H World Group Ltd Q2 FY2023 Earnings Call

Good day and thank you for standing by. Welcome to the H World Quarter 2, 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 your host today, 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 second quarter earnings conference call. Joining us today is our Chairman, Mr. JI Qi, 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 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. Reconciliation of those measures to comparable GAAP information can be found in our earnings release that was distributed yesterday. As a reminder, this conference call is being recorded. The webcast of this conference call, as well as a supplementary slide presentation, is available at ir.hworld.com. With that, now I will hand over the call to our CFO, Mr. HE Jihong for opening speech. Ms. HE, please.

Thank you, Jason. Good morning and good evening, ladies and gentlemen. Welcome to H World Group's second quarter 2023 earnings call. We are very happy to report that with a strong recovery of domestic China travel activities and continuous global travel improvement, our overall financial performance in this quarter and the first half of the year 2023 exceeded the guidance we announced earlier this year. In today's presentation, Group CEO, Mr. JIN Hui, will first highlight our business performance and the key initiatives we undertook to further improve our operations. I will then discuss the financial performance in more detail. Now, I will hand over to Mr. JIN Hui.

Thank you, HE Jihong. As usual, let's quickly review our RevPAR recovery in Q2, 2023. Please turn to page three. Thanks to robust travel demands, H World maintained a strong business rebound following last year's economic reopening, with RevPAR for Q2 reaching 121% of Q2, 2019. In April, May, and June, our blended RevPAR reached 127%, 115%, and 123% of 2019 respectively. The reopening of the Chinese economy, combined with economic rebound and stimulus policies, led to a significant increase in overall travel willingness. We have observed a surge in travel activity around major exhibitions and holidays. As we entered peak season, our RevPAR saw a recovery to 132% of Q2, 2019, which is better than our initial forecasts, although we remain cautiously optimistic about the future. It is important to note the macro-economy is still gradually recovering, which may bring some turbulence and uncertainties for the hospitality industry. Nonetheless, we are confident in the long-term prospects of the Chinese economy, which drives us to enhance our core competitiveness and navigate uncertainties to sustain our business development. Page four, please. I want to highlight the key drivers of our sustainable RevPAR. Firstly, we are achieving higher premiums through improved products and services. Secondly, we are uncovering opportunities in lower-tier cities as their travel infrastructure and willingness improve. Thirdly, we are operating more effectively by establishing regional offices and restructuring. Fourthly, we are increasing our market share in the upper mid-scale market while optimizing our product mix. We will continue to implement the lean development strategy set by management. Page five, please. The H World Group will expand our hotel network following our Quality Development Strategy. In Q2, we signed a total of 1,054 new contracts, marking an 88% year-on-year increase and achieving a historic high. This growth is due to the low baseline in Q2 last year and applying backlog signings during the COVID period. We see enhanced confidence among franchises owing to the strong recovery in the hospitality sector. The number of hotel openings has surged compared to Q1, with 374 openings, up by 41% year-on-year. However, we also closed 216 hotels, mainly as a result of deferred COVID-related closures, to streamline lower-quality and older brands for better network quality, including 130 Hanting 1.0 and economic soft branded hotels. Page six, please. As we focus on enhancing our performance and quality, the share of Hanting 1.0 and economic soft brands has decreased to less than 10% of our total hotels, down from 26% at the end of 2020. Meanwhile, Hanting 2.7 and better accounted for 26% at the end of June this year, up from 14% at the end of 2020. The H World Group will continue to target economy and mid-scale hotels for the mass market. Page seven, please. By the end of June, we had 8,622 operational hotels, with 56% being economy hotels and 36% mid-scale, which is a 3% increase in the mid-scale segment compared to last year. There are 2,808 hotels in the pipeline, with 38% being economy and 48% mid-scale, a 5% increase in mid-scale year-on-year. Among the Q2 openings, 90% were economy and mid-scale hotels, showing our commitment to quality as we focus on serving mass-market consumers. H World continues to enhance our presence in lower-tier cities and underrepresented areas. Page eight, please. Of our operational hotels, 39% are located in lower-tier cities, up by 2% year-on-year. In our pipeline, 55% are in lower-tier cities, increasing our city coverage to 1,196. Page nine, please. We are also growing our upper mid-scale hotel segment, with 562 upper mid-scale hotels in operation as of June, an 18% increase year-on-year. We have 317 upper mid-scale hotels planned, representing a 29% year-on-year rise. This rapid growth of mid-scale hotels in our pipeline will facilitate our future openings and market development in this segment. Page ten, please. We place high importance on membership development, having upgraded our H World brand image and market position. Our H World Members App now includes more location-based features and enhanced member offerings. We aim to evolve the H World Group membership into a comprehensive travel service platform, beyond just hotel reservations. That's all for the Q2 earnings overview. Now I will turn it over to our CFO, Madam HE Jihong, to go over our operational and financial results. Thank you.

Thank you, JIN Hui. I will now highlight the key financial metrics in this quarter. Please turn to Page 12. Our hotel network continues to expand in this quarter. Our number of rooms in operation increased 9% to 844,417. According to the research published by Hotels Magazine, we rank No. 6 worldwide in terms of rooms in operation. Our hotel turnover increased 72% compared to Q2, 2022, totaling more than RMB20 billion. Please turn to page 13. Legacy-Huazhu blended RevPAR in the second quarter stands at RMB250, improved 21.4% compared to the same period in 2019 and 77% over 2022. This recovery is largely driven by ADR improvement. The average ADR of RMB305 is 28.9% above the second quarter of 2019 and 39.8% over 2022. Occupancy of 82% in the second quarter is slightly lower than the second quarter of 2019 at 87%, but it is a 17.2 percentage point improvement over 2022. Please turn to page 14. RevPAR of our international business Deutsche Hospitality also improved by 18.5% over the same period in 2022. Blended RevPAR stands at EUR78 this quarter. This is driven both by ADR improvement, which is 5.6% over 2022, as well as occupancy improvement, which is 7.3 percentage points over 2022. Please turn to page 15. Our total Group revenue in this quarter was RMB5.53 billion, including RMB4.35 billion from Legacy-Huazhu and RMB1.18 billion from DH. This is an improvement of 64% compared to 2022, higher than our guidance set earlier this year. Our China business delivered a 76.6% revenue improvement. This strong performance is due to first, strong recovery of travel demand, especially in the domestic Chinese market. Secondly, continued product upgrade and product mix change. Thirdly, market penetration and synergies achieved through our regional offices. In the first half of 2023, we opened 638 hotels Group-wide. We expect the hotel opening to accelerate in the second half of this year due to faster pickup of construction activities and supply chain recovery. We stay with our guidance of 1,400 hotel openings this year. The European market further recovered this year as well, and our DH business delivered a 28.4% revenue improvement over 2022. Please turn to page 16. Hotel operating cost was 17.2% higher than the same quarter in 2022, driven by business recovery. We continue to spend considerable efforts to improve operational efficiencies and manage costs at the hotel level. SG&A costs were 45% higher than in 2022 due to higher marketing and sales expenses to drive the business. I would like to highlight that Legacy-Huazhu's SG&A cost was 11.6% of revenue in this quarter. Operating income of Legacy-Huazhu in the second quarter stands at RMB1.35 billion, representing a 31% operating profit margin. This is a significant improvement over 2022 when China was under serious COVID control. Income from operations at DH also turned positive in this quarter compared to the loss situation, both in the second quarter last year and the previous quarter. Please turn to page 17. Adjusted EBITDA in the second quarter stands at RMB1.77 billion. Legacy-Huazhu delivered RMB1.66 billion adjusted EBITDA, representing a 38% EBITDA margin. This quarter we did not have special effects like core share divestment gains as in the last quarter. Adjusted net income stands at RMB1.07 billion. Legacy-Huazhu delivered RMB1.05 billion adjusted net income, which represents a 24% net income profit margin. This improved EBITDA and net income margin results from business recovery as well as cost management. As we continue to move towards an asset-light business model and add hotels through our franchisees and partners, we expect our profit margin to continue to improve. The DH business turned positive this quarter with RMB112 million adjusted EBITDA and RMB21 million adjusted net income. This is a result of conscious improvement of sales efforts and continued cost management of our European team. Our operating cash flow at group level remains strong at RMB2.2 billion this quarter. Please turn to page 18. Our net cash at the second quarter of 2023 is RMB2 billion. Our cash balance is RMB7.8 billion and we have RMB2.8 billion unutilized bank facilities. Please turn to page 19. We expect our Group revenue in the third quarter of 2023 to grow 43% to 47% over the third quarter of 2022. Excluding DH, Legacy-Huazhu is expected to grow 49% to 53%. Based on a good recovery of travel demand and a better than expected performance compared to the estimations made at the beginning of this year, we raise our guidance for the full year 2023. We estimate the revenue in full year 2023 to grow 48% to 52% over 2022. Excluding DH, we estimate Legacy-Huazhu's revenue in 2023 to grow 54% to 58% over 2022. This concludes our management presentation. We can now start with the Q&A session.

Thank you. We will now begin the question-and-answer session. The first question comes from the line of Ronald Leung from Bank of America. Your line is open.

I’ll ask my questions in English as well. My first question is about RevPAR expectations. Management has raised full year revenue guidance and also provided revenue guidance. May I ask what the implied RevPAR expectations are for Q3 and the full year? The second question is about hotel signings. We have seen very strong hotel signings in both the first and second quarters. May I ask what management's expectations are for hotel signings for the rest of the year? Thank you very much.

Thank you for your question. My name is JIN Hui, and I will address your inquiry. As you mentioned, due to the overall momentum in economic development, particularly in domestic circulation, the rebound in consumption, and the recovery of tourism and activities, we are experiencing significant growth. Specifically, we believe that RevPAR will increase to between 128% and 130% in Q3, and for the entire year, the growth will be around 116% to 121%. To expand on your first question regarding RevPAR recovery, I provided the figures of 128% to 130% for Q3 and 116% to 121% for the full year. Regarding new signings, we are pleased to report substantial achievements in Q2. I want to highlight a few points. First, the economic recovery and the resurgence in the hospitality sector have bolstered confidence among franchisers. Additionally, part of our success this quarter can be attributed to the backlog of delayed signings from previous periods. It is important to note that H World Group has reached these milestones for several reasons: we have consistently developed in lower-tier cities over the past few years and have also focused on expanding into the mid-scale and premium markets.

One moment for the next question. The next question comes from the line of Simon Chen from Goldman Sachs. Your line is now open.

I would just ask the question again in English. I have observed that the guidance hasn't been revised up quite aggressively with I think first quarter 118%, second quarter 121%, and third quarter 125% at 2019 level. But based on your full-year guidance, that would imply the deceleration into the fourth quarter. Are you seeing any sign of weaknesses or any reason why you are expecting there to be a slowdown? And then the second one is in relation to potential use of the cash or cash flows, because your company is already in a $2 billion net cash position. How are you thinking about capital reallocation and whether you would consider paying dividends like one of your competitors does?

Thank you, Simon, for the question. I will answer your question. For your first question about the RevPAR, yes, we are very happy and very grateful to see the very good recovery of Chinese domestic travel. The first quarter was really a revenge after COVID, and in the second quarter, we observed very high leisure travel demand in the summer holiday. In the third quarter, we believe because of the October golden week, we will also have some good effects from that. And in the fourth quarter, because of the lack of summer holidays and those prolonged golden week effects, we expect the demand to come back to normal. We are still optimistic about the full-year results. That's why we still have 116% to 121% RevPAR improvement over 2019 for the full year. The second question regarding your cash allocation – capital allocation. Yes, we are also very, very happy to see that with the business recovery, our cash position improved significantly over 2022. So we will continue to monitor the speed of business recovery and also the accumulation of cash. At an appropriate time, we will also decide on a dividend policy as you mentioned.

Thank you for the questions. One moment for the next question. Next question comes from the line of Dan Xi from Morgan Stanley. Your line is now open.

Thank you, management, for the opportunity to ask my question. This is Dan from Morgan Stanley. My question is related to business travel demand and the pace of its recovery. In the last earnings call, management mentioned occupancy not yet fully recovered in terms of business travel demand. So I am wondering if management can share some recent details on business travel demand recovery, such as weekday and exhibition demand in Q2 and possibly Q3 please. Thank you.

Yes, as I mentioned earlier, looking at China's economic reopening from then to now, it has been less than a year. Typically, the recovery of global business travel takes a longer time. Therefore, I can say that this year's recovery of our RevPAR is primarily due to the leisure travel market and the usual summer holiday demand, while business and business-related travel activities are still gradually recovering.

Thank you, management, for your answers.

Thank you for the questions. Next question comes from the line of Sijie Lin from CICC. Please go ahead.

So I have two questions. The first one is that we observed strong interest in becoming a hotel franchisee and where the supply of branded hotels grows fast, which leads to intensifying competition? And do we see the interest differentiate from different brands? So my second question is about the Southern China part. Among our new signings this year, how many of them are in Southern China and will we expect our penetration rates in Southern China to see a significant increase? Thank you.

I will address the two questions. First, regarding the return on investment in the hospitality sector, we are seeing very positive recovery in revenue per available room due to macroeconomic factors. Additionally, real estate rental expenses are currently very low, creating an excellent opportunity for investment in the hospitality sector. It's important to highlight that our strong signings are a result of franchisors recognizing the value the H World brand brings, which emphasizes our brand's premium and extensive market presence. As for the second question about South China, I understand that many are eager to know about our expansion in this region, which boasts a large population and robust economic strength. H World Group places great importance on South China. Over the past two years, thanks to our organizational optimization and the strategy focused on lower-tier cities, I’m pleased to share that our penetration in South China has more than doubled since 2019. We are very optimistic about the South China market's development and will continue to enhance our presence there. I would also like to mention that we are experiencing strong business growth and gaining increasing recognition from local consumers for our brand, which is reflected in our operational results in this area.

Thank you for the questions. One moment for the next question. Next from the line of Lydia Ling from Citi. Please ask your question.

So management, this is Lydia from Citi and I have two questions. The first one is just sharing your full-year RevPAR guidance. Could you give us some color on your outlook for the next year's RevPAR trend, especially given the very high pace this year? And also India has shown a very strong performance this year. Do you think it could sustain next year? And my second question is on extensions. The closure, you know stock closure looks small in the second quarter because of the COVID impact previously. Could you share an update on your July and also August net opening trends? And so yes, like the closures almost down in the first half. Thank you.

Let me first address your question about the sustainability of our strong performance for ADR and RevPAR. I believe H World is committed to maintaining its core competitive edge in the China market. Considering the uncertainties ahead, it's essential for us to establish a long-term sustainable market position. We are focused on improving ADR and occupancy rates, and we take these matters seriously. In the future, we plan to implement more localized marketing strategies across various scenarios and will continue to leverage technology to enhance our overall performance. This commitment to sustainable development is important to us. As for your question about net openings in July and August, I don’t have specific numbers to share. However, I can say that the increase in signings for higher-quality premium hotels in our pipeline will likely result in more openings later this year and into next year. It typically takes us about six months to prepare these hotels for their official openings, so with an increasing number of high-quality hotels in our pipeline, we expect a rise in openings next quarter. Concerning the closure of lower-quality hotels, we have stayed committed to our operational strategy throughout challenges, including during the pandemic. Our focus has been on improving quality and enhancing our services, which is a key aspect of H World’s strategic transformation. We will continue to either transform, upgrade, or repackage our lower-quality offerings as part of our ongoing strategy.

Thank you. I just wanted to summarize here. We stay with our forecast this year or our guidance this year. We will open 1,400 hotels and plan to close 650 hotels.

Thank you for the questions. Our next question comes from the line of Lina Yan from HSBC. Please go ahead.

So will translate my first question. So first question is to ask management to help us reconsider the steady-state RevPAR for Huazhu. We got a lot of new information on the upgrade of the Huazhu hotel portfolio over the COVID period. If we think the overall hotel industry, the RevPAR probably will stabilize at 110% above the 2019 level. Does that mean Huazhu hotel RevPAR will stabilize at a much higher level compared to 2019, say 120% or even above? Yeah.

Thank you for your question. I will take your question about RevPAR. Yes, we are very happy to see that Huazhu's RevPAR recovery is higher than the average industry. This is truly due to our continued product upgrades, product mix change, and our effective sales efforts. For the full year, we provided guidance of 116% to 121%, and we remain confident that we can deliver this number. Regarding how RevPAR will develop in the near future beyond this year, RevPAR is always a result of economic activity. I can only assure you that Huazhu's hotel portfolio is very well positioned, independent of the economic cycle in the short term, because our large portfolio of hotels offers really affordable accommodations. We have observed that many guests from different segments enjoy our hotels as well.

My second question is on the peer comparison. We see some peers who focus on upper-end limited-service hotels deliver very strong RevPAR growth and expansion growth, likely from a low base. Meanwhile, we have commented that business-related travel has a moderate and gradual recovery. Can management help me reconcile the discrepancy and the comments and the results from the two perspectives?

For your question, I believe we have different interpretations of business-related travel compared to some of our competitors. However, looking at statistics from Ctrip and other industry players, you will see a trend: Q2 and summer holiday vacations are peak seasons for China's travel and leisure market, and this has always been the case. A significant factor for the strong performance during this period is the government's stimulus package aimed at boosting the leisure and tourism travel market, as well as the overarching culture and tourism industry. For instance, events like the barbecue festival in Zibo and the basketball activities in Guizhou are examples of this. The Chinese government continually invests in promoting the culture and tourism sector. Therefore, in this broader trend, we have witnessed solid performance driven by demand during peak seasons. However, regarding commercial and travel-related trips, I believe this has been partly influenced by the Chinese macroeconomic outlook, and recovery generally takes a longer time. The reopening period has lasted only eight months, which is insufficient for a complete recovery of this market. Yes, we have faced challenges in recent years, and recovery will take time. Thus, I don't anticipate significant discrepancies among industry players. Looking at H World Group, we are a leading entity in the hospitality market with extensive market coverage, appealing to the mass market. While there are some pricing challenges in certain regional markets, we will continue to enhance our product and service offerings to address these markets. Overall, I do not foresee substantial discrepancies among industry players.

Thank you for the questions. With that, I would like to hand the call back to management for closing remarks.

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

That concludes today's conference call. Thank you for your participation. You may now disconnect.