H World Group Ltd

BMV:HTHTN

Earnings Call Analysis

Strong Revenue Growth Amid Expansion and Cost Control

Despite a sluggish recovery in Germany, the company's portfolio outperformed the German market, showing resilience in the third quarter of 2023. Controlling costs in the face of inflation and focusing on technological improvements were key strategies. The hotel group expanded their rooms in operation by 11% to 885,756, and hotel turnover jumped by 55%, reaching CNY 23.5 billion. RevPAR growth was driven by an Average Daily Rate (ADR) increase, with Legacy-Huazhu's RevPAR recovering to 129% of its 2019 figure. Total revenue for H World saw a 54% increase, achieving CNY 6.3 billion, bolstered by strong domestic travel demand, continued product improvements, and market synergies. Operating income and adjusted EBITDA saw significant improvements, with Legacy-Huazhu posting notably strong figures, though Legacy-DH's adjusted EBITDA was modest, and their adjusted net income fell into negative territory. A consistent emphasis on cost management alongside revenue growth helped achieve these results. The group holds a robust net cash position, and they forecast revenue growth for Q4 2023 to be between 41% to 45% over Q4 2022.

A Strong Recovery Signal with Market-Leading Performance

The company maintained its market-leading performance, with Revenue per Available Room (RevPAR) recovering to 129% of the 2019 level, largely driven by Average Daily Rate (ADR) growth resulting from a modified product mix. Occupancy improved sequentially across the months of July, August, and September with percentages reaching 132%, 128%, and 128% of the 2019 levels, respectively. This rebound was energized by robust leisure travel in the summer months and a steady return of business travel. Despite potential short-term market volatility, the company is executing long-term strategies aimed at product enhancement, expansion, and gaining market share for sustainable growth.

Expanding Footprints and Upgrading Services

The company made strategic forays into lower-tier cities, driving stable performance in light of broader economic uncertainties. Organizational streamlining improved local operations, supporting growth in formerly underpenetrated regions. Committed to delivering superior service, the company prioritized the continuous improvement of product offerings across both economic and middle-scale segments. By bolstering its presence in the mid-scale market and upper mid-scale segment, the company is aligning with evolving consumer preferences for higher quality accommodation products.

Focused on Quality Growth

The third-quarter saw the opening of 545 new hotels, a year-over-year increase of 28%. The company is committed to enhancing the quality of its portfolio by exiting underperforming hotels and shifting focus to higher-quality product lines like the Hanting 2.7 version and above. A majority of the new hotel openings and those in the pipeline are in lower-tier cities, indicating a strategic commitment to these markets. Additionally, the proportion of mid-scale hotels within the company's inventory rose by 3 percentage points year-over-year.

Impressive Financial Performance with Growth Projections

The company's hotel network expansion resulted in an 11% year-over-year increase in rooms, contributing to a 55% surge in hotel turnover. Revenue growth for Q4 2023 is projected at 41% to 45% compared to Q4 2022, with Legacy-Huazhu revenue expected to grow by 48% to 52%. The solid financial performance is attributed to strong domestic travel, product upgrades, and regional market penetration. Operating income and adjusted EBITDA saw significant year-over-year improvements, reflecting effective cost management despite inflationary pressures and one-off adjustments.

Maintaining a Conservatively Optimistic Outlook

The management remains conservatively optimistic regarding the prospects of the China business, citing a superior product offering, improved operational metrics, and anticipated market consolidation as reasons to maintain their positive stance. The company will provide detailed guidance on RevPAR and new openings with its fourth-quarter earnings release next year.

Dividend Policy and Strong Cash Position

The company is in a robust financial position with significant net cash and unutilized banking facilities, inspiring confidence in funding its growth ambitions. Management has announced a disciplined dividend payout policy as part of its commitment to rewarding investors and is open to exploring share buybacks at opportune moments.

Key Strategic Initiatives and Prospects

Success with new hotel signings and pipeline growth is a testament to the company's pursuit of superior brand recognition and the inception of market-differentiating products like the Orange 3.0 version. Particularly noteworthy are advances in regions where the company had historically underperformed, such as Southern, Western, and Central China. The brand is also gaining market share in the upper mid-segment and consumer and franchisee acceptance continues to grow, especially with the InterCity brand, which also caters to a different type of franchisee with a broader capital expenditure spectrum.

Earnings Call Transcript 2023-Q3

[Operator]

Thank you for standing by and welcome to the H World Q3 2023 Earnings Conference Call. [Operator Instructions]I would now like to hand the conference over to Mr. Jason Chen, Senior IR Director. Please go ahead.

[Jason Chen, executive]

Thank you. Good morning and good evening, everyone. Thanks for joining us today. Welcome to H World Group 2023 Third Quarter Earnings Conference Call. Joining us today is our Chairman, Mr. Ji Qi; our CEO, Mr. Jin Hui; our CFO, Ms. He Jihong; and our President Ms. Liu Xinxin. Following their prepared remarks, management will be available to answer your questions.Before we continue, please note that the discussion today will include forward-looking statements made under the safe harbor provision of the United States Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, our results may be materially different from the views expressed today. A number of potential risks and uncertainties are outlined in our public filings with the SEC. H World Group does not undertake any obligations to update any forward-looking statements except as required [ by ] applicable laws.On the call today, we will also mention adjusted financial measures during the discussion of our performance. Reconciliations of those measures to comparable GAAP information can be found in our earnings release that was distributed last Friday. 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 hand over the call to our CFO, Ms. He Jihong for the opening speech. Ms. He, please.

[Jihong He, executive]

Good morning and good evening, ladies and gentlemen. Thank you for joining H World third quarter 2023 earning call today. We are delighted to report that H World delivered another strong quarterly financial result, reflecting the continued healthy recovery of 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.With this, I will hand over to Mr. Jin Hui.

[Hui Jin, executive]

[Interpreted] 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 number was benefited from the strong leisure travel demand during the summer holiday season as well as the continuous business travelling 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 our previously expected in the year beginning. 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 structure post the COVID should not be ignored. Especially, the demand for experience-related activities were growing rapidly with the government's efforts on stimulating the 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 condition could possibly remain volatile and uncertain, we will continue executing company's long-term strategies with focus 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 a long-term sustainable quality growth.Please turn to Page 4. With the current macro uncertainties, we want to re-emphasize below 4 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 lower-tier cities markets are more resilient.Secondly, the organizational restructuring and optimization enable 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 keep enhancing our products and services in order to further strengthening our dominant market position in the limited service hotel segment.Lastly, further breakthrough 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 3 key brands.Please turn to Page 5. At the end of September, out of total 9,028 hotels in operation, there were 40% were located in the lower tier cities and 55% of our 2,935 hotels in pipeline were in the lower tier cities. On a year-over-year basis, we see a small increase in the hotel proportion in the 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 the 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. And the number of cities that we covered reached to 1,217.Please turn to Page 6. We continued implementing our sustainable quality growth strategies and to expand 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 was mainly included 96 -- 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.Please turn to Page 7. 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. And over the same period, the proportion of Hanting 2.7 version and above increased from 14% to 27%.Please turn to Page 8. We emphasized that economic and mid-scale hotels will always be our core products. As we strive to better serve 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. Proportion of mid-scale hotels were 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 [ compromise ] economic and mid-scale segments, are always our key focus to continue improving in order to better meet the travel and accommodation needs for Chinese mass market. It is worth noting that within the limited service segment, we are seeing the proportion of mid-scale is increasing which perfectly match with consumers' rising demand on better quality of accommodation products.Please turn to Page 9. This year, we achieved encouraging breakthrough 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 the future development.Please turn to Page 10. Within the upper mid-scale segment, our 2 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 3 quarters, the new signings of InterCity grew meaningfully. At the end of September, we have 41 InterCity hotels in the pipeline and the number of pipeline for 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. Jihong, please.

[Jihong He, executive]

Thank you, Jin Hui. I will now elaborate DH's activity so far this year. Please turn to Page 11. Despite Germany's slow economic recovery post COVID, RevPAR of DH portfolio outperformed the overall German market using relevant [ RTI ] data.In third quarter 2023, year-over-year cost growth is in line with revenue growth despite inflationary pressure in Europe after excluding one-off adjustment and restructuring costs. Our priority remains to control and reduce costs through business restructuring as well as leveraging on technology. At the same time, we are repositioning the current hotel product design to reflect demand of the modern travelers. We are also spending effort in strengthening our presence in Middle East and exploring new international markets such as Asia Pacific.I'm now going to highlight the financial performance in the next section. Please turn to Page 13. Our hotel network continued to expand in the third quarter 2023. Total number of rooms in operation increased 11% year-over-year and reached 885,756. Hotel turnover increased 55% year-over-year and reached CNY 23.5 billion.Please turn to Page 14. Legacy-Huazhu blended RevPAR recovered to 129% of 2019 and achieved CNY 278. This was primarily driven by ADR increase which was 33% over Q3 2019 and 27.7% of Q3 2022. Occupancy still lags Q3 2019 by 1.8 percentage point. Nevertheless, the occupancy of 86% is quite a high benchmark for the size of our total portfolio.Please turn to Page 15. Legacy-DH blended RevPAR increased 4.5% year-over-year and achieved EUR79. ADR remained flat compared to third quarter 2022 but occupancy increased by 2.9 percentage point.Please turn to Page 16. Total revenue of H World increased 54% year-over-year achieving CNY 6.3 billion. Legacy-Huazhu revenue increased 62% year-over-year achieving CNY 5.1 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.Please turn to Page 17. Legacy-Huazhu operating income achieved CNY 1.9 billion in third quarter 2023. Compared to third quarter 2022 and the second quarter 2023, this is a significant improvement. This is achieved through revenue increase and at the same time, cost management effort for both hotel costs and SG&A expenses.On 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.Please turn to Page 18. Legacy-Huazhu adjusted EBITDA achieved CNY 2.1 billion in Q3 2023 and adjusted net income achieved CNY 1.4 billion. Legacy-DH adjusted EBITDA was CNY 55 million in Q3 2023. Adjusted net income fell into negative territory of minus CNY 37 million. On the group level, operating cash flow was CNY 1.2 billion. The fluctuation compared to Q2 2023 is due to short term change of timing of franchisee fee payment at the end of September.Please turn to Page 19. The group is in a net cash position as of end of September. There's a net cash of CNY 3.9 billion and unutilized bank facility of CNY 2.7 billion.Please turn to Page 20. We estimate the revenue in Q4 2023 will be a growth of 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 ends the management presentation. I hand over to Mr. [ Chen Ebua ].

[Jason Chen, executive]

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

[Operator]

[Operator Instructions] Your first question comes from Mr. [ Dan Chi ] from Morgan Stanley.

[Unknown Analyst]

[Foreign Language] 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 is it regular or special dividend.

[Hui Jin, executive]

[Interpreted] 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 to the market in terms of the exact policy and the payout ratio. And I want to add another point is as the H World business is going to be more asset-light, we definitely want to be well management on the cash and net profit going forward.

[Jihong He, executive]

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 Chinese lodging market will continue to recover. So we expect a very stable cash flow in our future operations. And with this kind of stable cash flow and net earnings, we would like to return some of our earnings back to our investors. So 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.And 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 will expect it around early next year.

[Unknown Analyst]

[Foreign Language]

[Operator]

Your next question comes from Ronald Leung from Bank of America.

[Ronald Leung, analyst]

[Foreign Language] Let me ask my questions in English. My first question is about the outlook for 2024. So would management have any preliminary forecast for the RevPAR growth and hotel openings for 2024? My second question is about balance sheet. So right now the company has a very strong balance sheet and cash flow. So what do you think is the optimal capital structure for the company?

[Hui Jin, executive]

[Interpreted] Let me translate the first answer. So in terms of the expectation for next year, in terms of the RevPAR and the new openings, we will be giving the guidance to the market when we release our fourth quarter earnings probably next year. But I just want to add we are still keeping our conservatively optimistic view for the China business given we think we are still having the best product for market-leading position and we shall still getting benefits from the continuously [ China ratio ] improvements and further consolidation of the market. So again, we keep our conservatively optimistic view unchanged.

[Jihong He, executive]

Okay. I will take over 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. And I'm very confident that with the business improving quarter by quarter, year by year, our cash position will remain very strong. So as a part of the effort to reward our investors, we already announced our dividend payout policy and this policy will continue. And we also do not exclude the possibility to do some share buyback at appropriate time as well.From a debt and the equity position, you can see that we still have USD 500 million convertible bonds at this moment and this will still take some time to mature. We will continue to leverage some of the bank facilities for our short-term working capital because the Chinese interest rate is very low. So pleased to be assured that the financial management team of H World will look into our cash position very diligently, manage our cash, and manage our reward program to our investors and at the same time, also leverage the lower interest environment in China and we will also continue to manage the overall debt positions so that we do not fall into any potential issues.

[Ronald Leung, analyst]

[Foreign Language]

[Operator]

Your next question comes from Simon Cheung from Goldman Sachs.

[Simon Cheung, analyst]

[Foreign Language] So I have 2 questions. The first question is in relation to the hotel opening. I've noticed that H World actually been able to achieve a much faster hotel opening than a lot of the peers. Wondering what are the reasons and whether management could share with us what's the latest update with the Southern China strategies?And then the second question is in relation to the fourth quarter RevPAR. We have noticed quite a bit of a meaningful downward trend in October. Wondering whether it's technical or structural. And what is the outlook going into November and December, and whether there is any reasons in relation to business versus leisure [ sharpening ]?

[Hui Jin, executive]

[Interpreted] Okay. To answer your first questions, post the COVID, since this year, we achieved quite good progress in terms of the new signings and the pipeline increase. This was mainly attributed to several reasons. Firstly is for our market-leading brands especially, in the limited service segment including Hanting and JI Hotel. Over the last several years, we keep enhancing our product quality and doing a lot of product upgrades and further enhance our brand reputation and awareness. That definitely benefits us for the -- increasing in the new signings. And also especially, in the middle-scale segment, last year, we tried to use the Orange to become our second main brand in this particular segment and since the first quarter when we launched Orange 3.0 version, the product itself has been very much well accepted by the market and franchisees, hence achieved quite good new signings since then.Certainly, it's because of the lower tier cities penetration as well as further enhance our presence in our previously weak market including the southern part of China, western part of China, and the middle part of China. This is the benefits from our organizational restructuring and further strengthening our business development capability on the ground. Currently, these 3 previously weak regions contributed more than 40% of our new signings year to date. And lastly, it is further breaking through into the upper mid segment and mainly because of the InterCity brand as well as the Crystal Orange brand as I mentioned previously in our prepared remarks and also presentation. And we are strongly confident on the further breakthrough and increased market share for this particular segment.In terms of the second questions on the RevPAR trend. So for the October, this is pretty normal seasonality because normally, post the Golden Week holiday, there was a low season following. So this is a normal seasonality impact. And for the entire fourth quarter, we are expecting the RevPAR recovery to be in range of 115% to 120% compared to the same period of 2019.

[Simon Cheung, analyst]

[Foreign Language]

[Operator]

The next question comes from Sijie Lin from CICC.

[Sijie Lin, analyst]

[Foreign Language] You have been to some low-tier cities to do some field research. So could you please share with us your main observations which make you feel that there are lots of opportunities in low-tier cities? And in order to seize the low-tier market opportunity, we have established regional headquarters and is there any other capability that we need to strengthen?

[Hui Jin, executive]

[Interpreted] Okay. So clearly, despite the urbanization rate have already achieved over 65% this year, we're still seeing that there's further urbanization progressing in the lower-tier cities and we're also seeing the population actually is also increasing in the lower-tier cities.Addition to that, the high-speed railway trend further development as well as the highway networks further expanding, and we were seeing the number of passengers transported by the high-speed railway trend this year achieved a historical high. This is mainly supported by a lot of government efforts on stimulating the domestic demand which increased a lot of population mobilities demand.And for the lower-tier cities, we also observed that it is really a high resilient market and more importantly, the lower-tier cities contain over 1 billion population. We think still there is a lot of huge opportunities to further discover. And as a leading company, H World is striving to further providing good products and service to match the demand for better accommodations in the lower tier cities.Okay. So the organizational restructuring is definitely creating some of the benefits and in line with our lower-tier cities penetration strategy. So basically, we want to be more close to our customers and more close to our franchisees and to be more localized. Because especially for the franchisees side, we are seeing a lot of new franchise -- new type of franchisees. Basically, some of them are self-owned properties, some of them are local small and middle property developers as well as some of the business owners. We want to be close enough to them and understanding their demand as well as our customers.

[Sijie Lin, analyst]

[Foreign Language]

[Operator]

Your next question comes from [ Duvai Lui from Citics ].

[Unknown Analyst]

[Foreign Language] Let me translate my question in English. We notice in the city it's gaining traction among franchisees. So could you tell us more about the current business situation such as ADR, RevPAR? Besides, can you share what cities are the distribution of InterCity in the pipeline? And what are the features of franchisees?

[Hui Jin, executive]

[Interpreted] Okay, thank you. Just to answer your questions, thanks for focusing on our InterCity brand. Since we launched last year and opened several leased InterCity hotels in several cities, so for this already opened hotel, given the scale is relatively small, we don't think it is suitable for now to compare or to release the ADR or RevPAR to the market at this moment because it is quite selective and we have only several InterCity hotels in operation. But if you really want to talk about these hotel's operational data so all the ADRs and RevPARs have been already doing better than our competitors. But we are very confident to see the brand is getting more accepted and [ aware ] by our franchisees and the market.And for the franchisees, we are seeing definitely a different type of franchisees compared to our limited service segment. There are two type of franchises. One is definitely the industry-leading franchisee because the InteCcity hotel requires a relatively big amount of CapEx investment. So a single InterCity hotel requires around RMB 30 million to RMB 50 million in CapEx. So only those very much leading position -- leading franchisees can afford that much CapEx. And second, we also see a lot of property developers or local property developers and property owners which used to doing business with those international brands are now finding us -- as InterCity to be a substitute because we are definitely leading in terms of the operational capability.

[Unknown Analyst]

[Foreign Language]

[Operator]

There are no further questions at this time. I will now hand back to Mr. Chen for closing remarks.

[Jason Chen, executive]

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

[Operator]

That does conclude our conference for today. Thank you for participating. You may now disconnect.[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]