H World Group Ltd Q4 FY2022 Earnings Call

Good day and thank you for joining us. Welcome to the H World Q4 2022 Earnings Conference Call. All participants are currently in listen-only mode. After the presentation, there will be a session for questions and answers. I would now like to introduce your speaker for today, Jason Chen, Investor Relations Director. Please proceed.

Thank you. Good morning and good evening, everyone. Thanks for joining us today. Welcome to H World Group 2022 fourth quarter and full year earnings conference call. Joining us today is our Chairman, Mr. Qi Ji; our CEO, Mr. Hui Jin; our CFO, Ms. Ye Fei; and our President, Ms. Hui Jin. 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 under applicable laws. On the call today, we'll 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 presentations, is available @ir.HWorld.com. With that, now I will turn the call over to our Chairman, Mr. Qi Ji. Mr. Ji, please.

Good morning and good evening, everyone. Thank you for joining our call today. 2022 has been a very challenging year for our business in China, with these strict COVID policies in place for quite a long period of time across the country. Our business has been thoroughly impacted, as many people expected. However, we have shown strong resilience throughout a difficult time and continue to expand our new hotel network. I would like to use this opportunity to extend our sincere appreciation to our customers, franchisees, employees, and business partners for their support to get through this tough period together. No matter how difficult the business environment was, we did not stop developing our company further. Last year, we transformed our Chinese operations through organizational restructuring and established a foreign brand in key regional markets with our six fully equipped regional companies in China, where we are now prepared for penetration into more regional markets. With China lifting the COVID restrictions and the ongoing economic development, we are embracing a strong recovery in the hotel market. We believe we are well positioned to capture this growth opportunity. This year, we will focus on three key areas. First, we will continue the high-quality expansion of our hotel network. This will be largely driven by limited service hotels, especially in lower-tier cities and less penetrated areas. Second, we will focus on developing and establishing a firm brand in the mid-scale and upper-scale segment through a multi-brand strategy. Last but not least, we will continue to strengthen our organizational and operational capabilities to achieve high operational efficiency and provide better services to our customers as well as franchisees. In our international business, we are very glad to report that we achieved improvements in many operational areas over the last year. Full-year adjusted EBITDA before impairment turned positive for the first time since our acquisition. In addition, we have made significant breakthroughs in our loyalty program, direct sales, channel development, and digitalization of operational processes. In 2023, we will focus on future margin improvement, digitalization, growing direct sales, and expanding our hotel network. This world is full of uncertainties as we cope with various challenges, including changes in international monetary policies and ongoing regional conflicts. We will strengthen our core competencies in operations and various platforms to build up our overall resilience. We are confident that with our continued innovation in our models and projects, we can navigate through different challenges and generate sustainable quality growth for our investors as well as our entire ecosystem. With this, I will turn the call to Jihong He.

Although the year 2022 was filled with challenges, we as one of the leading companies in the industry still overcame these obstacles and made several business advancements during the year. Let's first discuss our main achievements for the year. Please turn to Page Three. First of all, we kept our sustainable quality growth strategy unchanged. During the year, we opened 1,244 hotels. Also, we continued to remove inferior hotels from our network and upgrade hotel products across all brands to improve customer experiences. Secondly, we completed our organizational restructuring and established six regional offices to build a solid foundation for further market penetration and high-quality operations in the future. Certainly, we have conducted good cost control and achieved rental reductions of around RMB300 million in 2022, as well as a 15% headcount reduction in our headquarters during the year. Lastly, we waived around RMB300 million in management fees for our franchisees during the tough period last year, as we always treat our franchisees as our important business partners. We are very glad to see our RevPAR in China continue to perform well after reopening. Please turn to Page four. Since the official announcement of reopening in late November last year, our China RevPAR recovery was improving month over month. RevPAR recovered to 74%, 87%, 91%, and 96% in last year’s October, November, December, and January this year, respectively. In February 2023, RevPAR further recovered to 140% of 2019 levels. The recovery rate in February was mainly impacted by the timing mismatch of the Chinese New Year holiday period between 2023 and 2019. However, it also reflects the impacts from product mix changes over past years as contributions from midscale and upper midscale segments increased, as well as our improving capabilities on ADR optimizations. Looking ahead to 2023, sustainable quality growth will still be our core strategy. Under this strategy, we will focus on three key areas. Firstly, high-quality hotel network expansion through our membranes and flagship hotel strategy to achieve further in-depth penetration in the China market. Secondly, achieving new breakthroughs in the midscale and upper midscale segments, especially for those brands that we incubated in the past few years, such as Orange, Crystal Orange, Intercity, and Blossom House. Thirdly, we will further strengthen our organizational and digital operational capabilities. We will discuss each of these three focuses in detail in the following. We will continue to expand our hotel networks with a focus on quality, particularly in lower-tier cities and areas that have not been fully penetrated. By the end of 2022, we operated a total of 8,411 hotels in China, adding 705 hotels throughout the year. The contribution from lower-tier cities accounted for 38% of our total hotels as of 2022, which is a one percentage point increase from the previous year. We have a pipeline of 2,544 hotels, with about 57% located in lower-tier cities, also marking a one percentage point rise compared to last year. The total number of cities we serve with both operational hotels and those in the pipeline grew to 1,126, up from 1,062 cities the year before. Our expansion efforts continued despite the challenges posed by COVID last year. Last year, we signed contracts for 2,141 new hotels, a decrease from the 2,849 signed in 2021, primarily due to the impacts of COVID and reduced confidence among franchisees. However, after excluding the effects of economic soft branding that we ceased pursuing last year, we actually signed 2,123 new hotels in 2022 compared to 2,477 the prior year. On the issue of hotel closures, we shut down around 539 hotels in 2022 to adhere to our sustainable quality growth strategy, which involved removing lower-quality economic soft brand hotels and outdated versions of HanTing products. Removing these from consideration, our closures for 2022 amounted to 237 hotels versus 175 in 2021. It’s important to note that our closures were lower than the 600 we had previously guided for last year, as some closure processes were not completed in December due to the effects of the initial COVID reopening. We have been consistently working on enhancing hotel quality, which has led to a steady decline in the proportion of low-quality offerings. For instance, the percentage of economic soft brand and HanTing 1.0 version hotels fell to 13.4% by the end of 2022, down from 25.9% at the end of 2020. We continue to reinforce the standards for our core brands. In the economic and midscale segments, our key brands are Hanting and JI, supported by the Orange and other brands. We aim to enhance the strength of our core brand further. In the upper midscale segment, we will continue to employ a multi-brand strategy to gain deeper market penetration. Currently, we have eight brands in this segment: Crystal Orange, Intercity, Manxin, CitiGO, Madison, Mercure, and Novotel, amounting to 523 hotels in operation and 287 in our pipeline by the end of 2022. H World is dedicated to upgrading and strengthening our organizational and operational frameworks, enhancing our talent pool, digital capabilities, franchisee and customer services, sales and loyalty initiatives, supply chain management, and sustainable practices, all aimed at boosting operational efficiency and adding value for our franchisees and customers. In terms of customer service improvement, we are seeing our customer ratings for our hotels continuously improving. This demonstrates that our customers are becoming more satisfied with our hotel products and services. At the same time, the rate of negative customer ratings is consistently declining, indicating our ongoing efforts to enhance customer experiences through better services and products. We will focus on three areas to reinforce our marketing and royalty programs. The first area is on ADR optimization. After completing our organizational restructuring and establishing six regional offices, hotels located in each region can set up a more flexible pricing system based on local market conditions. Additionally, pricing synergy can be achieved among various brands in each region, and the pricing range for different segments can become more reasonable. The second area is the continuous enhancement and upgrading of the H World loyalty program. By leveraging the large number of members and traffic, we will further explore potentials through consistent upgrades and improvements to our loyalty program, including membership privileges. Lastly, we will further improve our sales capabilities with corporate clients. We will continuously develop new top-tier corporate customers and generate more revenue contributions from corporate clients through group bookings, conferences, banquets, and activities by leveraging our digitalized direct connection capabilities and closer cooperation with them. The operational efficiency improvements for our leased and owned hotels are also very important for the group. We will constantly optimize our current leased and owned hotel portfolios. Those leased and owned hotels that do not meet our requirements will be properly terminated. Furthermore, we will enhance operational efficiency in the hotel to reduce operating costs and improve profitability for leased and owned hotels. Lastly, any future investments in new leased and owned hotels will mainly be determined by the expected returns and strategic considerations, particularly for flagship hotels. We will also strengthen our supply chain capabilities, provide full supply chain services, and conduct in-depth operations for franchisees while continuously upgrading products to achieve better quality and more standardized services at lower costs and higher efficiency. Last but not least, we will pay more attention to ESG and long-term sustainable development. In addition to our continuous efforts in social welfare and employee care, we will make more efforts on ESG this year with three key focuses. The first focus is to continuously improve and optimize the company's ESG database. The second focus is to enhance the efficiency of energy and water usage. The third focus is to launch more green projects, including green suppliers and sustainable living across all our business reviews for the last year and strategic focus for this year. With that, now I will turn the call over to our CFO, Ms. Ye Fei, to discuss our DH business and our 2022 full year financial performance. Thank you. Hello everyone. Thank you, Ye Fei, and thank you, Jason. Please turn to Page 16. In our international front, we are very happy to report that the DH business achieved robust recovery in 2022, achieving RMB134 million adjusted EBITDA before special write-off impairment and unrealized loss. While we are fortunate to be able to capture the market recovery after COVID, this result would not have been possible without disciplined cost reduction measures and corporate restructuring efforts. In addition, we conducted a series of activities to elevate the DH business to a new level. We rolled out our proprietary digital infrastructure in our hotels, upgraded our loyalty program H Reward internationally with enhanced benefits, refreshed the brand positioning and products for InterCity and hotels, and finally, we implemented a new management system to attract talent for our hotels and headquarters. Please turn to Page 17. In 2023, DH will focus on four strategic areas. Most importantly, we will continue our efforts to improve margins, which includes both further improvement of our revenue as well as continued cost discipline. Number two, we will continue to invest in direct sales channels. With our H Rewards program, our reservation system, and mobile web booking platforms, we will continue to increase the ratio of direct bookings. Number three, we will continue to grow our hotel network by leveraging our strong brands, and number four; we will continue to digitize our core processes. Now I will turn to the financial section of today's call. Please turn to Page 19. We all know 2022 was a very difficult year in China due to strict COVID policy. Despite the tough operating environment, we managed to grow our hotel network. The number of rooms increased by 7% year-on-year to 809,478 rooms in 2022. Our hotel turnover was RMB49.6 billion, a 9% increase compared to 2021. Page 20; due to restrictions of COVID policies, blended RevPAR for our China business in 2022 was RMB157, a decrease of 8.8% compared to 2021 and a 20.5% decrease compared to 2019. This was mostly due to lower occupancy, which was 5.5% lower than 2021 and 17.7% lower compared to 2019. Page 21; in our international business, the market recovery started in Q2 2022. We achieved a 96% RevPAR increase compared to 2021, driven by a 23% ADR increase and a 21% occupancy increase. Please turn to Page 22. In Q4 2022, our total revenue for the group increased by 11% compared to Q3 '22, mainly due to a 66% revenue improvement in our international business. For the whole year 2022, our revenue increased by 8.4% year-on-year, which was contributed by a 108.5% revenue increase from DH. For the whole year 2022, revenue from our China business decreased by 5.3%. However, the recovery of our China business accelerated after the Chinese government announced reopening policy in mid-November. The overall Q4 2022 revenue was at the high end of our guidance despite fee waivers of RMB58 million to support our franchisees. Please turn to Page 23. Operating costs in Q4 2022 were RMB3.4 billion and RMB12 billion for the full year 22. This includes RMB195 million impairment loss for our China business and RMB169 million for the DH business. Income from operations was negative RMB93 million in Q4 '22 and negative RMB294 million for the full year '22. Please turn to Page 24. Our adjusted EBITDA was RMB398 million in Q4 '22 and RMB610 million for the full year 2022. Our China business reported a foreign exchange gain in Q4 '22, but this was offset by impairment losses. For the DH business, adjusted EBITDA in Q4 '22 decreased by RMB68 million compared to 2021 due to the absence of COVID-related government subsidies received in 2021. For the whole group, adjusted net income was negative RMB255 million for Q4 2022 and negative RMB1.27 billion for the full year 2022. Please turn to Page 25; as we had a substantial amount of non-cash impairment losses due to changes in the fair value of equity securities as well as foreign exchange losses, we would like to present normalized EBITDA and net income separately. We achieved this level of normalized adjusted EBITDA of RMB1.7 billion for the full year 2022 due to disciplined cost control measures such as rental reductions and streamlining of our headquarters' costs. Please turn to Page 26. We would like to update everyone on our liquidity position as well. As of December 31, 2022, our net debt was RMB4.8 billion, and our cash balance is RMB5.1 billion. We have an unutilized bank facility of RMB2.1 billion. It's worth noting that our cash position has further improved since we executed a very successful follow-up public offering of USD300 million in January 2023 and liquidated our core shares at €300 million in February 2023. Please turn to Page 27. As each year, we provide broad guidance for our business in the coming year. Since China is just starting its recovery journey, we need to further observe the business trend. We remain optimistic but cautious. We estimate our net revenue in Q1 2023 to grow by about 61% to 65% compared to Q1 2022. Excluding the DH business, our China business is estimated to grow by 53% to 57%. For the year, revenue is estimated to grow by 42% to 46% and the China business is estimated to grow by 46% to 50%. Our gross hotel opening target is estimated at 1,400, and we plan to close about 600 to 650 hotels. Many of the hotels to be closed this year are non-revenue generating but are still going through legal closure procedures due to delays caused by COVID. Many of these hotels are soft brand hotels and HanTing 1.0. We expect some of these hotels to be officially removed from our inventory this year. This concludes our presentation today. Now we can start with the Q&A session.

The first question comes from Ronald Leung of Bank of America. Please go ahead with your question.

Hi, good morning, management. I have two questions. The first question is about the revenue guidance. Based on the first quarter revenue guidance for domestic China growing 53% to 57% and the full-year revenue growing 46% to 50%, what would be the RevPAR recovery assumptions that management is putting in right now? The second question is about the global expansion strategy. What would be the next step for the global expansion strategy this year and next year? Will management still consider further mergers or acquisitions to complement the brand portfolios? Thank you very much.

To answer your first question, we are seeing that demand is getting quite strong at the beginning of this year, and we are noticing that RevPAR recovery is mainly driven by ADR. However, we still observe that business travel, especially, has some gaps compared to normal years, which explains why occupancy is also lagging. Considering all these factors, the revenue guidance actually implies that the RevPAR recovery compared to the same period in 2019 is around 110%. I will give you a brief overview of our strategy focus for 2023. After the reopening in the first quarter, we are witnessing quite strong demand in the China market, particularly during the Chinese New Year. We remain very confident regarding the demand in China and future growth potential. Our key focus will be the China market, where we intend to penetrate further by leveraging our key brands while also strengthening our mid-scale and upper mid-scale segment penetration. Regarding global expansion, the priority is to improve the operations of DH focus on its profitability and customer experience. At the same time, we will consider opportunities in global markets where they arise if they are suitable.

I can add a little more context to our international business. Since the acquisition of H, this business has been our foundation for international expansion after the COVID difficulties. We have seen a significant turnaround in the business. Starting in 2023, we will continue to use H as a base for our international expansion. The main goal, as mentioned by Ms. Ye Fei, is to improve H operations, but we are also looking to expand the H brand into different markets, such as the Middle East. For further international expansion, we remain opportunistic for additional M&A opportunities, but I would say H is our top priority at this moment.

Our next question comes from the line of Simon Cheung of Goldman Sachs. Please proceed with your question.

I will follow up in English with my questions. Ronald earlier asked about the 2023 revenue guidance and the implied RevPAR for the full year. Would you provide us with the RevPAR guidance for the full year? Additionally, what are your long-term expectations for RevPAR growth over the next two to three years, considering prevailing concerns over the overall situation in China? That's my first question. For my second question, I noticed that you have updated the acceleration guidance for hotel openings from 1,200 to 1,400. Have you observed a greater appetite from investors and hotel investors returning to the market? Also, do you have any updates on the Southern China Regional Office strategy? Thank you.

In answer to your first question, we are noticing that there's fairly strong overall demand since the year's beginning following the government's reopening policy. The RevPAR recovery has been mainly driven by ADR growth, particularly from leisure travel. In terms of RevPAR guidance for the current full year, we imply that the blended RevPAR will recover to 110% to 115% compared to the same period in 2019. Regarding your second question on business growth, we are indeed seeing a strong business recovery in the first quarter, with increasing franchisee confidence and an improved investment appetite, particularly following the Chinese New Year. From a numbers perspective, we’re observing trends of new signings and pipeline increases that are slightly better than our previous expectations. With regards to development in less penetrated markets, such as Southern China, we have seen great progress after completing our organizational restructuring and establishing regional offices. We remain very confident about our growth potential in those areas, focusing on leveraging our flagship store strategy and core brands.

One moment for our next question. Our next question comes from the line of Sijie Lin of CICC. Please proceed with your question.

So I have one question about Ni Hao Hotel. Considering its positioning as an economy hotel, is it quite similar to Orange Hotels’ positioning in mid-scale hotels? What is Ni Hao Hotel's opening target in the future? Also, what's the difference in the number of rooms compared to HanTing? Thank you.

To answer your question, along with our strategy for lower-tier city penetration and expanding throughout the China market, we realized there is significant new demand, particularly from younger generations and local leisure travelers. These customers may not fit the target demographic for HanTing, which has its unique business traveling focus. Hence, we incubated our Ni Hao brand starting from 2020 to address this new market demand, particularly in the economic segment. Our aim is to use both HanTing and Ni Hao as our key brands to further penetrate the mass market in China, providing more options for customers.

Thank you. At this time, I would like to turn back to Jason Chen for closing remarks.

Thank you everyone for taking the time to be with us today.