H World Group Ltd Q1 FY2023 Earnings Call

Good day and thank you for standing by. Welcome to the H World First Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I'd now like to hand the conference over to the IR Director, Mr. Jason Chen. Please go ahead sir.

Thank you. Good morning and good evening, everyone. Thanks for joining us today. Welcome to H World Group 2023 first quarter earnings conference call. Joining us today is our Founder and Chairman, Mr. Qi Ji, our CEO, Mr. Jin Hui; our CFO, Ms. He Jihong; and our President, Ms. Liu Xinxin. 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 findings 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. 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 at ir.hworld.com. With that, now I will hand over the call to our CFO, He Jihong for the opening speech. Ms. He, please.

Good morning and good evening ladies and gentlemen. Thank you for joining our first quarter 2023 earnings call today. With the reopening in China, we have experienced very positive growth in the first quarter 2023. Our franchisees are rebuilding their confidence and accelerating investment in new hotels. After COVID, we have observed people in China willing to spend more on experience-related activities like travel, similar to what happened in the rest of the world. In a nutshell, we had a very good start to this year and we're very happy to report a strong performance in the first quarter 2023. Mr. Jin Hui, CEO of H World Group, will highlight the key achievements in this quarter, followed by elaboration of financial performance. As always, we will have a Q&A session after management presentation. With this, I now hand over to Mr. Jin Hui.

Thank you, Jihong. Let's firstly turn to Page 3 to review our RevPAR recovery in the recent months. Overall, RevPAR has been trending up since the reopening in November last year. Our legacy hotel's blended RevPAR in January, February, March, and April recovered to 96%, 140%, 120%, and 127% of 2019 level respectively. The RevPAR recovery in the first quarter, and especially in February, was largely driven by the pent-up demand. While we are glad to see the strong rebound in traveling demand leading to a fast RevPAR recovery, we believe it is more important for us to continue enhancing our core competencies in order to achieve sustainable long-term RevPAR growth. Please turn to Page 4. We believe our sustainable long-term RevPAR growth will be driven by three key aspects. Firstly, our organizational restructuring and optimizations. The establishment of our original headquarters enables more localized and efficient operations, as well as achieving further market penetration and synergies in each region. Secondly, lower tier cities in China still appear to have plenty of growth opportunities, especially considering the local residents' rising spending power supported by high economic resilience. Thirdly, we will continue our efforts on further product and service upgrades and improvements in order to achieve a higher price premium. As we discussed in our last quarter’s earnings call, the sustainable quality growth is our core strategic focus in 2023. Under this core strategy, we will focus on three key areas. The first is our high-quality hotel network expansion. Please turn to Page 5. In the first quarter, excluding the soft economic hotels, we signed up 672 new hotels during the quarter, up 26% year over year, which reflects our franchisees' confidence level gradually improving in the first quarter. During the same period, we opened 262 new hotels, which was slightly down year-over-year, mainly due to COVID impact. On the hotel closure front, we closed a total of 209 hotels in the first quarter, including 122 inferior economic soft brands and HanTing 1.0 version hotels to further improve the quality of our hotel portfolios. In addition, as we mentioned in the last quarter, some hotel closure processes were uncompleted in the fourth quarter 2022 due to COVID impact and therefore were delayed to this year. Please turn to Page 6. We continued implementing our lower tier cities penetration strategy. As of March 2023, we have a total of 8,464 hotels in operation, of which 39% were in the lower tier cities, up 2 percentage points year-over-year. And we have 2,304 hotels in the pipeline with lower tier cities contributing around 56%, up 1 percentage point year-over-year. The number of city coverage for both hotels in operation and in pipeline increased to 1,132 cities, compared to 1,089 cities a year ago. Our second strategy is to further breakthrough in the midscale and upper midscale segment. Please turn to Pages 7 and 8. For our midscale segment, we launched Orange Hotel 3.0 version with orange as the theme color, emphasizing the concept of LOHAS, meaning lifestyle of health and sustainability. The Orange 3.0 version brings together healthy vitality and environmental sustainability. Every detail in the hotel conveys the idea of an environmentally friendly and sustainable lifestyle. For example, every kind of material we used in hotel renovation and the consumable products we provided to our guests in the hotel room are all degradable and renewable. In summary, our new Orange Hotel 3.0 version expresses a positive and happy lifestyle and pursues the concept of green and environmentally friendly. It provides a more energetic, sunny, and fresh accommodation experience to our customers. We believe our new Orange Hotel is well-positioned to meet younger customers' demands for nice design, experiences, and vitality, and becomes a good complementary product to our JI Hotel. We believe the Orange brand should further enhance H World competitiveness in the middle scale hotel segment. Please turn to Pages 9 and 10. For our upper mid-scale segments, we successfully introduced InterCity brands to China. We recently opened four new InterCity Hotels in Wuhan, Shenzhen, and Shanghai. These grand openings are very important steps for InterCity’s future scalable development in China. InterCity Hotels in Germany mainly target and service business travelers who frequently travel between cities. The hotel development is closely aligned with the railway development process in Europe, covering major transportation hubs in Europe. Development in the China market is always our key focus, and introducing InterCity brands in the China market is a reflection of that. As our Chairman Mr. Qi Ji once said, we are not simply introducing the German brands to China; instead, we are interpreting the German brands in China. Therefore, InterCity brands in China not only integrate the European features, but also conduct local brand evolutions and observations on consumer behavior to refine the InterCity brand DNA, which offers the ultimate business travel experiences from German features of efficiency, quality, and service. In China, InterCity hotels will be mainly located in major commercial centers and transportation hubs. The theme color of the hotel room is black, white, and gray, and the design is very simple, but highly functional. With the InterCity brands, we aim to provide the new generation of Chinese business travelers a better experience with high-quality stay, workspace, service, and food. Our third strategy is to further upgrade and strengthen our organizational and digital operational capability. Please turn to Page 11. We have always put great emphasis on membership program development and direct sales capabilities. We are very pleased to see our H World App and H World Mini programs' daily active users in the first quarter of 2023 increased by 2x and 3x, compared to the first quarter of 2019 respectively. In addition, our direct booking through our CRS system reached a record high of 62%, up 15 percentage points compared to the first quarter of 2019. It is worth noting that our CRS contribution includes booking through our own channels only and excludes contributions from OTAs and other third-party distribution platforms. Here concludes our business review and update for the first quarter of 2023. With that, I will now turn the call over to our CFO, Ms. He Jihong, to discuss our financial performance for the quarter.

Thank you, Jin Hui. I'm now going to elaborate on the key financial achievements in this quarter. Please turn to Page 13. Our hotel network continues to expand. In the first quarter of 2023, the number of rooms achieved 7% growth compared to the same period last year and stands at 820,099 rooms. Hotel turnover achieved 71% growth compared to the first quarter of 2022 and stands at more than RMB16 billion. Please turn to Page 14. Legacy-Huazhu blended revenue recovered to RMB210. This is an 18% increase compared to the first quarter of 2019 and 58% compared to the first quarter of 2022. The revenue growth and RevPAR growth is largely driven by ADR increase, which shows a 25% increase compared to the first quarter of 2019 and 24% compared to the first quarter of 2022. Our average occupancy rate stands at 76% in this quarter. Please turn to Page 15. Legacy-DH blended revenue recovered to EUR55. This is an increase of 66% compared to the first quarter of 2022. The recovery is driven by both ADR and occupancy. As of the first quarter of 2022, we still faced quite heavy COVID impact in many countries where DH operates. Please turn to Page 16. H World revenue grew to RMB4.48 billion in the first quarter of 2023. This is an increase of 67% compared to the first quarter of 2022, slightly above our guidance. Legacy-Huazhu revenue grew 58% year-on-year to RMB3.59 billion, and the legacy DH revenue grew 818% in the same period, achieving RMB886 million. This reflects the RevPAR recovery trajectory, thanks to the reopening of China and the rest of the world, continued product upgrades, as well as the market penetration and synergy achieved through regional offices in China. Please turn to Page 17. Our operating income in the first quarter of 2023 grew to RMB664 million, compared to a loss of RMB708 million in the first quarter of 2022. Legacy-Huazhu achieved RMB822 million, turning into positive territory compared to a loss of RMB416 million in the first quarter of 2022. Legacy-DH still made a loss in the first quarter of 2023, but it narrowed its loss by RMB140 million compared to the same period last year. As a group, we maintained total SG&A cost at 13.8% of our total revenue, with China at only about 12% in the first quarter. We are very disciplined about our SG&A cost as a percentage of revenue, and it is constantly under our close monitoring. In Germany and the European countries, we need to cope with costs in an inflationary environment, which has some impact on our profitability. Please turn to Page 18. In the first quarter of 2023, our adjusted EBITDA recovered to RMB1.65 billion. This is a significant increase from a negative RMB333 in the first quarter of 2022. This adjusted EBITDA increased around RMB500 million from gains of sales in Accor’s shares in the first quarter. Adjusted net income was RMB1 billion in this quarter, compared to negative RMB662 million in the same period last year. The strong EBITDA and net income performance are mainly contributed by the recovery of the Chinese business. Operating cash flow stands at RMB1.84 billion, a strong increase compared to cash outflow in the same period last year. Please turn to Page 19. Our liquidity position is quite strong. As of 31 March 2023, we have a net cash of RMB957 million. Our cash balance stands at RMB10.4 billion, and we have an unutilized bank facility at RMB2 billion. Please turn to the next page. Our revenue guidance for the second quarter of 2023 is 51% to 55% growth compared to the second quarter of 2022. Excluding DH, the revenue of Legacy-Huazhu is projected at a growth rate of 64% to 68%. This implies our RevPAR guidance announced early this year remains unchanged. We are confident about the market recovery and the performance for the rest of this year.

Yes. Thanks, Jihong. So, now we can open for the Q&A session. Operator, please.

Our first question comes from the line of Ronald Leung from Bank of America. Please go ahead, Ronald.

Hey, hello, good morning management. Thank you for taking my question. Hi. Good morning management. Let me ask my questions in English. My first question is, what is management expectation for RevPAR recovery in the second quarter? The second question is about supply outlook for the hotel industry. Has the RevPAR recovery been solid? Some franchisees' hotel owners are planning to reopen their hotels in the upcoming year. So, do you expect the increase in hotel supply will hurt the RevPAR recovery? Thank you very much.

Okay. So, thank you. So firstly, I will answer the first question. So, for the revenue guidance for the second quarter of this year, it implies the blended RevPAR recovery compared to the same period of 2019, which is in the range of 110% to 115%, which is in line with our annual guidance in terms of the RevPAR recovery. And for the second question, yes, for the first quarter, we are observing some of the supply gradually increasing, but on a relatively slower basis. Given the recent macro conditions, as well as the cyclical issues in the property market, we are not seeing a large increase in the supply, at least in the short term. Secondly, even though we are seeing some of the supply is gradually coming back into the market, the clear trend is that the branded hotel penetration or the churn ratio continues to improve. This keeps the main thesis of the market unchanged. And thirdly, in terms of competition, we think competition is always there, no matter before or post-COVID. But for us, we will continuously emphasize building up our core competencies through improved branding, products, and services, as well as our organizational capability to increase our entire competitiveness in the market. Thank you.

Thank you very much.

Thank you. Our next question comes from the line of Sijie Lin from CICC. Please ask your question, Sijie.

So, I'll translate my questions into English. So, my first question is a follow-up on RevPAR recovery. So, do we think the current ADR driven recovery is healthy and sustainable? Will the gap in OCC recovery, especially for business demand, exist for long? And my second question is, what's the pace of the hotel's new openings and the franchisees segment in Q2 after they saw Q1’s recovery? Thank you.

Okay. Now, I will answer the first question in terms of the RevPAR. Clearly, RevPAR is a combination of the ADR and OCC. In terms of the ADR, undeniably, you know in the first quarter, I think the RevPAR recovery was mainly driven by the ADR, and this is very much in line with the global market recovery post-COVID. This somewhat reflects the higher spending capability as well as the impact of inflation. Relatively, I think the ADR growth at this moment is still quite healthy. Again, we observed especially in the leisure market, people are becoming more willing to pay a premium for good quality products and services. This will support the ADR growth. In terms of business travel, yes, there remains some gap compared to pre-COVID. According to some public studies, we are expecting business travel demand to fully recover to pre-COVID levels by around 2024. Therefore, as a group, we will be planning according to this trend. Okay. In terms of franchisee confidence, after three years of COVID, we think our existing franchisees are becoming more stable and mature, and they have better knowledge regarding volatility and uncertainties. Thus, we feel they are very stable at this moment, and confidence is gradually improving. We are also very happy to see, especially in the lower-tier cities markets, many new franchisees joining us—some of whom may not be previously in the hotel industry, but are local property developers or from other industries. Thank you.

Thank you, management.

Thank you. Our next question comes from the line of Lydia Ling from Citi. Please go ahead, Lydia.

Thank you. Hi management. I’m Lydia from Citi. So, here I have two questions. The first one is on your overseas business. The DH business actually is showing some losses in the first quarter, so I want to check with management your view on the DH and its outlook for the full year, and also how to further narrow the loss, and any updates on the integration of the DH business? My second question is on the RevPAR growth. So, what's your view on your sustainable long-term RevPAR growth looking forward? Thank you.

Okay. Thank you, Lydia. This is Jihong. I'm going to answer your question first about the DH business. The loss in the first quarter is due to seasonality. We all understand that especially in European countries, the seasonality is quite strong and volatile. So, in the first quarter, the revenue was lower due to seasonality and at the same time, costs—also due to energy and inflationary environments—have increased our costs. For the whole year, we are confident that we will continue to improve our performance on the revenue side and continue to control our costs. We are confident that for the whole year, our EBITDA will come back to positive territory. Regarding RevPAR, from the history of Huazhu, we have been improving RevPAR year-by-year. This is not only through the same-store growth but also through product upgrades and product mix. Typically, a company’s RevPAR grows with the economic growth as well. Over the past several years, we are confident that in the future, our RevPAR will continue to grow with the larger economic environment.

Thank you.

Thank you. Our next question comes from the line of Lina Yan from HSBC. Please ask your question, Lina.

Hi. Yes, I will translate my question myself. So, the first question is on the RevPAR drivers, especially on the pricing power for the ADR. We have seen a very strong ADR increase in the first quarter, driven by inelastic demand, but going forward, we will see the supply-demand gap narrow, and also the spending power is not as strong as the economy has shown. Management also guided that RevPAR in the second quarter will be 110% and 115% of the 2019 level. Does that imply that management also sees a weakening trend in ADR or what kind of change in the mentality of ADR trend might we see going forward? The second question is regarding the impact of portfolio upgrades on RevPAR. Management mentioned it's a key driver for RevPAR as well. So, can you quantify the impact? For example, what percentage of hotels has been upgraded in our portfolio versus 2019, and what is the impact on RevPAR growth compared to 2019? Third question is you commented that business travel hasn't recovered to the 2019 level. Can you provide more details on the recovery in business travel compared to last year or pre-2019? Yes, that's my question. Thank you.

Okay, thanks for your questions. Yes, we understand that quite a lot of you are concerned about RevPAR and ADR. That's why I would like to elaborate a bit more detail and express and emphasize our views again by taking this opportunity. For us, since the beginning of the year during our budgeting process and during our last year earnings conference call, our views have remained cautiously optimistic. I hope you can understand this. Our view has been unchanged since then. In terms of RevPAR and ADR, it is quite a complex relationship, especially for us. In the China markets, we have the lower tier cities, leisure markets, upper scale, and upper mid and middle scales. It is a very diversified market. Undeniably, regarding business travel, considering the impact of the economic cycle, some business travel demand is not fully returning yet, but we do see strong local demand, especially from leisure travel since the beginning of the year. A lot of activities have taken place, supported by the government on leisure travel activities. Another point is that if you look at recovery in April, we noticed that the airline industry is not fully recovered, but the railway services are recovering well, which also indicates strong demand. For us, again, in terms of sustainable long-term RevPAR growth, we are still concentrating on building our core competencies through branding, products, and services. We have different product mix strategies, not only focusing on the upper mid-scale but also lower tier cities penetration. It's a very complex combination for us. If you remember, maybe two years ago you asked us whether our lower tier cities penetration would negatively affect our RevPAR growth in the future. Given our developments in China—not only in lower tier cities but also upper mid-scale and upscale—it's complicated, making it difficult for us to provide accurate guidance at this moment. Thank you. Due to three years of COVID, we have witnessed significant pent-up demand initially, particularly in the first quarter, where individuals are eager to travel and businesses are keen to resume operations swiftly. Confidence and purchasing power at this moment were quite strong. However, we did observe some gaps or slight slowdowns recently, which we believe are natural when compared to the global market because of divergent reopening timelines in different regions. We traveled a lot to Europe and noticed that their recovery is not as robust as before, given that they experienced a shorter pandemic duration. We believe the market requires some patience regarding a sustainable recovery going forward. As mentioned previously, the airline occupancy rates have yet to recover to pre-COVID levels, while the railway sector is performing excellently. We are still seeing travel demands active across different sectors. While we do not have specific statistics for self-driving travel activities, we firmly believe it remains strong. Therefore, whether during or post-COVID, we continue to see eager demand for travel on leisure or business fronts. Long-term, we think hotels with relatively lower prices will be more resilient, whether during COVID or financial crises. Recent consumption trends indicate people prefer spending a bit more to achieve significant happiness, and those who are inclined to spend may not be in the higher income bracket. Subsequently, we believe upscale segments will take more time to recover. We focus not solely on ADR growth but on creating core competencies and an integrated ecosystem that benefits all partners in our network. For us, it is challenging to predict ADR movements due to multiple influencing factors. Thank you.

Thank you. Our next question comes from the line of an unidentified analyst. Please go ahead.

Thanks for the opportunity. Can you explain how the organizational structure supports the developments of the new brands such as Orange 3.0 or Orange Crystal InterCity? Are there any problems in the operation of this organizational structure? How can the management solve them? Thank you.

Thanks for your questions. I'm very glad you asked about our organizational restructuring. Firstly, I would like to clarify that it has only been a year since we conducted our organizational restructuring last year. I would like to elaborate on the purpose behind this restructuring. One of our core strategies is to penetrate the China market fully in the limited service segment alongside our sustainable quality growth strategy. By establishing these six regional headquarters, we have seen initial positive outcomes over the last year. The regional headquarters are closer to our franchisees and customers, achieving higher operational optimization and synergy. Regarding the upper mid-segment, these brands are still using the vertical organizational structure; however, regional headquarters will assist in their development while management remains centralized. As for challenges, we believe that we still have room for improvement in talent acquisition, but we are working on building this up further. Thank you.

Thank you. I'm showing no further questions. I'll now turn the conference back to the management team for closing remarks.

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

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