H World Group Ltd Q2 FY2022 Earnings Call

Good day, and thank you for standing by. Welcome to the H World Group Conference Call. I would now like to hand the conference over to your speaker today to Mr. Jason Chen, Investor Relations Director. Please go ahead.

Thank you. Good morning, and good evening, everyone. Thanks for joining us today. Welcome to H World Group's 2022 Second Quarter and First Half 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 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. H World 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. Reconciliations 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 H World Group's website at ir.hworld.com. With that, now I will turn the call over to Mr. Ji Qi. Mr. Ji, please.

Good morning, and good evening, ladies and gentlemen. The second quarter of 2022 has been both a turbulent and promising period for our business. In China, the large-scale outbreak of COVID, especially in major cities like Shanghai, posed significant challenges to our hotel operations. We took all necessary measures to protect our customers and employees, and collaborated with the government in carrying out preventive procedures against the COVID outbreak. We provided support to our franchisees to help them overcome difficulties as well. In order to maintain a healthy cash position in this disruptive period, we further conducted cost reductions in a very disciplined way, including streamlining our headquarters. On the other hand, our European business has experienced a very healthy recovery. Pent-up demand for travel led to growth in both ADR and occupancy. Second quarter RevPAR almost recovered to similar levels for the same period in 2018 and 2019. The recovery trend continued in the third quarter. In the past several years, COVID waves and geopolitical conflicts have posed many disruptions and challenges to our business. Facing the uncertainties of the external environment, we have been focusing on strengthening our core competency, a resilience recognition, which is able to carry us through different economic factors. We continue to focus on sustainable quality growth, ensuring quality, consistency, and improvement for our existing hotels and upcoming new openings are essential for our needs. Therefore, we continue to remove inferior hotels, including soft brands, from our hotel network. China, our core market, is a significant large-scale market with vast potential. We will further increase our market penetration, especially in lower-tier cities. In order to be close to the local market, we have become more agile in our decision-making process. We established six regional headquarters. Each headquarters is equipped with experienced development personnel, which will create a better understanding of the market as well as support our customers, franchisees, and employees. We are confident that such a restructuring of the operating management will allow us to accelerate our quality growth and provide more opportunities for our business partners in the local markets. With that, I will turn the call to Jin Hui to discuss the details.

Thank you, Ji Qi. As usual, let me first review our China business RevPAR recovery for the quarter. Please turn to Page 3. Due to the impact of COVID, our RevPAR recovery reached a bottom in April at only 53% of the 2019 level. However, since then, our RevPAR recovery has started to improve gradually in the following months. RevPAR in July recovered to 90% of the 2019 level. In terms of our RevPAR in Beijing and Shanghai, it only recovered to the range of 50% to 60% of the 2019 level in July. Other cities and provinces showed further RevPAR recovery with over 95% of the 2019 level. As we mentioned in our first quarter earnings conference call, we started to reinforce cost control measures for our China operations. In fact, we achieved some improvements during the quarter. Please turn to Page 4. On the rental expenses front, we achieved over RMB 60 million rental reduction in the second quarter. For overhead cost optimization in our headquarters, we reduced roughly 10% of headcounts in the second quarter compared to the beginning of the year. We also mentioned previously that we would continuously focus on our customers, franchisees, and employees to build our capabilities to navigate through the economic cycle. Therefore, in the second quarter, we provided a total of RMB 120 million in fee waivers for our franchisees to help them overcome challenges. At the same time, in order to maintain our sustainable quality growth strategy, we also adjusted and upgraded our organizational structure and continued to remove unnecessary hotels from our existing networks. The hotel business is a highly localized industry. As we penetrate more into less penetrated markets, we have come to realize the importance of localized management capability and the necessity of continuing to upgrade our organizational structure. Please turn to Page 5. In the fourth quarter of last year, we established South China and West China regional headquarters. These two regional offices have been developing and performing well since then. Therefore, we applied this experience to the entire country and established six regional headquarters this year. We transitioned our organizational structure from a previous brand-based to a regional-based management and operation for our economic and middle-scale brands. There are three key purposes for making these adjustments. Firstly, a localized team can understand local customers' and franchisees' preferences better and react more swiftly to local market changes. Secondly, a localized regional office can achieve more synergy in operations, sales, marketing, and management, ensuring higher operational efficiency and a shorter decision-making process. Lastly, it would help us accelerate our penetration and development in lower-tier cities as well as achieve our long-term sustainable quality growth target. Regarding brand and product development, we are also committed to our sustainable growth strategy. Based on our own experiences and market trends over the last three years, we decided to accelerate our exit from the economic soft brand hotel market in the next one to two years. Please turn to Page 6. As you may notice, in previous quarters, we have already cleaned up mainly inferior economic soft brand hotel pipelines. In the next one to two years, we will continue to remove inferior hotels, including soft brand hotels from our existing hotel networks to further improve our quality. Please turn to Page 7. Our lower-tier cities penetration is progressing continuously. As of June 30, 37% of our hotels in operation and 56% of our hotels in pipelines come from lower-tier cities. In the second quarter, 58% of the total 561 new signings were from lower-tier cities as well. City coverage also increased to 1,130 cities in the second quarter. Please turn to Page 8. Our Upper Middle and Upscale hotel segments are progressing steadily. Like economic and middle-scale segments, we will keep our organizational structure unchanged for these two segments. We will continue to use brand-based management and operational structures, as each brand in these segments should have its own unique and differentiated strategy regarding brand positioning, product innovation, and customer experience. In terms of future development, we believe our Upper Middle Scale segment is ready to harvest. By the end of June, we had a total of 445 upper middle-scale hotels in operation and 229 in pipelines in China. Our leisure brand, Manxin, recently achieved the milestone of its 100th hotel opening. Meanwhile, we are going to leverage our Madison brand to seek more conversion opportunities in the existing market. Moving to the Upscale segment, given the recent weak property market, our new signings of newly built upscale hotels have been negatively impacted. However, we are now also focusing more on finding local government cooperation and conversion opportunities in the market to support future development. Lastly, our Blossom House and the recently introduced Blossom House Series brands are well recognized and accepted by the market, enabling us to further tap into the booming domestic leisure market. The DH solid business recovery continues in the second quarter. Please turn to Page 9. We saw DH RevPAR recovery improved month over month, recovering to 99% and 100% in May and June, while July RevPAR already exceeded the 2019 level with a recovery rate of 103%. More importantly, considering the recent solid recovery, we expect DH's recurring EBITDA to turn positive for the full year of 2022. Please turn to Page 10. In terms of business recovery in the second quarter, the blended RevPAR recovered to 93% of the 2019 level, mainly driven by a roughly 10% increase in ADR, and the trend continues into the third quarter. The recovery was mainly driven by leisure travel and also supported by pent-up corporate group demand. However, although the recent business recovery is solid, we are continuously implementing strict cost control for DH, which includes overhead cost reduction, operational efficiency improvements, CapEx control, as well as energy efficiency improvements and cost control. Lastly, for long-term development, we are enhancing DH's organizational capability by integrating H World digital distribution capabilities for efficiency and a direct channel performance, relaunching our Rewards membership program for better digital guest experiences and capturing limited service market share in Europe by investing and developing InterCity and Zleep brands. With that, I will turn the call to Ye Fei to discuss our second quarter operational and financial performance.

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 second quarter of 2022. As shown on Slide 12, our hotel rooms expanded by 12% in the second quarter to 774,000 compared with the second quarter of 2021, which had 692,000. Excluding DH, Legacy-Huazhu hotel rooms expanded by 12% year-over-year to roughly 749,000 in this quarter. For our hotel turnover in the second quarter, our total hotel turnover declined by 10% year-on-year to RMB 11.8 billion in this quarter. This decline was mainly due to the large-scale outbreak of the Omicron variant since late March in China, but it was partially offset by our continuous network expansion in China and the strong business recovery of our European operations. Excluding DH, hotel turnover of Legacy-Huazhu declined by 19% year-on-year to RMB 10.3 billion in this quarter. Turn to Page 13, Legacy-Huazhu blended RevPAR for Q2 declined by 31% compared to 2019 due to the impact of the Omicron outbreak since mid-March. The ADR in Q2 2022 was down by 7.8% compared to 2019 at RMB 218, while occupancy in Q2 was 22 percentage points lower than 2019. Excluding the impact of hotels under requisition, RevPAR would have recovered to 75% of the 2019 level. Turn to Page 14. Legacy-DH's business recovery further accelerated in the second quarter. Our Legacy-DH blended RevPAR for Q2 grew by 233% year-on-year to EUR66 compared with Q2 2021, although still behind the 2019 level. Occupancy improved by 35 percentage points compared with Q2 2021, and ADR improved by 35% to EUR110, which actually exceeded the 2019 level by 10%. Please see our financial results on Slide 15. Total revenue declined by 5.7% year-on-year to RMB 3.4 billion in Q2, mainly impacted by the nearly 27% revenue decline of Legacy-Huazhu in Q2 to RMB 2.5 billion. Legacy-DH recorded a strong revenue growth of 311% year-on-year to RMB 921 million. Revenue was in line with our previous guidance at the lower end. The decline in Legacy-Huazhu revenue was mainly due to the large-scale Omicron variant outbreak since March. Breaking down the revenue for Q2, Leased and Owned revenues increased by 3.5% year-on-year to RMB 2.4 billion. Excluding DH, Leased and Owned revenue of Legacy-Huazhu declined by 28.7% to RMB 1.5 billion. Total revenue from Manachised and Franchised hotels declined by 25% to RMB 945 million, mainly dragged down by the decline of Legacy-Huazhu's business but offset by the 100% year-on-year growth of Legacy-DH. The 26.7% year-on-year decline of revenue from Manachised and Franchised hotels of Legacy-Huazhu also includes roughly RMB 200 million in management fee waivers provided to our franchisees and also less CRS contribution because of the channel change in this quarter. Due to the strong recovery of the Legacy-DH business, the Manachised and Franchised revenue contribution temporarily shrank to 27.9% in Q2 2022 compared to 35% in Q2 2021 at the group level. For Legacy-Huazhu, despite expanding hotel networks with an asset-light model, our management fee waivers provided to franchisees and lower CRS contributions in Manachised and Franchised revenue reduced the contribution of the Manachised and Franchised business. Now, let's move on to the cost and profitability session on Slide 16. In Q2, the reported operating income was RMB 8 million compared to a positive RMB 629 million last year and a loss of RMB 708 million the quarter before. The large decline of operating income year-on-year was mainly due to weaker China business performance. Excluding DH, the Legacy-Huazhu operating income in Q2 2022 was RMB 21 million compared to a positive income of RMB 763 million last year and a negative RMB 416 million a quarter ago. The hotel operating cost for the second quarter of 2022 was RMB 3 billion, which increased by 8.5% year-on-year. For Legacy-Huazhu, it recorded RMB 2.2 billion in hotel operating costs, indicating a 1.5% year-over-year decline or a 3.9% decline on a quarter-over-quarter basis. Besides the variable cost savings associated with lower occupancy, a major driver is also roughly RMB 60 million in rental cost reductions, which is expected to continue in the next few quarters. For Legacy-DH, it recorded RMB 804 million in hotel operating costs, indicating a 49% year-over-year growth. This increase was mainly due to the rise in variable costs associated with business recovery, including labor, F&B, consumer goods, variable rents, etc. Other factors also included the impairment cost of terminated lease agreements during this quarter and less rental reductions compared to the same quarter last year. Our preopening costs increased by 93% year-on-year to RMB 31 million in Q2, mainly due to more limited service, leased, and owned hotels under construction during this quarter in China. However, the absolute dollar amount of preopening costs remains low as our future expansion of upscale hotels will mainly use an asset-light model, as mentioned in previous quarters. Our SG&A in Q2 declined by 7.8% year-on-year and 12.7% quarter-over-quarter to RMB 510 million, driven by a decrease in Legacy-Huazhu but offset by an increase in Legacy-DH. Excluding DH, the SG&A for Legacy-Huazhu declined by 21% year-on-year to RMB 332 million. This decline was mainly attributable to the cost control measures by streamlining headcount and expenses in headquarters as well as less selling expenses, along with weak China business performance. On the other hand, DH selling expenses increased in line with business recovery. Other operating income in Q2 decreased by 57% year-on-year to RMB 153 million because of significantly less subsidy received from the German government compared to the same quarter last year. Turning to Page 17. Our adjusted EBITDA was RMB 53 million in Q2 compared to RMB 1 billion last year. DH EBITDA turned positive in Q2 2022 to RMB 30 million compared to a loss of RMB 72 million in '21, driven by accelerated business recovery. Excluding DH, Legacy-Huazhu recorded an adjusted EBITDA of RMB 23 million compared to RMB 1.1 billion in Q1 2021. This decline was mainly due to the impact of the large-scale Omicron variant outbreak during the quarter, as well as roughly RMB 400 million in foreign exchange losses resulted from asset depreciation, including our shares in Accor and our loans to DH. However, this adjustment is not temporary. In Q2 2022, we recorded an adjusted net loss of RMB 84 million, narrower than a loss of RMB 662 million the previous quarter. Excluding DH, Legacy-Huazhu recorded an adjusted net loss of RMB 32 million, improved from a loss of RMB 339 million the previous quarter. Coming to the cash position, our net debt reduced to RMB 5.7 billion by the end of Q2 from RMB 6 billion last quarter, mainly due to cash generated from operations in this quarter. Our cash balance was RMB 4.7 billion, and the unutilized bank facility was RMB 3 billion. Given the COVID impact remains uncertain in the foreseeable future, we remain cautious on CapEx and OpEx spending to preserve cash. Additionally, we successfully refinanced our upcoming syndication loan with a total outstanding amount of EUR 340 million. We are also prepared to meet the potential redemption of the 2017 convertible bond later this year. Turn to Page 20 on guidance. In the third quarter of 2022, we expect revenue to grow by 13% to 17% compared to the third quarter of 2021, or to grow by 5% to 9% excluding DH, on the assumption that there is no large-scale Omicron outbreak again as we mentioned before. With that, let's open up for Q&A. Thank you.

Thank you. Our first question comes from Billy Ng from Bank of America.

Basically, I just want to know whether the recovery trend that we’ve seen in July continued in August and September. And what kind of blended RevPAR assumption are we using when we provided the revenue growth guidance for this quarter?

Billy, this is Fei. To your question, we estimate roughly an 85% blended RevPAR recovery compared to 2019 for the third quarter.

And for August and September, do you think that will be better than July in terms of recovery or worse?

Actually, I think August is actually slightly better than July, around 88%, if we talk about recovery compared to 2019.

For the second quarter, we actually signed up roughly over 500 new hotels during the quarter, but some of them were from the previous quarter's backlog. In fact, given the impacts of COVID, as well as the economic conditions, many cities, especially Tier 1 and Tier 2 cities, are experiencing some slowdown. Undeniably, this will negatively impact new signings in the near future. However, entering the third quarter, given that the provision policies have gradually improved, our new openings and construction for the hotels have been less affected by COVID. But putting all those factors together with COVID and economic conditions, especially in those major cities, the impact is going to last for a while. Next question please.

I show our next question comes from the line of Simon Cheung from Goldman Sachs.

So my first question is related to the acceleration of exiting the soft brands hotel. Having seen some of the other competitors also accelerating their positioning in these market segments, I'm wondering what is the strong rationale or reasoning behind accelerating this exit in the market? And what major challenges do you foresee in the next one or two years?

Yes, we understand that many investors are curious about this part. We also notice that some of our peers are using a very different approach and developing strategies compared to us. As our management team, as well as our Chairman, have emphasized several times in the previous quarters, we are going to insist on implementing our sustainable quality growth strategy under these conditions. This is what drives our key decisions. There are three reasons behind this shift. Firstly, in China, we sense a trend towards consumption upgrading, especially in lower-tier cities, where residents are increasingly demanding high-quality products and better living standards. Secondly, stricter compliance requirements and regulations are being imposed on inferior products, not just hotels but across various industries. We believe our strategy aligns with the government's push for quality growth in the future. Lastly, we have strong confidence in our ability to develop high-quality economic hotel products, including HanTing, ibis, and other major brands. This is why we decided to accelerate our exit from the soft brand economic segment in the next one to two years.

So, my second question is regarding the setup of the six regional headquarters. The company has successfully controlled costs in the last quarter. I'm wondering what the implications of this new regional office setup will be for both cost and revenue in the coming quarters?

Yes. As you may know, we have shifted our economic and middle-scale limited service brands to regional offices and changed our organizational structure from a brand-based to a regional-based approach. This change puts us much closer to our local customers and franchisees and increases efficiency in management and operations, especially in lower-tier cities. It also enables us to build a more comprehensive localized supply chain and sales strategy, creating synergies in sales and marketing. While we are focused on cost control, despite building six regional offices, we assigned some people and talent from our previous headquarters to the regional offices. We are not only assigning team members for development but also for management. In terms of overall cost control measures, we can continue to manage our total costs effectively, even under these circumstances. Thank you.

Thank you. These two are very good questions. This is Ji Qi. In regards to the soft brands, probably everyone knows that a few years ago, there was another brand called OYO that aggressively entered China and became one of the largest hotel groups that year. It made us reconsider our approach to compete with them. Over the years, we have realized that small-scale hotels largely do not require management, PMS, or technology support at all. Thus, we are unwilling to sacrifice our brand by including them in our networks. Instead, we aim to empower them using our technology and supply chain capabilities to help operate in the industry. In the near future, specifically in the next one to two years, our Group's new openings may not be as bright or large-scale as we have previously stated. As mentioned multiple times, we emphasize quality growth. By leveraging the opportunity presented by COVID, we have also been cleaning up inferior hotels and making necessary internal adjustments. In fact, new openings are not the only focus; our long-term target is to enhance our ability to manage risks and achieve sustainable growth. Different companies have their own strategies, and I won’t comment further on this. Regarding our organizational restructuring, some may wonder if we will hire extensively. In reality, we do not plan to make massive hires. Having studied markets in the United States, Europe, and South America, it is clear that China is large enough. Additionally, each province and region has very distinct cultures. For example, the differences between Shanghai and Tibet or Shaanxi are significant. Therefore, further penetration into the local market necessitates changing our organizational structure to be closer to these localities. In fact, many of the CEOs of these six regional headquarters are individuals assigned from our headquarters. We have promoted many talents to be assigned to regional offices. Each regional office will implement strict cost control; they will not be hiring excessively. Overall, reaching our goal of having 10,000 to 20,000 hotels in total in the future requires these regional offices to support this target effectively. Next question, please.

I show our next question comes from the line of Sijie Lin from CICC.

So, I have a question regarding the mid-to-upscale market. We mentioned before there is still potential in the Chinese major upscale market. What operations have we made in the recent years to accelerate expansions in this segment in the future? Generally, what are the benefits for mid-to-upscale hotel members? How do we design our member benefits?

In terms of our mid-scale and upscale development, as I mentioned earlier, we have been progressing steadily. We have been preparing for this segment for the last few years. Huazhu has excelled in operating limited service, particularly in the economic and middle-scale segments. However, for the upper-middle scale, we need to shift focus towards branding and customer experiences. As such, we have spent several years experimenting and adjusting our strategy accordingly. Specifically, in this segment, we have several key points. In regards to product diversity, we are continuously upgrading our product and branding. We currently have a total of six brands, including Crystal Orange, Mercure, InterCity, Madison, Manxin, and Novotel, to provide differentiated customer experiences. In terms of operational and organizational structure, we have three key business units: Crystal Orange and Manxin in the first unit, InterCity and Mercure in the second unit, and Madison for capturing conversion opportunities in the current market. For our membership program, especially for the upper-middle scale segment, we have ongoing internal discussions. Firstly, we will maintain essential customer experiences, similar to those of Amazon Prime members. There is a significant focus on core customer experiences in all membership programs. Additionally, in the upper-middle-scale segment, we delve into the unique privileges and customer experiences offered by each brand and hotel itself. In the next six months, we may make further adjustments and discussions about the membership programs in collaboration with Deutsche Hospitality.

Thank you. That concludes the Q&A session. At this time, I would like to turn the call back over to Mr. Jason Chen, Investor Relations Director for closing remarks.

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

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