Earnings Call Transcript - HTHT Q3 2022

Operator, Operator

Good day, and thank you for standing by. Welcome to the H World Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. And now I'd like to hand the conference over to Mr. Jason Chen, Investor Relations Director. Thank you. Please go ahead, sir.

Jason Chen, Investor Relations Director

Thank you. Good morning and good evening everyone. Thanks for joining us today. Welcome to H World Group third quarter 2022 earnings conference call. Joining us today is our Chairman, Mr. Qi Ji; our CEO, Mr. Hui Jin; our President, Ms. Xinxin Liu; our CFO, Ms. Chen Hui; our Deputy CFO, Ms. Fei Year-on-year; and our CEO of International Business, Ms. He Jihong. 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 provisions 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 measures to comparable GAAP information can be found in our earnings release that was distributed yesterday. As a reminder, this conference call is being recorded. The webcast of this conference call as well as supplementary slide presentation is available at ir.hworld.com. With that now, I will turn the call over to Mr. Qi Ji. Mr. Ji please.

Qi Ji, Chairman

Good morning and good evening, everyone. Thank you for joining our call today. We are happy to report that our China business grew positively in the third quarter, recovering to 90% of 2019 levels, thanks to the pent-up leisure travel demand as well as a recovery of business travel. This recovery is closely associated with the relaxing of our COVID policy in the third quarter. However, with the recent increase in COVID cases, we may face more uncertainties and the negative impact on our business recovery as a consequence of tightened control measures. In the third quarter, we reported that we executed organizational restructuring and established six regional headquarters to focus on economic and middle-scale segments. We have been further implementing our regionalization strategy under strengthening our regional organizations. At the same time, we realigned the structure for Up and Middle Scale, Upscale and leisure brands in China to provide more efficiency to management. With our long-term sustainable quality growth strategy, we have further emphasized improvement of products and service quality. We accelerated the exit from low-quality soft brands in the economic segment. Moreover, we continuously upgrade our mature brands such as HanTing and Ji Hotel to enter new versions with better design and quality. Looking back over the last three years, COVID brought tremendous challenges to the Chinese lodging market. However, branded chain hotels have shown higher resilience than independent hotels. In fact, over these last three years, chain hotels have continuously gained more market share and led the recovery of the industry. We believe there is a shift from independent hotels to branded hotels in leisure momentum and we will have a brand-new hotel chain to consolidate the leisure market. We are confident that we will benefit from this shift with our strong brand and quality products. With the recovery of the international travel market, our Deutsche hospitality business achieved another good quarter with further RevPAR improvement. RevPAR in the third quarter recovered to 102% compared to 2019 levels. With cost management and the reorganization of business structure in place, we are in a good position to continuously improve our product and facilities. Due to recent large sporadic resurgences of COVID in many provinces and cities in China, we see strict COVID measures continue to be executed in order to cope with short-term turbulences and preserve dry powder. We will further streamline operations, be prudent on CapEx spending and allocate resources in a disciplined way. We always work closely with our franchisees and partners to help them cope with the challenges during this special period. Together with friends and partners in our ecosystem, we will further strengthen the foundation and build resilience of our company. With this, I will turn the call to Hui Jin to discuss our significant developments in detail.

Hui Jin, CEO

Thank you, Qi Ji. Firstly, please turn to page 3. Let me briefly review our key achievements in the third quarter. First, our RevPAR recovery in China continues despite the impact of COVID. Second, we are expanding our network with a focus on sustainable quality growth. Third, we are on track for the development of the upper middle scale and upscale segments. Fourth, we successfully launched the new H World App with enhanced features. Fifth, Deutsche Hospitality is on a recovery path. Now, I will discuss each of these points in detail on the following pages. Please turn to page 4. Despite the ongoing COVID resurgence, we achieved a relatively good RevPAR recovery in the third quarter in China, recovering to 90% of 2019 levels. This was mainly driven by pent-up leisure demand in July and August, along with a gradual recovery of business travel in late September. However, we saw sporadic COVID resurgences in October, leading to strict restrictions again. Our RevPAR in October recovered to only 74% of 2019 levels. Please turn to page 5. Our hotel network expanded further, with GMV continuously increasing during the quarter. At the end of the third quarter, our number of hotel rooms rose by 10% year-over-year to 797,000, with hotel rooms in China growing 11% year-over-year to 772,000. Our total GMV in the third quarter increased by 24% year-over-year to RMB 15.2 billion, where China GMV grew 22% year-over-year to RMB 13.5 billion. Our strategy for penetrating lower-tier cities is making steady progress. Please turn to page 6. By the end of the third quarter, hotels in lower-tier cities contributed 41% and 59% of total hotels in operation and pipelines, respectively. However, our new signings during the quarter were still lower than a year ago, reflecting that our franchisees' confidence level has not fully returned due to the resurgence of COVID. Please turn to page 7. Looking back over the past few years post-COVID, data from the China lodging industry shows that branded chain hotels have demonstrated better resilience than independent hotels. Many independent hotels, which have weaker risk management capabilities, have closed, with roughly 22% and 13% closing in 2020 and 2021, respectively. During the same period, our hotel network continued to grow, with closure ratios of 10% and 7% in 2020 and 2021, significantly lower compared to independent hotels. The chain hotel ratio in the China lodging industry has increased from only 19% in 2018 to 35% in 2021, indicating that the trend of further industry consolidation post-COVID remains firm. Additionally, as Mr. Ji mentioned at the beginning, an increasing number of independent hotels are opting to join branded chains, which could provide more consolidation opportunities for us in the long run. Please turn to page 8. We remain committed to our sustainable quality growth strategy for long-term development. For example, with our Hanting brand, we have continuously upgraded our products over the past few years. We found that upgrading to newer versions improved RevPAR by roughly 20% compared to older versions on average. At the end of the third quarter, 2.7 versions and above accounted for about 59% of total Hanting Hotels in operation, an increase of 25 percentage points since 2020. Likewise, Hanting's customer satisfaction score improved along with product upgrades, rising from 4.5 in 2020 to 4.67 in the third quarter. Please turn to page 9. All our brands are enhancing overall hotel quality. As shown, contributions from low-quality soft brand economic hotels and Hanting 1.0 versions have gradually decreased over the years. As of the third quarter, they accounted for roughly 14.3% of our total hotels in operation. Improvements in hotel product quality have also led to a continued rise in customer satisfaction scores, increasing from 0.54% in 2020 to 4.68% in this quarter. Please turn to page 10. Our Orange brand hotel achieved a milestone of 500 hotels during the quarter, reaching 505 hotels by the end of the quarter. It becomes the third brand in our group, alongside Hanting and JI Hotel, to surpass 500 hotels. The mid-scale segment is also progressing steadily. Please turn to page 11. We introduced a new version of the InterCity brand during the quarter, which will primarily be situated in traffic hubs or commercial centers, bringing German simplicity and pragmatism to hotels in China for efficient customer service. Our two newly opened InterCity hotels are located in Shenzhen and Wuhan. In the upscale segment, our Blossom House brand is quickly entering the leisure travel market. Please turn to page 12. Since our acquisition, we have transformed its business model from 90% lease-based hotels to about 67% operating on an asset-light franchise model. Furthermore, the brand has expanded from a single Blossom House brand to include Blossom Lifestyle Community and Blossom Collections, achieving a multi-brand development model. Please turn to page 13. We have further upgraded our H World app and successfully launched its 4.0 version, focusing on the full digitalization of guest experiences and enhancing interaction with guests across various touchpoints. For instance, our Intelligent Laundry function allows customers to book remotely and track the laundering process in real-time, enhancing the perception of member benefits. In the first nine months of 2022, 99 million customers utilized our online services compared to just 27 million the previous year. Usage of online services also rose to 71% in October, up from 21% last year. The above are our key business development updates for the third quarter. With that, I will now turn the call over to our CEO of International Business, Mr. Jihong, to discuss our DH business development during the quarter.

Jihong He, CEO of International Business

Thank you, Qi Ji and Jason. Hello. My name is Jihong. I'm responsible for international business at H World. In our international business, we are very happy to report that we have continuous recovery in the third quarter. Our blended RevPAR increased 102% compared to the same quarter in 2019, with this recovery trend continuing into October as well. The recovery was primarily driven by ADR, which increased by 17% compared to the same quarter in 2019. This demand continues to be driven by transient leisure travel and pent-up corporate group businesses. In the third quarter, our team in Deutsche Hospitality continues to focus on cost management and margin improvement. As a result, we can report the third quarter EBITDA of RMB 94 million, a significant improvement compared to the loss of RMB 115 million in the third quarter of 2021 and an achievement of 213% increase compared to the second quarter of 2022. This margin improvement was driven by headquarter overhead reductions and operational efficiency improvements, along with the RevPAR growth. At the same time, we are carrying out several energy management initiatives in our hotels to cope with increasing energy costs in Europe, especially in Germany. In the third quarter, we added 23% system size growth of hotel rooms compared to the third quarter of 2019. We launched our new website with all brands and a new H reward program to focus on loyalty development in the direct booking channel. We rolled out several new digital products to improve technology deployment. We are currently focusing on a digital leap to further improve the efficiency of our budget hotels through technology deployment. With this, I'm handing over to Ms. Ye Fei for the third quarter financial results.

Ye Fei, CFO

Thank you, Jihong. Good morning or good evening to everyone. Let's move on to our operational and financial review for the third quarter of 2022. As shown on slide 17, Legacy-Huazhu blended RevPAR for Q3 performed well, only 10% off from 2019, mainly dragged down by the occupancy rate. The ADR in Q3 2022 was up by 3% on a year-over-year basis and RevPAR was up by 9%. Turning to page 18, Legacy-DH business recovery further accelerated in the third quarter, as Jihong mentioned. Our Legacy-DH blended RevPAR for Q3 grew by 57% to €76 compared with Q3 2021 and also grew by 2% compared with the 2019 level. The occupancy improved by 17 percentage points compared with Q3 2021, but still remains 9.6 percentage points lower than the 2019 level. The ADR improved by 15% year-over-year to €114, which actually exceeded the 2019 level by 17%, driven by the pent-up demand in Europe and price increases to counter cost inflation. Please see our financial results on slide 19. Total revenue grew by 16% year-over-year to RMB 4.1 billion in Q3, mainly driven by the 7.7% year-over-year revenue growth of Legacy-Huazhu to RMB 3.2 billion and 68% year-over-year revenue growth of Legacy-DH to RMB 932 million. Revenue was in line with our previous guidance. Legacy-Huazhu revenue growth was mainly supported by leisure demand during the summer holiday in July and August and the gradual recovery of business travel in late September, as well as a low base from last year. Breaking down the revenue in Q3, leased and owned revenue grew 15% year-over-year to RMB 2.7 billion. Excluding DH, leased and owned revenue of Legacy-Huazhu grew by 0.5% year-over-year to RMB 1.8 billion, despite shutting down some loss-making hotels during this quarter. Revenue from managed and franchised hotels declined by 16% to RMB 1.3 billion, mainly driven by a 16% revenue increase from Legacy-Huazhu and a 22% revenue growth from Legacy-DH. The 16% year-over-year growth of revenue from managed and franchised hotels of Legacy-Huazhu also included roughly RMB 120 million impact from the management fee waiver provided to the franchisees during this quarter. Due to the strong business recovery of Legacy-DH leased and owned hotels during this quarter, at the group level, the managed and franchised revenue contribution was flat at 32% in Q3 compared to last year. However, in China, considering the management fee waiver provided to our franchisees, our managed and franchised revenue contribution in the third quarter further expanded to 40% compared to 38% in Q3 last year, thanks to our continuous network expansion with an asset-light model. Now let's move to the cost and profitability section on Slide 20. In Q3 2022, the reported operating income was RMB 500 million, compared to only RMB 72 million last year and RMB 8 million a quarter before. The significant increase in operating income year-over-year was mainly due to better performance in our China business and the recovery of the DH business. Excluding DH, Legacy-Huazhu's operating income in Q3 was RMB 449 million, growing by 88% year-over-year and significantly improving from RMB 21 million a quarter ago. The hotel operating cost for Q3 was RMB 3 billion, which increased by 6.6% year-over-year. For Legacy-Huazhu, it recorded RMB 2.3 billion in hotel operating costs, almost flat from last year. The increase was mainly from variable costs such as utilities, salaries, performance-based bonuses for hotel GMs, and more GMs recruited as our hotel network expands. We were able to offset the costs by roughly RMB 130 million in rental reductions, which doubled what we achieved in Q2. For Legacy-DH, we recorded RMB 744 million in hotel operating costs, indicating an 18% year-over-year growth. The increase was mainly due to the rise in variable costs associated with business recovery such as labor, F&B, variable rents, etc., but we had less rental reduction compared to the same quarter last year as business recovered. Our pre-opening cost was RMB 25 million in Q3, mainly due to limited service leased and owned hotels under construction during this quarter, including the flagship InterCity hotels. This number is expected to be small as we raised the hurdle for leased hotels and focused on the asset-light model. Our SG&A in Q3 increased by 1.6% year-over-year and 15% Q-over-Q to RMB 586 million. Excluding DH, SG&A for Legacy-Huazhu was flat on a year-over-year basis at RMB 435 million, where labor costs remained roughly the same as last year while headcounts were already trimmed during this time. Further efficiency improvements are underway. The 31% Q-over-Q increase was due to the resumption of business in the Shanghai headquarters after the lockdown in Q2. On the DH side, overall selling expenses increased along with business recovery while generating higher efficiency as selling expenses as a percentage of revenue declined by 2% from the previous quarter's weakest performance. Although other operating income in Q3 2022 increased by 90% year-over-year to RMB 76 million, mainly due to more subsidies received from the government for our China business side. Turning to page 21, our adjusted EBITDA was RMB 491 million in Q3 2022 compared to RMB 385 million a year ago. DH achieved better profitability in Q3 with EBITDA at RMB 94 million compared to the loss of RMB 116 million last year. Excluding DH, Legacy-Huazhu recorded an adjusted EBITDA of RMB 397 million, which declined by 20% year-over-year but significantly improved from RMB 23 million a quarter ago. The year-over-year decline was mainly due to the RMB 340 million Forex loss brought about by the depreciation of the euro/dollar against our accounting currency USD, which is largely a non-cash loss. If we exclude the Forex loss, the EBITDA would be over RMB 150 million higher than 2021. In Q3 2020, we recorded an adjusted net loss of RMB 375 million, a large increase from the loss of RMB 46 million a year ago and a loss of RMB 84 million a quarter ago. Excluding DH, Legacy-Huazhu recorded an adjusted net loss of RMB 389 million, which was a large increase from a loss of RMB 39 million a quarter ago. The net loss was mainly due to the Forex loss as I mentioned previously and also the timing adjustment of effective tax payments in China between the quarters. Adjusted net profit of Legacy DH turned positive for RMB 14 million for the first time in Q3 compared to the net loss of RMB 164 million a year ago. Coming to the cash position, our net debt increased slightly to RMB 6 billion in Q3 from RMB 5.7 billion in the previous quarter, mainly due to some bank facilities withdrawn this quarter. Our cash balance improved to RMB 5.2 billion in the quarter from RMB 4.7 billion a quarter ago. The unutilized bank facilities are RMB 2.9 billion. Given the COVID impact remains uncertain, we are very cautious on CapEx and OpEx spending to preserve cash. Additionally, we have successfully redeemed our convertible note of $475 million recently through a combination of bank facilities and cash generated from operations. Turning to page 24 on guidance, given the recent resurgence of COVID in many provinces and cities, H World expects revenue to grow 7% to 11% in the fourth quarter of 2022, compared to the fourth quarter of 2021 or to decline by 1% to 5%, if excluding DH. Again, this guidance reflects our current view which is subject to change. With that, let's open for Q&A. Thanks.

Operator, Operator

Thank you. We will now begin the question-and-answer session. Our first question comes from the line of Dan Xu from Morgan Stanley. Please ask your question, Dan.

Dan Xu, Analyst

Hi. Good morning. Can you hear me?

Hui Jin, CEO

Yes.

Dan Xu, Analyst

Sorry, please allow me to repeat my question in English. This is Dan from Morgan Stanley. I have two questions. My first question is regarding Legacy-Huazhu. For the China domestic business, I would like to inquire about the recent RevPAR trends for October. We noticed a decline in RevPAR due to increased tightening measures, with October's RevPAR at 74% of 2019 levels. I would like to know the trend for November. Additionally, concerning the revenue guidance for the fourth quarter, particularly for Legacy-Huazhu, what factors does management consider regarding RevPAR and hotel opening expectations? Thank you.

Hui Jin, CEO

Okay. To answer your first question, due to the sporadic resurgence of COVID in various cities and provinces in China, we are witnessing stricter restrictions enforced by local governments to uphold the zero policy. As a result, we now anticipate that our RevPAR recovery for the fourth quarter could be between 70% and 75% for our China operations. Regarding openings in the fourth quarter, the recent COVID situation will impact them to some extent. However, if you're inquiring about the effect of new openings on revenue, the impact will be quite limited in the fourth quarter. The primary influence on revenue will come from the RevPAR recovery, which is significantly affected by the recent resurgence of COVID. Thank you.

Dan Xu, Analyst

My second question is about the overseas DH business. Considering the rising inflation in Europe, can management provide more insights on the energy efficiency measures that have been implemented by DH? We noticed that DH operating expenses actually decreased by 4% quarter-on-quarter in the third quarter. What is the trend looking like for the fourth quarter? Should we anticipate further increases during the winter? Thank you.

Ye Fei, CFO

Thank you, Dan, for your question. I will address the issues of international businesses. Your question is quite complicated, so I will try to dissect it into different areas. Actually, we are focusing, first of all, on top line management. So we are focusing on revenue management really to generate top line results and increased ADR where possible, which is really in line with all the international hotel management groups, especially with inflationary results. At the same time, of course, we continue our operational improvement program as we already started this year, including operational cost management, especially in headquarters, efficiency improvement, and energy efficiency management as you mentioned. At the same time, we are also conducting our portfolio review about the performance of assets. The energy efficiency management at the hotel level is very granular and operational. For example, we do not turn on the air conditioning when it's not necessary. We turn down the heat when it is too warm, and we turn off the lights when there's nobody around. So we really try to penetrate into all day-to-day operations to cut down our energy costs. At the same time, we are also negotiating with energy supply companies to manage our costs. We have some short-term fixed price arrangements and mid to long-term flexible pricing. But I assure you that we are already working very closely with the energy supply companies to manage our costs. Some of these effects we reported this quarter should continue to be observed in the fourth quarter and next year as well, especially regarding some of the efficiency improvement programs and overhead cost reductions; the full-year result will only start to show after the one-time write-off. I hope that addresses your question, Dan.

Dan Xu, Analyst

That's very clear. Thank you, Ms. Ye.

Operator, Operator

Thank you for your question. Our next question comes from the line of Ronald Leung from Bank of America. Please ask your question, Ronald.

Ronald Leung, Analyst

Hi. Could you hear me?

Operator, Operator

Yes, please go ahead.

Ronald Leung, Analyst

Please allow me to ask the question in English. Over the past few months, there have been ongoing COVID outbreaks in various cities and provinces in China. Do you expect this to further affect franchisee sentiment negatively? Additionally, could you provide the monthly hotel sign-ups for the last few months? Thank you very much.

Hui Jin, CEO

Okay. To address your question, we agree that the ongoing restructuring due to COVID is still affecting our franchisees' confidence. Regarding new signings, we are currently seeing them at about 80% of what we would expect in a normal period for the third and fourth quarters. However, we analyze this differently across China, as there are significant variations between Tier 1, Tier 2, and lower-tier cities. In lower-tier cities, the impact on confidence and COVID is considerably less compared to Tier 1 and Tier 2 cities, where more COVID outbreaks have occurred. Thus, confidence in lower-tier cities remains relatively stronger. For a full recovery, we believe we need to wait for further easing of COVID restrictions and improvements in economic conditions in the near future. Our strategy will remain focused on advancing our presence in lower-tier cities and increasing our market share in the upscale and mid-scale segments. Thank you.

Ronald Leung, Analyst

I ask my question in English. The Southeast market in China is one of the regional markets that the company has focused on. Could you share the latest developments in the southern market? Additionally, if possible, could you provide the mid to long-term development target in the Southeast market of China? Thank you very much.

Hui Jin, CEO

Thank you for your questions. Regarding the southern part of China, it is a key area for us to further penetrate. Over the past year, we have been preparing extensively for this. A major step was our significant organizational restructuring, which involved relocating our entire organization to regional offices and shifting many middle management roles from our Shanghai headquarters to local markets. Additionally, we are developing localized talent pools and implementing tailored marketing strategies and supply chain management to align with customer demands in that area, which differ from those in Eastern China, such as Shanghai. Our long-term goal remains consistent with other regions, targeting a 20% market share in southern China. We have opened several flagship stores in key cities like Shenzhen and Guangzhou, featuring our HanTing, JI Hotel, and Orange and Crystal Orange brands as examples in the market. We expect to see substantial growth in that region over the next three to five years. Thank you.

Ronald Leung, Analyst

Thank you, Jason.

Operator, Operator

Thank you for your question. Our next question comes from the line of Simon Cheung from Goldman Sachs. Please ask your questions, Simon.

Simon Cheung, Analyst

My first question is about the price of ADR. We have noticed that over the last few quarters, ADR has shown strong resilience, even surpassing the 2019 level. Considering that many independent hotels have closed recently due to COVID, does management see a chance to increase prices once the pandemic is over? Thank you.

Hui Jin, CEO

Thank you. Yes, the ADR has benefited from both external and internal factors. Internally, we have been implementing regional management strategies over the past few months. We are leveraging pricing synergy, brand synergy, and regional synergy to improve the ADR and ensure healthier, more sustainable growth in the long run. This is crucial for our long-term revenue management. Externally, factors such as higher inflation and the ongoing closure of independent hotels are also contributing to the opportunity for enhancing ADRs in the long term. Thank you.

Simon Cheung, Analyst

The next question is about the brand strategies observed. I noticed in the presentation that you now have three brands with more than 500 stores, including HanTing Hotel and Orange. I'm curious whether the company will focus on these three brands or consider diversifying and expanding into more brands like some competitors. Thank you.

Hui Jin, CEO

Yes, to address your questions regarding our brand strategy, our main objective is to establish the top one or two brands in each market segment. In our economic segment, we have successfully built a strong brand, HanTing, and we are also developing the Ni Hao brand specifically for expanding into lower-tier cities. In the mid-scale segment, JI Hotel has gained significant recognition and is currently among the leading brands in that category. We are also seeing positive progress in developing the Orange Hotel brand. Therefore, in each segment, our goal is to have one or two leading brands that are well-loved by our customers while also supporting our franchisees' success. Thank you.

Simon Cheung, Analyst

Thank you.

Operator, Operator

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

Hui Jin, CEO

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

Operator, Operator

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