H World Group Ltd Q2 FY2024 Earnings Call

Good day and thank you for standing by. Welcome to H World Second Quarter 2024 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. It is now my pleasure to hand you over to the Senior IR Director of the Company, Mr. Jason Chen. Please go ahead.

Thank you, everyone. Good morning and good evening, everyone. Thanks for joining us today. Welcome to H World Group 2024 second quarter earnings conference call. Joining us today is our Founder and 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 under 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 CEO, Mr. Jin Hui, to discuss our business performance in the second quarter of 2024. Mr. Jin, please.

Hello, everyone. Before presenting our second quarter operating performance, please allow me to share good news with you all. In May, we opened our 10,000th hotel in China. As you can see, this HanTing Hotel is located in Motuo County, Linzhi, Tibet, which is the last county in China to have access to highways. After more than four years of hard work, since we proposed the goal of 10,000 hotels in 1,000 cities at the end of 2019, we have finally achieved this milestone. More importantly, as our lower-tier cities' penetration strategy continuously progresses, we not only recognize that there are still huge opportunities and growth potentials in the Chinese market but also accumulated a large amount of practical expertise and organizational capabilities. Therefore, we will continue to focus on our service excellence-centric, sustainable quality growth strategy and move towards the next goal of 20,000 hotels in 2,000 cities. Next, let's go through our second quarter operating performance. Please turn to Page 4. Legacy-Huazhu's RevPAR in the second quarter was RMB244, down 2% year-over-year. ADR was RMB296, down 2.9% year-over-year, while the occupancy rate was 82.6%, up 0.7 percentage points year-over-year. Despite the relatively weak macro and consumption, the overall travel demand in China remained resilient in the first half of 2024. Data released from airlines, high-speed railways, and the Ministry of Culture and Tourism all confirmed this trend. For example, domestic airlines transported 320 million passengers in the first half of this year, up 16.4% year-over-year and 12.4% compared to the same period in 2019. The high-speed railways transported 2.1 billion passengers in the first half which was a record high and represented an 18.4% year-over-year increase. In addition, based on the data from the Ministry of Culture and Tourism, the number of domestic tourists was 2.7 billion in the first half, up 14.3% year-over-year, showing relatively strong leisure travel demand. As for our own operating results in the quarter, the total number of room nights sold in China increased by approximately 21% year-over-year during the quarter. While our hotel network expanded rapidly, our occupancy rate still increased by 0.7 percentage points year-over-year. This was in line with the occupancy rate improvement targets set by the company at the beginning of the year and also reflected the stability of the overall traveling demand. In terms of the ADR, the pent-up demand and the temporary supply shortage right after the reopening last year definitely led to a very high base of ADR, especially in the second and third quarters. We believe that both occupancy rate and ADR should gradually return to a relatively healthy and sustainable growth trend this year and onwards. Of course, we're also proactively taking various measures to improve our ADR and to ensure that we can continuously outperform the industry as well as bringing long-term RevPAR growth potential. Please turn to Page 5. We focus on three key areas to achieve RevPAR. Firstly, product upgrades, continuously upgrade our main brand with the introduction of new versions to meet customers' changing demands, at the same time, upgrading and renovating old hotels and old products to improve hotel quality. Secondly, the service excellence, with the principle of customer-centric, we intend to provide the best accommodation experiences for our guests and create value and returns for our franchisees, which could lead to a win-win ecosystem. Lastly, our membership program. We continuously focus on improving our member stickiness and repurchase through constant updates of our H Rewards App. At the same time, we further strengthened our capabilities on direct B2B booking and corporate client customers to capture more business traveling demand. We believe that these three aspects could continuously strengthen our core competitive advantages and drive our long-term sustainable growth. Please turn to Page 6. In the second quarter, we continued to expand our network. During the quarter, we maintained the strong hotel opening momentum since last quarter and opened 567 new hotels. The number of hotel closures in the second quarter was 101. If excluding low-quality economic soft brands and HanTing 1.0 versions, we closed only 58 hotels, 28 fewer than the same period last year. Going forward, we will stick to our high-quality growth strategy and continuously remove low-quality hotels from our network to ensure better quality of our entire hotel portfolio. While we maintain a high speed of new hotel openings, the number of hotels in the pipeline at the end of the second quarter reached a record high of 3,266, continuously demonstrating our strong brand power and attractiveness to our franchisees. Our strategic focus on economy and middle-scale hotels for serving the mass market continues to be the key driver of our hotel network expansion. Please turn to Page 7. As of the second quarter of 2024, economy and middle-scale hotels accounted for 92%, 82%, and 89% of our hotels in operation, hotels in pipeline, and hotel openings, respectively. As we mentioned earlier, consistent product upgrades are one of the important drivers of our continued RevPAR outperformance compared to the industry. It is also a key factor for us to achieve industry-leading, high-quality growth. Taking our core brand in the Limited Service segment as an example. Please turn to Page 8. The proportion of HanTing 3.5 and above version in operation continued increasing, reaching 36.3% in the second quarter of 2024, representing an increase of 6.5 percentage points compared to the end of last year. Please turn to Page 9. For our JI Hotels in operation, the proportion of JI Hotel 4.0 and above increased from 30% in 2020 to 65.7% at the end of 2023 and further increased to 71.2% in the second quarter of this year. Please turn to Page 10. The proportion of our latest LOHAS version rapidly increased from 58.4% of the Orange Hotel in pipeline in 2023 to more than 90% in the second quarter of this year. In conclusion, the products and brand power of each of our key brands have been further strengthening through continuous product upgrades. In terms of our regional expansion, we keep penetrating into lower-tier cities. Please turn to Page 11. At the end of the second quarter of 2024, 41% of the hotels in operation were located in Tier 3 and below cities, up 2 percentage points year-over-year. The proportion of pipeline hotels in third tier and below cities reached 54%. Although the proportion was slightly lower than the same period in 2023, the absolute number still recorded double-digit growth year-over-year. The increase in the proportion of pipeline in first-tier cities is mainly due to the acceleration of new signings of our upper-middle segment as well as faster penetration in Southern China. The number of cities covered reached 1,328 cities at the end of this quarter, about 132 cities added compared to the same period last year. With the company's continuous penetration into the lower-tier cities and the consumption trend of customers continuously seeking more value-for-money products, we further explored and developed the economy and budget hotel markets. Please turn to Page 12. In the second quarter, we repositioned our HI Inn brand and redesigned its product. The new HI Inn 6.0 version is positioned as ultimate value for money, with the brand's core value of sleeping well and spending less, focusing on customers' core accommodation needs of good sleep and showering. It offers customers a global standard of accommodation experiences by providing standardized hotel rooms and convenient and high-effective self-service with automatically good value for money pricing. In order to achieve high operational efficiency in a hotel and achieve its brand positioning of ultimate value for money, HI Inn innovatively created a 3-in-1 digital operational system which combines guest self-service, digital front desk, and a mobile staff. Overall, HI Inn will become a strong supplement to our HanTing and Ni Hao brands to further help our lower-tier cities' penetration strategy and strengthen and solidify our leading position in the economy and budget hotel market. Additionally, our upper-mid segment development continued progressing in the second quarter. Please turn to Page 13. At the end of the second quarter of 2024, the number of upper-mid hotels in operation reached 738 hotels, up 31% year-over-year and 8% quarter-over-quarter. The number of hotels in the pipeline reached 509 hotels, up 61% year-over-year and 18% quarter-over-quarter. In the second quarter, the sequential growth rate of both the number of hotels in operation and hotels in pipeline accelerated compared to the previous quarter, demonstrating that our upper-mid brands are increasingly gaining recognition among customers and franchisees. Affected by the macroeconomic situation, the overall business travel market is still recovering relatively slowly. Nevertheless, we managed to offset some shortages from individual business traveling demand by rapidly growing our direct B2B business. This is also a key factor for us to achieve a resilient occupancy rate. Please turn to Page 14. In the second quarter of 2024, the number of room nights booked directly via our B2B platform exceeded 6 million, up 31% year-over-year and 26% quarter-over-quarter. The number of active corporate clients exceeded 3,600, up 47% year-over-year and 36% quarter-over-quarter. Now we are moving to our overseas business. Please turn to Page 15. DH RevPAR in the second quarter was EUR 82, up 4.5% year-over-year, driven by a 2.7% increase in ADR to EUR 120 and a 1.2 percentage point increase in occupancy rate to 68.3%. In June, our DH hotel in Germany performed well, benefiting from the Euro Cup. Please turn to Page 16 for our globalization strategy. As of the second quarter of 2024, about 53% of the hotels in operation were located in Germany. In terms of the hotels in the pipeline, only 39% of the hotels are in Germany and the remaining are in other European countries, Asia, and Africa, each accounting for 36%, 18%, and 7%, respectively. Among them, the proportion of pipeline hotels in Asia has increased meaningfully compared to the proportion of hotels in operation, achieving some periodic results and was in line with the strategy that was set at the beginning of the year. All of the above concludes our second quarter 2024 business update. Now I will hand over the call to our CFO, Mr. Zou Jun, to discuss our regional and financial performance during the quarter.

Thank you, Jin Hui. Good morning and good evening to everyone. Let's go through our operational and financial review for the second quarter of 2024. Now please turn to Page 18. As Mr. Jin Hui mentioned, we reached a remarkable milestone during the second quarter of 2024. The number of hotels in operation for both the group and Legacy-Huazhu stood at 10,000 and the overall number of rooms increased 19% year-over-year to over 1 million as of the second quarter this year compared with over 840,000 a year ago. Hotel turnover for the second quarter of 2024 was RMB23.4 billion, representing a 15% year-over-year increase, of which Legacy-Huazhu's hotel turnover grew 16% year-over-year to RMB21.3 billion. Now please turn to Page 19. In the second quarter of 2024, our total revenue for the group increased 11% year-over-year to RMB6.1 billion, at the high end of our previously announced guidance of 7% to 11% year-over-year growth. Revenue from Legacy-Huazhu grew 11% year-over-year to RMB4.8 billion, also reaching the high end of our guidance for the segment. The growth was driven primarily by our strong new hotel openings. Legacy-DH revenue rose 12% year-over-year to RMB1.3 billion, attributable to both business recovery and hotel network expansion. Next page, please. We are committed to growing under the asset-light model, expanding our hotel network using manachised and franchised hotels. As a result, revenue from our manachised and franchised hotels continued rising. In the second quarter of 2024, manachised and franchised hotels contributed to 48%, or nearly half, of our Legacy-Huazhu revenue, up from 42% a year ago. We expect this trend to continue as we become more and more asset-light. This should lead to a gradual margin expansion for the business as well as to help us become more resilient against economic and industry headwinds. Now please turn to Page 21. Hotel operating costs were RMB3.7 billion in the second quarter of 2024, up 7% year-over-year. The increase was primarily driven by rising staff costs from our continued network expansion. The year-over-year increase in hotel operating costs was meaningfully lower than our revenue growth, thanks to our asset-light strategy. Preopening costs maintained at a low level as we continue moving towards the asset-light model and stay selective on opening leased and owned hotels. SG&A expenses were RMB919 million in the second quarter of 2024, up 24% year-over-year. The year-over-year increase was attributable to headcount normalization as well as a rise in share-based compensation to secure and reward our core employees for sustainable long-term business growth. Income from operations in the quarter reached RMB1.6 billion, representing a 14% year-over-year increase, driven primarily by the strong network expansion of our manachised and franchised hotels as well as further business recovery of DH. Now please turn to Page 22 for our profitability and cash flow during the quarter. In the second quarter of 2024, our adjusted EBITDA increased 15% year-over-year to RMB2 billion. By segment, Legacy-Huazhu's adjusted EBITDA grew 14% year-over-year to RMB1.9 billion, with adjusted EBITDA margin expanding 1% to 39.5%, thanks to our continued business growth, asset-light strategy, as well as our cost-saving initiatives on non-personnel-related expenses. Our DH business generated RMB131 million adjusted EBITDA, turning profitable from a loss position in the previous quarter and representing a year-over-year growth of 35%. Our group's adjusted net income was RMB1.3 billion in the second quarter of 2024, up 17% year-over-year. Operating cash flow for the quarter was flattish year-over-year at RMB2.2 billion. Now turn to Page 23 for our liquidity position. As of end of June 2024, the group had RMB9.9 billion in cash, cash equivalents, restricted cash, and time deposits and was in a solid net cash position of RMB4.3 billion. Including time deposits, we also have RMB3.1 billion in unutilized bank facilities as of the end of our second quarter. Please turn to Page 24 now for shareholder returns. As we become more asset-light and cash-rich, we are committed to rewarding our shareholders through dividends and buybacks. Last month, we announced a three-year shareholder return plan with an aggregate amount of up to US$2 billion. This includes semi-annual ordinary dividends of no less than 60% of the net income this year, as well as special dividends and share buybacks. Concurrently, the Board approved a five-year share repurchase program with an aggregate amount of up to US$1 billion, effective from August 21, which is today. Next page, please. Under the new shareholder return plan, the Board declared a US$200 million interim cash dividend for the first half of 2024. We also continued to buy back shares and have bought back roughly US$143 million worth of shares from the market as of July year-to-date. Lastly, Page 26 on guidance. For the third quarter of 2024, we expect our revenue to grow between 2% to 5% compared to the third quarter of last year or 1% to 4% excluding DH. To reflect our strong hotel opening momentum, we revised up our full year growth hotel opening target to over 2,200 hotels, up from the previous guidance of around 1,800 hotels. With that, we are ready to take your questions.

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

Ronald from Bank of America. I have two questions. So my first question is about the RevPAR expectations. Could you comment on your RevPAR expectations for Q3 2024 and also for full year 2024? Yes. Okay. This is my first question. My second question is about the investment appetite for franchisees. Could management comment on the current investment appetite for the franchisees? Do you see any signs that the franchisee sentiment may slow down because of the RevPAR decline? So let me translate my questions.

Okay. Let me answer your questions, firstly, in regards to the RevPAR. As you may see from the industry numbers released from STR, I think in July and the several weeks of August, on a year-over-year basis, the RevPAR was around a 10% decline. Clearly, we also observed that the macro condition and the hotel consumption, especially the end consumption, was relatively weak. But also, last year, the third quarter was a very high base because that was a peak season right after the reopening post-COVID. But as you may know, from the data itself, our RevPAR performance has always outpaced the industry number. So for the third quarter, we expect that could decline around mid-single digit year-over-year. However, I think this year, the RevPAR should gradually return to a healthier and sustainable development trend, as we mentioned previously. Additionally, another factor is supply has increased year-over-year for this year, especially for certain regions, for example, the eastern part of China. Some of the performance—we also see different performance in different regions. For example, the western part and the central part of China performed quite well. We still see a very strong traveling demand in particular regions. But in the eastern part of China, there may be some over-temporary oversupply or some weak business traveling demand that could be a bit underperforming. But for us, in a longer-term perspective, we remain focused on the mass market. And we think through our strategy and high-quality growth, we remain confident in the longer-term perspective. For the second question, in terms of the franchisees, as you can see, our pipeline continuously grows despite our high-speed new hotel opening because we insist on our key strategy of lower-tier cities penetration and also the upper-mid segment penetration as well. For next year, we will remain focused on these two areas, and through better product and better branding, we are confident that the hotel franchisees' confidence will remain at a healthier and sustainable level. I want to add one more point. Since 2022, we started our high-quality growth. This year, we initiated the service excellence. For both parts, we want to further strengthen our core competitiveness and maintain a strong competitive advantage in the industry. Hopefully, our shareholders or analysts can understand our strategy and plans. Thank you.

Our next question comes from the line of Dan Xu from Morgan Stanley.

Please allow me to translate my question. This is Dan from Morgan Stanley. My question is regarding hotel opening and pipeline, as well as supply chain building. The management continues to mention the pipeline increase on top of the rapid network expansion. So my question is about the company's opening capacity; can management update us on the progress you have made regarding hotel opening, especially as we increased the growth opening target from 1,800 hotels to 2,200 hotels? I assume we are signing more than that number in a year and the pipeline right now is over 3,200 hotels. With more progress made on the supply chain, can we assume this annual opening number will continue to go up? And is there a limit to the number per year?

Okay. Let me clarify in terms of the supply chain. The supply chain is a very important factor for us to maintain our high-quality growth and achieve the 10,000 hotels in 1,000 cities. There are three key areas that the supply chain needs to look at. One is cost leadership, two is high quality, and third is efficiency. In the second half, we will continue to improve our supply chain capability by replacing higher-quality suppliers and further improving our efficiency to lower costs. That won't be—the supply chain could help us to further accelerate hotel network expansion with relatively lower cost and high efficiency. We are very happy to see that we can open more than 2,200 hotels this year. This has supported our localized strategy in our regional offices and the further improvements in supply chain capability. However, I want to emphasize one more time that in the future in terms of hotel network expansion, we will focus on higher quality over scale. We will continue to develop flagship hotels and implement our high-quality, sustainable growth strategy, especially in lower-tier cities. As you may see that given that we are doing a lot of flagship hotels, the number of rooms per hotel actually increased, indicating that the total number of hotels' growth is higher than the total number of hotel rooms' growth itself. All in all, we will remain focused on more quality than scale and implement our high-quality system growth strategy. Thank you.

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

Let me translate the questions. I think there are a lot of concerns about hotel supply in the industry, particularly; we have seen the hotel supply has fully recovered to 2019 levels, therefore actually exceeded year-to-date. I am wondering how you're seeing the hotel supply in the medium term and how that will impact the industry RevPAR? Correspondingly, how will H World think about your RevPAR performance? Additionally, the second question is related to the impact of the RevPAR, now that the guidance seemingly is a bit softer in the second half of the year, how would that impact the margins? My third question is related to DH. We have seen quite a healthy performance in the second quarter and have seen the hotel additions actually accelerate a bit. Wondering if you have some sort of a long-term target, particularly in Asia where you have been—where you have done quite well.

Let me translate my first answer. So in terms of market supply, so basically, the hotel market in China is relatively mature and it's also a market-driven business. We believe the supply and demand will always return to equivalence and supply will also be affected by demand movements. Historically, the entire industry benefited from generational improvements, economic development, and rapid demand increases. Therefore, there are a lot of new suppliers entering the market. But again, our observation is very clear: there is no lack of supply, but there is a lack of high-quality supply. That is the reason why we continuously emphasize high-quality sustainable growth together with service excellence. By doing so, we want to maintain our core competitiveness and provide good supplies and high-quality supplies to the market to gain competitive edge. This is our view on the demand/supply dynamic for the hotel lodging market in China. In terms of the long-term RevPAR development trends, we refer to the developments in the U.S. market over the last 40 years. It shows a clear trend that RevPAR in the U.S. is very positively correlated to GDP growth and inflation and is significantly affected by macroeconomic indications and performance. Given we have established a very strong brand, good products, and organizational capability, as well as traffic sources and membership programs, we believe we could be very competitive in the market in the longer-term perspective. Regarding our DH strategy, there are three aspects. Firstly, it is the asset-light transformation. Historically, we had many leased and owned hotels; now we are focusing on asset-light transformation. Secondly, it’s continuously on cost control and efficiency improvement to maintain healthier and sustainable profitability and cash flow. Lastly, we want to leverage DH's strong brand and product to develop in the Middle East and Asia Pacific.

So about margins, I think, firstly, you see that there are some short-term fluctuations in RevPAR in the market and in business; however, in the long term, we're confident that we'll have a very good RevPAR growth trend through product upgrades, service excellence, and membership program upgrades, as Jin Hui mentioned in his presentation, and we will continue to outperform the market. Secondly, with our business continuously moving towards an asset-light model, the revenue structure, as I mentioned in my presentation, has changed and that will bring a natural margin improvement in the long term. We started to implement a flexible budget and rolling forecast, which will allow us to nimbly respond to market condition changes and adjust our spending levels. We are also meticulously measuring our ROI for each significant spending. With all these efforts, we believe, in the long term, we will have a better margin profile. Thank you.

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

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

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.