H World Group Ltd Q4 FY2023 Earnings Call

Good day, and thank you for standing by. Welcome to H World Fourth Quarter and Full Year 2023 Earnings Conference Call. Please be advised that today's conference is being recorded. It is now my pleasure to hand you over to H World Senior IR Director, Mr. Jason Chen. Please go ahead.

Thank you. Good morning, and good evening, everyone. Thanks for joining us today. Welcome to H World Group 2023 Fourth Quarter and Full Year Earnings Conference Call. Joining us today is our Chairman, Mr. Ji Qi, our CEO, Mr. Jin Hui, and our CFO, Mr. Zou Jun. 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 a supplementary slide presentation is available at ir.hworld.com. With that, now I will hand over the call to our CEO, Mr. Jin Hui, to discuss our business performance in 2023. Mr. Jin, please.

In 2023, the domestic traveling industry experienced strong momentum of recovery along with the robust rebound of the industry. H World continued implementing our sustainable, high-quality growth strategy and achieved great results. First of all, let's take a look at our achievements in 2023. Thanks to the strong leisure demand and the gradual recovery of business demand post-pandemic. In 2023, our China business achieved a robust recovery with RevPAR recovered to 122% of the 2019 level for the whole year. Entering into 2024, we still see our RevPAR performing steadily so far. Our hotel network continued to expand. Excluding the economic softer brand, we opened a total of 1,641 hotels in 2023, reaching a record high in terms of annual opening number. At the same time, we closed 789 hotels in 2023. However, excluding the low-quality economic softer brand and HanTing 1.0 version, the closures were only 273 hotels, a slight increase from 237 in 2022. The high closure number in 2023 demonstrated our determination to remove or upgrade low-quality hotels in an accelerated manner, which is in line with our sustainable quality growth strategy. In terms of our pipeline by the end of 2023, our hotels in the pipeline reached 3,061, another record high. The limited-service segment remains our key strategic focus. Our economic and middle-scale products, which target the mass market, are the key drivers of our network expansions. Breaking down our hotels in operation, hotels in pipeline and hotel openings in 2023, the proportion of economic and middle-scale hotels were 92%, 85%, and 90%, respectively. H World has set a specific brand strategy named Iron Triangle to develop the economic and middle-scale segments. The Iron Triangle strategy consists of our three key brands, namely HanTing, JI Hotel, and Orange. In 2023, we have upgraded products for all these three brands. Our HanTing products were being constantly upgraded. The proportion of HanTing 1.0 version was significantly declined from 28.5% as of 2020 to only 4.4% as of 2023. While the proportion of HanTing 2.7 and above version steadily increased from only 34.4% as of 2020 to 71.2% as of 2023. As the first flagship brand with the longest history within the group, HanTing has maintained its market competitiveness and attractiveness to customers and franchisees through continuous product innovation and upgrades. We launched the newest version 5.0 for JI Hotel at the end of last year. The new version further elaborates the lifestyle of oriental aesthetics and shows confidence in distinctive Chinese style service. Starting from the design stage, JI Hotel 5.0 implements the concept of sustainable development, such as adopting prefabricated designs, intelligent lighting systems, and environmentally friendly construction systems. These implementations could largely help reduce environmental pollution and energy consumption. Additionally, we explored some new business models in the public area of the lobby area of JI Hotel 5.0. We introduced an innovative Tea Space or Tea House in JI Hotel's public area and also strengthened the curtain products, which is the scenario-based retail business. Lastly, our Orange brand. We launched the LoHaS version in 2023. After only 1 year post its official launch, Orange LoHaS version has already gained tremendous popularity in the market. As of 2023, the LoHaS products accounted for 58% of the total pipeline of the Orange brand. H World continued to expand geographic coverage of our hotel network. We kept penetrating lower-tier cities in China. As of 2023, around 40% of hotels in operation were located in Tier 3 and 4 and below cities, representing a 2-percentage point increase compared to 2022. At the same time, 55% of hotels in the pipeline were located in lower-tier cities. The percentage numbers were lower compared to 2022, but the absolute number was higher. As of 2023, the number of city coverage was 1,257, adding 131 new city penetrations compared to 2022. In addition, our capabilities for localized development and operation in previously less penetrated or weak areas in China have improved significantly, and we achieved initial results post our organizational restructuring by establishing regional headquarters. In the South, West, and Central China, the total new signings in 2023 increased more than 100%, 80%, and 40% year-over-year, respectively, and increased more than 200%, 130%, and 110% compared to the pre-COVID year of 2019. Our upper mid-scale segment development is continuously progressing. As of the fourth quarter of 2023, there were 645 upper-midscale hotels in operation, representing a 23% year-over-year increase and a 7% quarter-over-quarter increase. There were 386 upper-midscale hotels in the pipeline, representing a 34% year-over-year increase and an 8% sequential increase. Combining the hotels in operation and hotels in pipelines together, the total number of our upper-mid hotels reached 1,031 in 2023. We are very glad that we have achieved our target set in the second quarter of 2021. However, it is still far from enough. We will continue to strengthen our footprint in the upper-midscale segment, mainly through our core brands, and strive to become a leading brand in the market in the foreseeable future. Being one of our core brands in the upper-midscale segment, the Intercity brand launched its new products in 2022. The number of its pipeline hotels has quickly increased to 53 at the year-end, demonstrating the high market recognition and acceptance of the brand and the products. At the same time, the Crystal Orange gained good momentum of new signings as well. By the end of 2023, the number of hotels in the pipeline reached 119, which doubled from the beginning of 2023. Lastly, let's review our performance regarding membership and the Central Reservation System. The total number of members continued to increase to 228 million in 2023 and has ranked #1 worldwide. Direct bookings through our Central Reservation Systems were 62.6% in 2023, representing a 9-percentage point increase on a year-over-year basis. Overall, we continue to reinforce our membership program and Central Reservation System. After discussing our achievements in 2023, let's now go through our key strategic forecast in 2024. Service Excellence-Centric Sustainable Growth; quality growth will be the strategic focus of Legacy-Huazhu in 2024. This strategic focus is divided into 3 major areas. Firstly, High-Quality Hotel Network Expansion. In the limited-service segment, we will continuously expand our footprint nationwide by executing our Iron Triangle strategy, which focuses on less penetrated areas and lower-tier cities. In the upper-middle segment or selected service segment, we will consistently implement our multi-brand strategy to further strengthen our presence. Secondly, customer-centric product upgrades and service excellence. In terms of product quality, we will continue to upgrade old hotels and introduce new products for each brand to meet our customers' diversified needs. In terms of service quality, 2024 marks the beginning of a year of service excellence for H World. It means that we are going to put more emphasis on the service provided to both our customers and franchisees to continuously enhance their experiences and their satisfaction. Lastly, the Digitalized-Based Organizational Capability Enhancement. Continued improvements in both product and service quality would be difficult without strong support from a robust organizational and digitalization capability. We are going to further enhance our management capability and operational efficiency in areas such as supply chain optimization, integrated marketing program, talent reserve, organizational capability, and so on through a comprehensive digitalization process. By doing so, it could help us establish a solid foundation to support our business development in a rapid and sustainable manner. In terms of our overseas business, there are our four major strategic focuses. Firstly, transforming to an Asset-light model; secondly, continuously focusing on cost reduction and profitability improvement; thirdly, further strengthening direct sales via H Reward Global Loyalty Program; and lastly, looking for APAC and Middle East growth opportunities. All of the above are our 2023 review and our 2024 strategic focus discussions. Now, I will hand over the call to our CFO, Mr. Zou Jun, to discuss our 2023 fourth quarter and full-year operational and financial reviews. Mr. Zou, please.

Thank you, Jin Hui. Good morning and good evening to everyone. Let's go through our operational and financial review for the fourth quarter and full year of 2023. In 2023, we continued to expand our hotel network. Our overall number of rooms increased 13% year-over-year to over 912,000 rooms by the end of 2023 compared to over 809,000 rooms as of the end of last year. Our hotel turnover for the full year of 2023 was RMB 80.4 billion, representing a 62% increase compared to 2022. Excluding DH, Legacy-Huazhu Hotel turnover grew 66% year-over-year to RMB 73.3 billion. Since China lifted travel restrictions in late 2022, we saw a strong rebound in leisure travel and a gradual recovery in business travel throughout 2023. Blended RevPAR for Legacy-Huazhu reached RMB 242, representing a recovery of 122% compared to the 2019 level and a year-over-year increase of 54%. The robust RevPAR growth was primarily driven by ADR, which raised 27% to RMB 299 in 2023, mainly due to our product mix change as well as continued product upgrades over the last few years. The occupancy rate also improved throughout the year to 81% for the full year of 2023. For the DH business, full year 2023 blended RevPAR grew 14.5% year-over-year to EUR 71, driven by a 1% increase in ADR and a 7% increase in occupancy rate to 63%. In Q4 2023, our total revenue for the group increased 51% year-over-year to RMB 5.6 billion, exceeding our previous guidance of 41% to 45% year-over-year growth. For the full year of 2023, our group revenue increased 58% year-over-year to RMB 21.9 billion, of which Legacy-Huazhu achieved 64% year-over-year revenue growth to RMB 17.4 billion, and DH grew 39% year-over-year to RMB 4.4 billion. The revenue growth of Legacy-Huazhu was driven by the strong travel demand in China as well as our continued product upgrades and market penetration through regional offices. For DH, its revenue growth was attributable to market recovery on network expansion as well as favorable exchange rates. Hotel operating costs were RMB 4 billion in the fourth quarter of 2023 and RMB 14.3 billion for the full year of 2023. The year-over-year increase was primarily due to our business recovery, with the quarter-over-quarter increase in the fourth quarter largely due to a RMB 200 million impairment loss on the Legacy-Huazhu level as well as RMB 162 million impairment from Legacy-DH. The increase in our hotel operating costs was slower than our revenue growth, reflecting operating leverage. The pre-opening expenses reduced meaningfully as we continued to execute our asset-light strategy and became more selective on opening lease and owned hotels. SG&A expenses were RMB 970 million in the fourth quarter of 2023 and RMB 3.2 billion for the full year of 2023. The year-over-year increase in SG&A was mainly due to increased personnel costs, OTA commissions, and promotional expenses, along with the business recovery. Overall, we achieved operating leverage and delivered income from operations of RMB 757 million in the fourth quarter of 2023 and RMB 4.7 billion for the full year of 2023 compared to an operating loss in the fourth quarter and the full year of 2022. Legacy-Huazhu reported adjusted EBITDA of RMB 1.3 billion in the fourth quarter of 2023 and RMB 6.8 billion for the full year. Please take note that the reported adjusted EBITDA consisted of several one-off items, including around RMB 590 million gains from selling across shares and other investments, around RMB 213 million COVID-related tax subsidy, and rental reduction for the full year of 2023, as well as an unrealized foreign exchange gain of RMB 71 during the year. For the full year of 2023, our DH business reported a positive adjusted EBITDA of RMB 87 million. Our group adjusted net income was RMB 657 million in the fourth quarter of 2023 and RMB 4.1 billion for the full year of 2023. Compared to the net loss in the fourth quarter and the full year of 2022, our operating cash flow improved significantly, reaching RMB 2.4 billion in the fourth quarter of 2023 and RMB 7.7 billion for the full year. As of December 2023, the Group had RMB 10.5 billion cash, cash equivalents, restricted cash, and time deposits on hand and was in a solid net cash position with RMB 5.2 billion net cash, including time deposits. We also had RMB 2.8 billion unutilized bank facilities at the end of last year. In November 2023, we declared approximately USD 300 million cash dividend, which includes USD 200 million regular dividend and a USD 100 million special dividend. We also repurchased about USD 122 million worth of shares from the market during the first quarter of 2023. As we become more asset-light and cash-rich, we'll continue to reward our shareholders. For the guidance, for the third quarter of 2024, we expect revenue to grow 12% to 16% compared to the first quarter last year or 11% to 15%, excluding DH. For the full year of 2024, we expect revenue to grow 8% to 12% year-over-year or 8% to 12% excluding DH. We'll further accelerate our high-quality network expansion, setting our gross hotel opening target of around 1,800 hotels in 2024, and we expect to close about 650 hotels. With that, we're ready to take your questions.

Our first question comes from Dan Xu from Morgan Stanley.

We would like to understand the recent franchise signing progress. Do we have a target for this year on signing, particularly on products and city distribution? Do you see any significant differences compared with last year? Regarding hotel opening, congratulations again on the record-high opening last year. I remember CEO, Mr. Jin mentioned that one bottleneck of annual hotel opening is supply chain and construction. I saw you increased your gross opening target to 1,800 hotels this year, another record high. Does this mean that we have made progress in this bottleneck issue? Should we expect gross openings to gradually increase every year going forward if signing keeps up?

Yes, let me answer your first question. Over the last several years, we have done some of the right things to improve our organizational operation capabilities. We also benefit from three major areas. First is the continuous regeneration improvements in the market, especially benefiting top-tier companies like H World. The second benefit is from the lower-tier cities’ penetrations, where we began building our organizational capability and human resources to support these opportunities several years back. Thirdly, we have caught opportunities from the consumption upgrade and the increase in leisure travel demand, which helped us to develop the upper-mid segment. Given our established capability, we are confident that we're going to have another good year for new signings as well as new openings, just like our guidance for 1,800. Regarding the supply chain, you are correct. Last year, due to the post-pandemic rise, there was a capacity bottleneck, and the industry recovery was very robust. However, we don’t see the supply chain being a bottleneck going forward. In fact, I believe there will be very supportive factors for us for future sustainable, high-quality growth.

Our next question comes from the line of Simon Cheung from Goldman Sachs.

The CEO, Jin Hui, just earlier mentioned that the company has greatly benefited from three macro or structural trends in the hotel industry over the last several years. I am curious whether he has observed any new structural trends or opportunities as well? My second question relates to margin and costs. Last year, you did quite well in terms of the EBITDA margins, particularly in the China business. Can the management share with us the cost and margin guidance for 2025 this year?

Let me answer your first question. Apart from the three benefits that I just mentioned, we think the China lodging market certainly presents opportunities, especially regarding service excellence. Customers are more focused on value for money and good service products across all segments. Thus, we will build our capabilities to meet customer demands in multiple aspects, including operational capability, sales capability, and marketing capability. Our management goal is to elevate the Chinese lodging company to a world-class status in the near future. For mature markets, there are opportunities to rethink the market through product upgrades and improved service.

Simon, I will address your second question regarding cost and profitability. While we continue to strive for healthy growth and service excellence, we will also focus on improving our management systems, streamline operations, and meticulously measure ROI on every dollar spent. Our overall goal remains to strive for operating leverage, and that's definitely our target.

Our next question comes from the line of Ronald Leung from Bank of America.

My first question is about the RevPAR growth outlook. What is management's expectation for the RevPAR growth in Q1 2024 and full-year 2024? My second question relates to the enhancement of service quality. Could management emphasize the areas where the company did not perform well in terms of service quality? Is it possible to provide any specific initiatives to enhance service quality into Q4 and beyond?

Let me answer your first question regarding RevPAR. Last year, post-pandemic, the RevPAR recovery was primarily driven by very strong leisure travel demand. However, the recovery in business travel demand was relatively slower. Therefore, considering the high base of 2023 RevPAR, for 2024, we expect a conservative estimate. That's why we expect the RevPAR to be flat to low single-digit growth on a year-over-year basis. On your second question regarding service quality, indeed, service excellence is not a short-term goal but long-term. We are seeing a rapid evolution of our customer base, and we aim to improve experiences and satisfaction further. For example, we’ve noticed a surge in marathon events across China, and we need to meet the distinct needs of these customers compared to general business travelers. Ultimately, our service excellence strategy is a management goal aimed at growing the company into the next phase.

Our next question comes from the line of Sijie Lin from CICC.

What is the RevPAR guidance for Q1? Would you mind sharing that with us? Considering that we are opening hotels with higher RevPAR while closing hotels with poor performance, how much percentage of RevPAR growth will be contributed by this mix upgrade?

Thanks for your question, Sijie. In the first quarter, our RevPAR might grow around the low single digits. As you mentioned, we will maintain healthy growth with service excellence. However, we also encourage you to look into drivers beyond RevPAR. RevPAR is undoubtedly one of our metrics, but we're evolving from a heavy model to an asset-light model. More franchise and managed hotels will be opened throughout the year. There will be different drivers contributing to our growth in the future.

Our next question comes from the line of Lydia Ling from Citi.

I want to follow up on the store opening pace this year. How is the franchise confidence currently in the market given the macro conditions? Is the company going to offer more support to the franchisee? My second question is on the overseas business, the DH business, which has already shown a positive EBITDA for last year. What strategies will you implement to further drive profitability this year? Do you have any target for this year?

Let me answer your first question regarding franchisees. A healthy return or ROI for franchisees is crucial, and we are putting significant effort into helping them achieve good returns on their investments. We will definitely continue providing quality service, along with supportive policies to ensure that every hotel they open generates good returns. For existing franchisees, we are assisting them in opening hotels profitably. For new franchisees, particularly in emerging regions and segments like lower-tier cities and the upper-mid segment, we are engaging many new franchisees from local property companies, governments, and SOEs. To summarize, we aim to provide excellent service and supportive policies for franchisees to ensure each hotel opened yields a satisfactory return on investment.

Hi, Lydia. I will address your second question regarding DH profitability and cost structure. Firstly, we are committed to the DH moving steadily to an asset-light business model and we are making progress there. Secondly, DH is striving to achieve operational efficiency and is focused on fostering a lean organization. We are meticulously measuring ROI on all major capital and operational spending at the DH business level. With all these efforts, we are determined to gradually improve DH's profitability and reach cash flow positivity.

We have reached the end of the question-and-answer session. Thank you very much for all your questions. I'll now turn the conference back to the management team for any additional closing comments.

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

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