels. As the pandemic is gradually controlled recently, our number of hotels in requisition has started to decline from the peak in April. From another perspective, it is a win-win choice for us to provide hotels for requisition purposes during the pandemic period. Given the normal business and leisure travel demands declined sharply due to traffic restrictions during the pandemic, the requisition helped our hotels achieve a relatively better occupancy rate and support operational performance. Despite the pandemic impacts, we are striving to capture any sales opportunities during this period. Firstly, we actively seek COVID-related accommodation needs such as requisition hotels as mentioned earlier. We actively seek any accommodation needs of quarantine medical teams, delivery riders, governmental officers, and corporates for leased, owned, managed, and franchised hotels. For example, in Shanghai, our hotels served over 9,500 medical staff and over 5,000 delivery riders during the lockdown period. Additionally, we initiated several creative product packages to meet special needs during the pandemic, such as online class hotel rooms and 'work from hotels.' Secondly, we adjusted our sales strategy from previously brand-based to a new regional-based approach to unify our sales and marketing strategy. By doing so, we can more accurately target strong local demands for specific regions, especially those areas less impacted by the pandemic. Lastly, we extended expiration dates of our members' privileges and points and maintained their member status to further enhance loyalty. Simultaneously, we are actively cooperating with external traffic platforms and participating in various marketing campaigns organized by different OTA platforms to capture recovery opportunities post-COVID through pre-sales activities. The pandemic shutdown resulted in a physical shutdown of our headquarters in Shanghai. However, we maintained high working and operational efficiency through remote work. The H-Tone, our internal information platform, provides a solid foundation and connector for our hotel staff, headquarters employees, franchisees, and suppliers for efficient remote work. For example, our headquarters employees in Shanghai hosted over 10,000 online meetings, sent and received over 250,000 daily messages, and utilized over 7,000 online documents per day on the H-Tone platform. The pandemic and subsequent lockdown demonstrated our capability for digitalization.

Thank you, Jin Hui. Good morning or good evening to everyone, wherever you are. Let's move on to our operational and financial review for the first quarter of 2022. A shown on Slide 17, our hotel network expanded by 15% in the first quarter of 2022 to 765,000 rooms compared to 663,000 rooms in Q1 2021. Excluding DH, Legacy-Huazhu's hotel network expanded by 16% year-on-year to roughly 740,000 rooms, with midscale hotels contributing most of the growth. In our hotel turnover for the first quarter of 2022, total hotel revenue grew 16% year-on-year to RMB 9.5 billion, mainly due to continuous network expansion in China and a strong business recovery of our European business. Legacy-Huazhu's hotel turnover grew 11% year-on-year to RMB 8.8 billion in the quarter, and DH recorded a 70% increase to a turnover of RMB 683 million. Moving on to Slide 18, the blended RevPAR of Legacy-Huazhu declined by 25% compared to 2019. The ADR in Q1 was up by 1.2% compared to the 2019 level at RMB 224, mainly driven by the mix change from midscale and upper midscale hotels. However, the occupancy in Q1 is 21 percentage points lower compared to 2019 due to the impact of the Omicron variant outbreaks in mid-March. Moving to Slide 19, Legacy DH business has also faced impacts from the Omicron variant at the beginning of this year. However, due to the reopening of Germany since mid-February, its RevPAR recovery has accelerated since then. Therefore, DH's blended RevPAR for Q1 2022 grew 158% to €33 compared to Q1 2021. The occupancy improved by 19 percentage points compared to Q1 2021, and the ADR improved by 28% to €88. Now please see our financial results on Slide 20. Total revenue grew by 15% year-over-year to RMB 2.7 billion in Q1 2022, mainly driven by 165% revenue growth of Legacy DH in Q1 2022. Excluding DH, Legacy-Huazhu recorded a 4.6% year-over-year revenue growth to RMB 2.3 billion. Revenue was in line with our previous guidance. Leased and owned revenue of Legacy-Huazhu was flat at RMB 1.3 billion due to the large Omicron variant outbreak since March. Net revenue from managed and franchised hotels grew by 9% to RMB 974 million, primarily driven by the growth of over 1,100 managed hotels. The revenue growth of DH is mainly driven by the recovery of leased hotels. Therefore, overall, the Group's managed and franchised revenue contribution temporarily shrank to 37% in Q1 2022, compared with 38% in Q1 2021 at the Group level. However, for Legacy-Huazhu, due to further expansion with the SLI model, the managed and franchised revenue contribution further expanded to 43%, compared to 41% a year ago. Now let's move to the cost and profitability section on Slide 21. In Q1 2022, the reported operating loss was RMB 708 million compared to a loss of RMB 575 million last year and a positive RMB 39 million a quarter ago, mainly due to the weaker performance of the China business. Excluding DH, Legacy-Huazhu’s operating loss in Q1 2022 was RMB 416 million compared to RMB 172 million last year and a positive income of RMB 60 million a quarter ago. The hotel operating costs for Q1 2022 were RMB 2.8 billion, an increase of 14% year-over-year. For Legacy-Huazhu, it recorded RMB 2.3 billion in hotel operating costs, indicating an 11.7% year-over-year growth. The increase was mainly attributed to higher rental costs of newly opened leased hotels, higher personnel costs as we continue to grow our hotel network, and higher depreciation and amortization costs related to upscale hotel openings and the upgrading of existing hotels, alongside the consolidation impact of the CitiGO acquisition. For Legacy DH, it recorded RMB 558 million in hotel operating costs, indicating a 25% year-over-year growth due mainly to the increase in variable costs aligned with business recovery. Our reopening costs increased by 24% year-over-year to RMB 26 million in Q1 2022 from RMB 21 million last year. While the absolute dollar amount of preopening costs remains low, our future expansion will primarily utilize the SLI model as mentioned in previous quarters. In Q1 2022, our SG&A increased by 34% year-over-year to RMB 584 million, driven by increases in both Legacy-Huazhu and Legacy DH. SG&A for Legacy-Huazhu increased by 29% to RMB 424 million; the increase was mainly due to the rising headcounts in our business development team to support penetration into lower tier cities, as well as operational teams in Southern and Western China, corporate customer expansion sales teams, enhanced IT teams, and the expansion of the upscale hotel division. However, due to the significant impact of the recent Omicron outbreak, we have begun implementing strict cost control measures by streamlining overhead costs, such as headcounts and expenses. DH’s SG&A increased by 48% compared to last year, driven by increased OTA commission alongside business recovery and one-time restructuring costs. Our adjusted EBITDA loss was RMB 333 million in Q1 2022 compared to a loss of RMB 133 million a year ago. DH’s EBITDA loss narrowed in Q1 to RMB 240 million compared to a loss of RMB 340 million last year, thanks to the reopening in Germany that accelerated business recovery. Excluding DH, Legacy-Huazhu recorded an adjusted EBITDA loss of RMB 93 million compared to a positive EBITDA of RMB 207 million in Q1 2021, due to the impact of the large-scale Omicron outbreak and higher costs. In Q1 2022, we recorded an adjusted net loss of RMB 662 million, larger than a loss of RMB 451 million a year ago. Excluding DH, Legacy-Huazhu reported an adjusted net loss of RMB 339 million compared to a loss of RMB 150 million in Q1 2021. Turning to Slide 25 on guidance, given the rapid spread of the Omicron variant in China, which severely affects our business performance now, as well as the COVID prevention policy rendering business performance more unpredictable in the foreseeable future, we will suspend providing or updating guidance on revenue and hotel openings until the situation sustainably improves. Nevertheless, we will continue to provide quarterly guidance based on our best understanding of the most recent situation. In the second quarter of 2022, Huazhu Group expects revenue to decline by 2% to 6% compared to the second quarter of 2021, or to decline by 23% to 27% if excluding DH, mainly due to the significant impact from the Omicron outbreak in China. DH itself expects a threefold revenue increase as its recovery is on a healthy track. Again, this guidance only reflects our current view, which is subject to further change.

Thank you. Our first question comes from the line of Billy Ng from Bank of America. Please go ahead.

Actually when we see from the presentation, we saw that there were about 700 new sign-ups year-to-date up until April which is actually on track for almost 2000 for this year's, so my question is have you seen any slowdown in new sign-ups recently and could you give some color on the new openings? I remember in Q1, you opened 300 hotels; just wondering if you have seen a slowdown in new openings in the last couple of weeks or months? Thanks. That's my first question.

Thanks for your questions. Yes, I think you are correct. In the first quarter, given we invested considerable resources in expanding our BD team last year, we achieved relatively great new signings for the first quarter. However, since the Omicron outbreak started in late March, this significantly impacted our new signings due to the pandemic, strict traffic control, and a decline in franchisee confidence. Therefore, we are indeed seeing a slowdown in new signings recently. Regarding construction, the pandemic has also had a huge impact on construction, particularly due to transportation limits and supply chain management caused by traffic control, which slowed construction significantly in April and May, negatively affecting our new openings for the year.

Thank you and my second question is regarding cost streamlining. I wonder if you could provide a little more detail in terms of the numbers, and what run rates we can expect in the next few quarters compared to the first quarter, specifically for SG&A or hotel operating costs?

Yes, so essentially, the pandemic has presented us with many challenges and difficulties. However, we remain committed to our focus on China as well as maintaining our long-term sustainable quality growth strategy. Regarding cost savings, I can share that we will be focusing on our headquarters for streamlining headcounts, planning to reduce headcounts by at least 20%, and we will assess if further reductions are necessary depending on market conditions. Nevertheless, as I mentioned earlier, our frontline and operational staff are valuable assets for us, so we will ensure they are returned to operations. Our cost savings will mainly focus on our headquarters.

Thank you. Next question comes from Lin Sijie from CICC. Please go ahead.

So my first question is regarding the extension to Southern China. How is it progressing? Is there anything above or below expectations?

As you may know, Huazhu was previously weak in the southern part of China. However, this region is not only important for the entire Chinese economy but also a critical market for Huazhu. Despite the impacts of the Omicron outbreak since March, I am pleased to report that our new signings in the first quarter have already exceeded our peers, making Huazhu the company with the largest new signings in Southern China in the first quarter.

Thank you. My second question is that generally speaking, reduced supply is a positive factor for industry recovery. Meanwhile, the macro and consumption environment may pose challenges. How should we expect the coming industry recovery?

The business recovery in China is very much tied to policies. China continues to implement the dynamic zero-COVID policy, which adds uncertainty in the foreseeable future. However, despite these uncertain market conditions, we are focused on our strategies, including improving our local sales capability to capture local demand, and during the pandemic, we are aiming to capture unusual business travel demands, including those corporates needing accommodations for resuming operations. Our cost control and efficiency improvements will remain key focuses in the near future.

Thank you. Our next question comes from Dan Xu from Morgan Stanley. Please go ahead.

Please allow me to translate my question. First, I would like to thank you for the opportunity to ask the question. My question is about debt management, specifically regarding the current plan and progress for the US$475 million convertible bond expiring in November this year and the remaining €338 million credit facility expiring in December this year. What are the current plans and progress?

Thank you for the question. We have several approaches to address these issues. Firstly, we have offshore cash on our balance sheet. Secondly, we are preparing a new bank loan to repay the upcoming due bank loan in the latter half of this year. Additionally, we have similar approaches for potential redemption of the convertible bond as we do with bank loans.

Thank you very much. That's my only question.

Thank you. Our next question comes from Simon Cheung from Goldman Sachs. Please go ahead.

I wanted to ask about the new hotel sign-ups, the addition of the hotel completion, and the RevPAR recovery. Could you provide insights on how this cycle differs from the last several shutdowns during viral resurges, and if management can offer expectations on how quickly recovery might proceed now that Shanghai has gradually reopened?

I must be very honest with you; this round of the Omicron outbreak comes after two years since the initial outbreak back in 2020. Franchisees have been suffering significantly over the last two to three years, leading to declining confidence and cash flow. Although new signings have been negatively impacted by Omicron, we are working hard to penetrate regions less impacted by the outbreak, such as central and Southern China. Regarding Shanghai, I expect most operations will gradually resume to normal starting tomorrow, and with the supply chain and transportation gradually restored, construction work should resume as well next month. However, new signings might take longer to recover as it is not directly tied to the pandemic and depends more on investor confidence, which could take around a quarter to normalize.

Given the guidance for the second quarter suggests that DH will likely grow threefold year-on-year, could you clarify whether achieving positive EBITDA for DH might be feasible in the second quarter?

Certainly, DH is on a very healthy recovery trajectory. While we are budgeting growth towards Q4 of 2020, there is potential for us to move towards positive EBITDA for the year, but it's a bit early to commit to that for Q2 since we are still in recovery mode. We will provide more details once we are ready.

Thank you. Our next question comes from an unidentified line from CSC. Please go ahead.

My question concerns our regional headquarters, particularly in Shenzhen and Chengdu. Can you provide some insight regarding these regional headquarters?

Thank you for your questions. The hotel management business is very localized, and with our China focus strategy, we aim to penetrate every market not just with our hotels but also our brands. Consequently, last week we established new regional headquarters, and throughout the year, especially during the pandemic, we adjusted to more regional management modes, which has proven more efficient.

Thank you. We have reached the end of the question-and-answer session. I'll now turn the call back to the management team for closing remarks.

Thank you, everyone for taking your time with us today, and we look forward to contacting with you again in the upcoming quarter. Thank you. Bye-bye.

Thank you. This concludes our conference for today. Thank you for participating. You may all disconnect.