Earnings Call Transcript - HTHT Q3 2023

Jason Chen, Senior IR Director

Thank you for standing by and welcome to the H World Q3 2023 Earnings Conference Call. All participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. I would now like to hand the conference over to Mr. Jason Chen, Senior IR Director. Please go ahead.

He Jihong, CFO

Good morning and good evening, ladies and gentlemen. Thank you for joining H World third quarter 2023 earnings call today. We are delighted to report that H World delivered another strong quarterly financial result, reflecting the continuous healthy recovery of the lodging market in China. In today's call, H World Group CEO, Jin Hui, will first elaborate on the business performance and highlight our achievements. I will then go through the key financial numbers. As usual, we will have the Q&A session after the management presentation.

Jin Hui, CEO

Thank you, Jihong. Please turn to Page 3. As usual, let's go through Legacy-Huazhu's RevPAR recovery in the recent months. In the third quarter, we maintained our market-leading performance since the year beginning. Our RevPAR recovered to 129% of the 2019 level. The RevPAR recovery continued to be supported by ADR growth, which was mainly driven by our product mix change. Meanwhile, occupancy rate recovery also improved sequentially in this quarter. Breaking down into monthly numbers, our RevPAR in July, August, and September recovered to 132%, 128%, and 128% of the 2019 levels in the corresponding months respectively. This strong set of numbers benefited from the strong leisure travel demand during the summer holiday season, as well as the continuous business travel recovery. In addition, our RevPAR performance reflected our hotels' superior product quality and brand power, which should continue to support our industry-leading position in operational performance. This year, the rebound of China's leisure traveling demand was better than we previously expected at the beginning of the year. Nevertheless, we keep our cautiously optimistic view on the market outlook unchanged. We certainly saw some pent-up leisure travel demand during some of the peak seasons, such as the Chinese New Year, May holidays, and the summer holiday. But the structural changes in Chinese consumers' consumption post-COVID should not be ignored. Especially, the demand for experience-related activities was growing rapidly with the government's efforts on stimulating domestic demand. After the strong summer holiday season, our RevPAR recovered to 123% of the 2019 level during the Golden Week holiday. For the entire month of October, our RevPAR still recovered to 120% of that in 2019. In the short term, although the macro conditions could possibly remain volatile and uncertain, we will continue executing the company's long-term strategies focusing on building and enhancing our products, brands, management, and execution capabilities. We will continue to expand our hotel networks and further gain market share to achieve long-term sustainable quality growth. Please turn to Page 4. With the current macro uncertainties, we want to re-emphasize four key points to drive our RevPAR to achieve long-term sustainable growth. Firstly, further penetrating into lower-tier cities. That could help us to deliver relatively stable and solid performance with macro volatility and uncertainties, given that lower-tier cities' markets are more resilient. Secondly, the organizational restructuring and optimization enables us to achieve more efficient localized operations. We have accomplished some initial success since the establishment of our original headquarters. We believe those regional headquarters will continue to support the company's hotel network's expansions and achieve further penetration into regions that we were previously weak. Thirdly, the continuous upgrade and improvements of our products and services to achieve better RevPAR premium. No matter in economic segments or middle-scale segments, we are committed to keeping enhancing our products and services in order to further strengthen our dominant market position in the limited service hotel segment. Lastly, further breakthroughs in the upper mid-segment to increase our market share and optimize our overall hotel network portfolio. This year our upper mid-scale segment achieved encouraging progress in operational performance, mainly supported by our three key brands. At the end of September, out of total 9,028 hotels in operation, there were 40% located in the lower-tier cities and 55% of our 2,935 hotels in pipeline were in lower-tier cities. On a year-over-year basis, we see a small increase in the hotel proportion in Tier 1 and Tier 2 cities, thanks to the economic recovery post-COVID in those top-tier cities. Nonetheless, we continue to push forward our lower-tier cities penetration strategy. In terms of absolute hotel number increase in lower-tier cities, our number of hotels in operation increased by 6% year-over-year to reach close to 3,600 hotels, and the number of hotels in pipeline grew around 20% year-over-year to over 1,600 hotels. The number of cities that we covered reached 1,217. Please turn to Page 6. We continued implementing our sustainable quality growth strategies and expanding our hotel networks by opening high-quality hotels. Supported by strong new signings and hotels in pipeline, our hotel openings in the third quarter increased both year-over-year and quarter-over-quarter. In the third quarter, we opened 545 hotels, up 28% year-over-year, and we closed 139 hotels, which mainly included 94 Hanting 1.0 version and soft economic hotels. Under our sustainable quality growth strategy, we have been continuously cleaning up those unqualified hotels, which can help improve the overall quality of our hotel portfolios. The proportion of Hanting 1.0 version and soft economic hotels decreased from 26% at the end of 2020 to only 8% at the end of September this year. Over the same period, the proportion of Hanting 2.7 version and above increased from 14% to 27%. We emphasized that economic and mid-scale hotels will always be our core products. As we strive to better serve the Chinese mass consumer market, as of the end of September, 55% of our hotels in operation were economic hotels and 37% were mid-scale hotels. The proportion of mid-scale hotels was up 3 percentage points on a year-over-year basis. For hotels in pipeline, around 37% were economic hotels and 48% were mid-scale. The proportion of mid-scale hotels was up 5 percentage points year-over-year. In the third quarter, 91% of the new hotel openings were economic and mid-scale hotels. As you can see, while we are optimizing and enhancing our overall hotel product quality, our limited service hotel segment, which comprises economic and mid-scale segments, are always our key focus to continue improving in order to better meet the travel and accommodation needs for the Chinese mass market. It is worth noting that within the limited service segment, we are seeing the proportion of mid-scale increasing, which perfectly matches consumers' rising demand for better quality accommodation products. This year, we achieved encouraging breakthroughs in the upper-mid segment. At the end of September, we had 605 hotels in operation, which represented a year-over-year and quarter-over-quarter increase of 18% and 8%, respectively, and we had 357 hotels in pipeline which grew 35% year-over-year and 13% quarter-over-quarter. The strong pipeline growth reflects the rising brand awareness of our upper mid-scale hotels and provides solid support for future development. Within the upper mid-scale segment, our two key brands, including InterCity and Crystal Orange, both have achieved remarkable new signings this year. Last year, we launched DH's InterCity brands in China and opened several new leased InterCity hotels in Wuhan, Zhengzhou, Shenzhen, Shanghai, and so on. Over the past three quarters, the new signings of InterCity grew meaningfully. At the end of September, we had 41 InterCity hotels in the pipeline, and the number of pipelines for the Crystal Orange brand reached 108. The fast-growing pipeline demonstrates that our InterCity and Crystal Orange products and brands are getting more recognized and accepted by our franchisees. Here concludes our business review and updates for the third quarter of 2023. With that, I will now turn the call over to our CFO, Ms. He Jihong, to discuss DH's operational update and our group's financial performance.

He Jihong, CFO

Thank you, Jin Hui. I will now elaborate DH's activity so far this year. Despite Germany's slow economic recovery post-COVID, RevPAR of DH portfolio outperformed the overall German market using relevant data. In the third quarter of 2023, year-over-year cost growth is in line with revenue growth, despite inflationary pressure in Europe after excluding one-off adjustments and restructuring costs. Our priority remains to control and reduce costs through business restructuring as well as leveraging technology. At the same time, we are repositioning the current hotel product design to reflect the demands of modern travelers. We are also making efforts to strengthen our presence in the Middle East and explore new international markets such as Asia Pacific. I'm now going to highlight the financial performance in the next section. Our hotel network continued to expand in the third quarter of 2023. The total number of rooms in operation increased 11% year-over-year and reached 885,756. Hotel turnover increased 55% year-over-year and reached RMB23.5 billion. Legacy-Huazhu blended RevPAR recovered to 129% of 2019 and achieved RMB278. This was primarily driven by ADR increase, which was 33% over Q3 2019 and 27.7% compared to Q3 2022. Occupancy still lags Q3 2019 by 1.8 percentage points. Nevertheless, the occupancy of 86% is quite a high benchmark for the size of our total portfolio. Legacy-DH blended RevPAR increased 4.5% year-over-year and achieved EUR79. ADR remained flat compared to the third quarter of 2022, but occupancy increased by 2.9 percentage points. Total revenue of H World increased 54% year-over-year achieving RMB6.3 billion. Legacy-Huazhu revenue increased 62% year-over-year, achieving RMB5.1 billion. This achievement was possible through, first, strong domestic travel demand, especially during the summer holiday; second, continued product upgrade and improvement of product mix; and the third, market penetration and synergy through regional offices. Revenue from Legacy-DH also improved 26% year-over-year, driven by higher RevPAR and higher hotel turnover. Legacy-Huazhu operating income achieved RMB1.9 billion in the third quarter of 2023. Compared to the third quarter of 2022 and the second quarter of 2023, this is a significant improvement. This is achieved through revenue increase and, at the same time, cost management efforts for both hotel costs and SG&A expenses. On the Legacy-DH side, operating costs increased in line with the revenue increase. On SG&A side, there are some one-off effects and restructuring costs booked in Q3 2023. Taking this effort out, the SG&A cost also increased proportionally with the revenue increase compared to Q3 2022. Legacy-Huazhu adjusted EBITDA achieved RMB2.1 billion in Q3 2023, and adjusted net income achieved RMB1.4 billion. Legacy-DH adjusted EBITDA was RMB55 million in Q3 2023. Adjusted net income fell into negative territory of minus RMB37 million. On the group level, operating cash flow was RMB1.2 billion. The fluctuation compared to Q2 2023 is due to short-term change of timing of franchisee fee payment at the end of September. The group is in a net cash position as of the end of September, with net cash of RMB3.9 billion and an unutilized bank facility of RMB2.7 billion. We estimate the revenue in Q4 2023 will grow by 41% to 45% compared to Q4 2022. Excluding DH, the Legacy-Huazhu revenue is estimated to grow 48% to 52% compared to Q3 2022. This concludes the management presentation.

Jason Chen, Senior IR Director

Hi, operator. We can start the Q&A session, please.

Unidentified Analyst, Analyst

Good morning, management. First of all, congratulations on a very strong third quarter result. I have a question regarding the recent announcement of Board resolution on cash dividend. I'm wondering if the company can share a bit more details on this dividend payment. For example, timing, what to expect, size of the dividend that is proposed, and whether it is a regular or special dividend?

Jin Hui, CEO

Let me answer your question first. Yes, our Board is considering a cash dividend and once we get the approval from the Board resolution, we will immediately release the information to the market regarding the exact policy and the payout ratio. I want to add another point: as H World business is going to be more asset-light, we definitely want to manage cash and net profit effectively going forward.

He Jihong, CFO

Just a little bit to add to Mr. Jin Hui's comment. Huazhu, especially Huazhu China, has recovered very well. We are very confident that especially the Chinese lodging market will continue to recover. So we expect a very stable cash flow in our future operations. With this kind of stable cash flow and net earnings, we would like to return some of our earnings back to our investors. We will resume our continuous stable base dividend policy, as well as special dividend policy from time to time if our cash flow shows very strong performance. Please just be patient; we have a couple of days until the Board resolution is decided, and we will announce it in time. As for the cash payment, we expect it around early next year.

Ronald Leung, Analyst

Let me ask my questions in English. My first question is about the outlook for 2024. Does management have any preliminary forecast for the RevPAR growth and hotel openings for 2024? My second question is about the balance sheet. Currently, the company has a very strong balance sheet and cash flow. What do you think is the optimal capital structure for the company? Thank you very much.

Jin Hui, CEO

Let me translate the first answer. In terms of expectation for next year regarding RevPAR and new openings, we will provide guidance to the market when we release our fourth quarter earnings probably next year. However, I want to add that we are still keeping our conservatively optimistic view for the China business given that we believe we are still offering the best product for a market-leading position, and we should continue to benefit from the ongoing improvements and further consolidation of the market.

He Jihong, CFO

Okay. I will take the question about the capital structure. As you can see, Ronald, from our balance sheet for the third quarter, we have a very strong net cash position. I'm confident that with the business improving quarter-by-quarter, year-by-year, our cash position will remain strong. As part of the effort to reward our investors, we have already announced our dividend payout policy, which will continue. We also do not exclude the possibility of some share buybacks at the appropriate time. Regarding debt and equity, we still have $500 million convertible bonds at this moment, which will take some time to mature. We will continue to leverage some of the bank facilities for our short-term working capital because Chinese interest rates are very low. Please be assured that the financial management team of H World will manage our cash position diligently, managing our reward program for investors while also leveraging the lower interest environment in China and managing overall debt positions to avoid any potential issues.

Simon Cheung, Analyst

So I have two questions. The first question is in relation to the hotel opening. I've noticed that H World has actually been able to achieve a much faster hotel opening than many peers. I wonder what the reasons are and whether management could share with us the latest update with the Southern China strategies. The second question is regarding the fourth quarter RevPAR. We have noticed a significant downward trend in October. I am curious whether this is technical or structural, and what the outlook is going into November and December, particularly whether there are reasons related to business versus leisure travel.

Jin Hui, CEO

To answer your first question, post-COVID, we've achieved significant progress in terms of new signings and pipeline increases this year. This was mainly attributed to several reasons. Firstly, our market-leading brands, especially in the limited service segment, including Hanting and JI Hotel. Over the last several years, we've enhanced our product quality and conducted many upgrades, which have further enhanced our brand reputation and awareness. This has undoubtedly benefited us in terms of increasing new signings. Specifically in the middle-scale segment, last year we positioned the Orange brand to become our second main brand in this area, and since the launch of the Orange 3.0 version earlier this year, it has been well received by the market and franchisees, resulting in significant new signings. Additionally, further strengthening our presence in lower-tier cities has played a critical role, as well as improving in previously weak markets, including southern, western, and central China. This is a benefit of our organizational restructuring, which has enhanced our business development capabilities on the ground. Currently, these three previously weak regions are contributing more than 40% of our new signings year to date. Lastly, we are achieving a breakthrough in the upper mid-segment, mainly due to our InterCity and Crystal Orange brands, as I mentioned earlier. Regarding your second question about the RevPAR trend, the decline in October is primarily due to normal seasonality; usually, following the Golden Week holiday, there is a low season. This is a normal seasonal impact, and we expect the RevPAR recovery in the fourth quarter to be in the range of 115% to 120% compared to the same period in 2019.

Sijie Lin, Analyst

Thank you, management. You have been to some lower-tier cities to do field research. Could you please share your main observations that lead you to believe there are many opportunities in lower-tier cities? Additionally, in order to seize the low-tier market opportunity, we've established regional headquarters. Are there any other capabilities we need to strengthen?

Jin Hui, CEO

Despite the urbanization rate reaching over 65% this year, we're still observing further urbanization progress in lower-tier cities. We're also seeing population increases in these cities. The development of high-speed rail and expanding highway networks have contributed to record-high passenger numbers transported by high-speed rail this year. This is primarily supported by governmental efforts to stimulate domestic demand, increasing demographic mobility. The lower-tier cities represent a resilient market, and importantly, these cities house over 1 billion people. We believe there's significant potential to further explore these markets. As the leading company, H World is committed to providing superior products and services to meet the demand for better accommodations in lower-tier cities. The organizational restructuring has certainly generated benefits in alignment with our penetration strategy for the lower-tier cities. We aim to get closer to our customers and franchisees to better understand their demands.

Unidentified Analyst, Analyst

We notice InterCity is gaining traction among franchisees. Could you tell us more about the current business situation such as ADR and RevPAR? Additionally, can you share what cities represent the distribution of InterCity in the pipeline? What are the characteristics of your franchisees?

Jin Hui, CEO

Thank you for your interest in our InterCity brand. Since its launch last year, we’ve opened several leased InterCity hotels in multiple cities. However, given the relatively small scale, we don't think it's appropriate to disclose specific ADR or RevPAR metrics at this time, as we currently operate only a few InterCity hotels. That said, if we discuss operational data, all ADRs and RevPARs have performed better than our competitors. We’re confident that the brand is gaining acceptance among franchisees and within the market. Regarding franchisees, we are observing distinctive types compared to our limited service segment. There are two main types of franchises: firstly, industry-leading franchisees, as opening an InterCity Hotel requires significant CapEx investment, typically around RMB30 million to RMB50 million, which only top franchisees can afford. Secondly, we're also seeing many local property developers and owners, who have previously partnered with international brands, are now considering us as a substitute due to our leading operational capabilities.

Jason Chen, Senior IR Director

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.

Operator, Operator

That does conclude our conference for today. Thank you for participating. You may now disconnect.