Huazhu Group Ltd

HKEX:1179

Earnings Call Transcript 2021-Q3

[Operator]

Hello, everyone. Thank you for standing by. Welcome to Huazhu Group's Q3 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions]

I would now like to hand the call over to your first speaker today, Mr. [ Jason Chen ] from the company. Please go ahead.

[Unknown Executive]

Thank you. Good morning, and good evening, everyone. Thanks for joining us today. Welcome to Huazhu Group's 2021 Third Quarter Earnings Conference Call. Joining us today is our Founder and Chairman, Mr. Qi Ji; our CEO, Mr. Jin Hui; our President, Ms. Liu Xinxin; our CFO, Ms. Chen Hui; and our Deputy CFO, Ms. Ye Fei. 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. Huazhu Group does not undertake any obligations to update any forward-looking statements except as required on 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 supplementary slide presentation is available on Huazhu Group's website at ir.huazhu.com.

With that, now I will turn the call over to Mr. Qi Ji. Mr. Ji, please.

[Qi Ji, executive]

Good morning, and good evening, everyone. Thank you for joining us today. There's an old saying in Chinese, [Foreign Language], which means a heavy shower really lasted for a day.

I was optimized -- optimistic at the beginning last year. And although the pandemic that you just heavy shower, not a light one. However, I didn't expect that it's more like the yellow [indiscernible] in Shanghai, turning us back and forth. The persistent COVID-19 variation and the recurrency from last year had brought serious impacts and uncertainties to the lodging industry and also seriously affected consumers' traveling activities. It also had brought varying degrees of disruption to our hotel construction and opening progress from time to time.

Undeniably, the longer than expected [indiscernible] COVID-19 has been -- weakened the franchisees' confidence and the willingness to invest in lodging market. In the past few years, concerning the increase in influence of external online traffic, we have been consistently implementing a large-scale expansion in order to be more independent. However, recently, we had witnessed the complexity and the challenges of global macroeconomic and international politics worsened by COVID-19.

And at the same time, Chinese government has been continuously promoting the supply-side structural reform and optimization from [ quantitivity ] to [ qualitivity ] can change. With such backdrop, we reviewed our strategy and decided to adjust our growth from previously mega scale growth to lean going forward. It means in addition to the absolute size of the hotel network, we will continuously provide better product and refined service to improve customers' experience. We hope our hotel products represent truly craftsman spirit, become more durable, environment-friendly and bring sustainable benefit to our franchisees. Meantime, we will further utilize our core competencies such as loyalty programs, technology and supply chain capability to support our franchisee to overcome the recent difficulties, manage hotels more easily and achieve better profitability in the long run.

The lean growth strategy where we -- carried out by our new management team, CEO, Mr. Jin Hui; and President, Ms. Liu Xinxin. Both of them have been with Huazhu for a long time and made a tremendous contribution to this company. I would like to thank them for their strong commitment in the current challenging environment to take the new roles. And I believe that there will be a strong leadership team for Huazhu for the new chapter of growth.

With that, I will turn the call to Jin Hui to update our present business [indiscernible]. Thank you.

[Hui Jin, executive]

[Foreign Language] Thank you, Qi Ji. As mentioned by Qi Ji before, Huazhu's future growth strategy will be adjusted from mega scale growth to lean growth. In fact, Huazhu had already implemented its COVID-19 prevention measures since the initial outbreak of COVID-19 back to 2020. In order to provide safety to our customers, Huazhu had required all its hotels to use intelligent contactless services, including self-check-in and checkout, robot delivery, online check-in through Huazhu's app and so on, has enabled our customers to spend less time in public and lobby areas to reduce the risk of virus transmission and cross-infection.

In May 2020, Huazhu released Comfort 360 white paper, which is the first white paper in the China lodging industry. It is the first professional cleaning standard report for Chinese lodging industry. In the beginning of this year, with our concept of quality hotel, Huazhu further upgraded our Comfort 360 program. The upgraded version mainly focused on 2 areas: one is COVID-19 prevention and safety and the second one is the customer experiences. At the same time, we also used both our online big data management and offline quality checks to ensure the implementation of this program.

In details, Comfort 360 program will assess the hotel quality from 4 key dimensions to ensure a 360-degree great customer experiences without any [ dark corners ]. Hotels can only be certified as quality hotel when complied with all 4 dimensions, which including central procurement standard, hotel facility standard, hygiene standard and safety standard.

As of now, 67% of our hotels in operation had complied with all above 4 standard. Hotel's products and service quality are very critical parts for our future lean growth strategy. Therefore, our Comfort 360 program were consistently being upgraded to ensure the best quality of hotel and services to be provided to our customers for better staying experiences.

Nextly, please turn to Slide 5. I will review our RevPAR recovery trends over the last year. Since January to now, COVID-19 recurred 8x totally in either small or large scale. As you can see from the figure, those large-scale outbreak, with spreading over to many provinces and cities, have significantly impacted our RevPAR recovery.

The most recent resurgence beginning in November had already spread over to more than 20 provinces, which again significantly impacted our November RevPAR recovery. As of 23rd of November, the month-to-date RevPAR only recovered to 68% of 2019 level.

As Qi Ji mentioned in the beginning, the persistent COVID-19 recurrences and the traveling restriction imposed by the government have significantly impacted our construction progress as well as franchisees' willingness on timely hotel openings.

Please turn to Slide 6. The figure shows our monthly number of hotel openings for 2021, taking August and October as an example, which had big impact from COVID-19 resurgences. Before the COVID-19 occurred, according to our pipeline and hotels in construction, our planned hotel openings were 169 and 134 hotels in each month, respectively. However, due to the COVID-19 impact, there was a gap of over 80 hotels between our plan and actual number of hotel openings.

Please turn to Page 7. As you can see, our new signings has grown relatively healthy at 41% by the end of September 30. The total new signings achieved over 2,100.

In addition, along with our lower-tier cities penetration, our hotels in pipeline and in operation, which from the lower-tier cities contribute over 57% and 54%, respectively.

In fact, undeniably, consistent resurgence of COVID-19 had put in a lot of impacts to our franchisees' willingness and confidence. Compared to the first 2 quarters, our new signing speed slowed down a little bit in the third quarter. Therefore, in the current uncertain situations and market conditions, our franchisees becomes more careful.

Please turn to Slide 8. As Qi Ji said previously, our future growth will focus more on lean growth. For this strategy, franchisees' operation, performance and profitability is one of the most important part. Therefore, we launched a new franchisee caring policy in June.

The franchisees' caring policy mainly including 1 provided up to 2 months of 50% management fee discount for franchisees whose hotels are located in middle or high-risk areas in China; secondly, the deferred payment on management fee and CRS fee; and thirdly, helped every qualified franchisees to [indiscernible] up to RMB 1 million bridge loan from financial institutions.

Huazhu is the only hotel group which provides management fee discounts to franchisees in middle or high-risk areas in China in the industry. As one of the leading company, we will go through the recent tough period together with our franchisees.

Moving to our progress of upscale hotel development, please turn to Page 9. The pictures in the slide show some of our upscale hotels opened during this year. As of September 30, Huazhu totally opened 10 upscale hotels and signed up 44 upscale hotels. Those opened and signed hotels covers various brands such as Steigenberger, Blossom House, Song Hotel and so on.

Moving to Page 10. In addition to above, our joint venture company, [indiscernible] Huazhu, is recently rebranding around 20 upscale hotels which were previously operated or managed by other hotel groups. In addition, we had already transferred the core system of these upscale hotels to Huazhu's own system within only 30 days, achieving another milestone.

To rebrand around 20 upscale hotels within such a short time period would significantly help Huazhu to further penetrate into high-end hotel segment and grab more market share there. However, undeniably, this also brings many challenges to Huazhu.

For the high-end hotel segment, we are still in the experimental stage. Huazhu is good at operating the limited service hotels, but for the upscale hotels, there are still some shortcomings such as branding, operations, talent cultivation and organizational adjustment, which brings many challenges to the company on how to figure out a great way to better operate upscale hotels. However, we are very confident that Huazhu has the capability to its own way for a unique operation in the market.

Moving to Slide 11. We're continuously investing our IT development. Our IT investments mainly focus on two aspects: to C for the customer and to B for our franchisees.

At to C level, we are devoting our further -- we are devoting on further strengthening our direct sales capability and building up an omnichannel marketing and selling system. And to B level, we are devoting to achieving a full cycle empowerment of our -- for our franchisees through hotel location selection, hotel construction, hotel operation and so on.

Although Huazhu's IT capability is in the leading position in the market, we're still seeing a lot of rooms for further improvements. For example, for the -- for to C side, our single hotel sales capability and customers' acquisitions capability can be further improved. Also, a more precise revenue management as well as various digitalization application across all hotels and organizations still see plenty of room for the improvement.

For to B side, a better urban planning and more precise location identification are also seeing many improving potentials. Putting them together, we would further leverage our technology and the data capability to drive more precise business empowerment to achieve our lean growth strategy in the future.

As I mentioned before, also the persistence of COVID-19 recurrence impacted our business operations. We are happy to see our members, our loyalty programs, especially our corporate members' contribution, achieved another great result for the third quarter.

Please turn to Page 12. As of now, our total number of members continuously grow to nearly 190 million, even considering a high base.

Please turn to Page 13. Our CRS contribution also improved from 56% in third quarter 2020 to 60% in third quarter 2021. At the same time, along with our lower-tier cities' penetration strategy, the CRS contribution in lower-tier cities is very close to the higher-tier cities. As of the third quarter of 2021, CRS contribution in Q3 and below cities achieved 59%, which is only 1 percentage point below compared to Tier 1 and Tier 2 cities at 60%.

Please turn to Page 14. The room nights contributed by our corporate customers are also further increased from only 9.6% in third quarter last year to 11.8% in this quarter. Especially in the up middle and upscale hotel segments, the increase in corporate customers' contribution is more significant.

As of the end of the quarter, the room nights contributed by corporate customers for our up middle and upscale hotel segment achieved 30.2% and 35.4%, respectively, both improved by 5 percentage points compared to the same period of last year.

With that, I will turn the floor to Fei Ye to discuss our third quarter operation and financial performance.

[Fei Ye, executive]

Thank you [indiscernible]. Good morning or good evening to everyone, wherever you are. Let's move on to our operational and financial review for the third quarter of 2021.

As shown on Slide 16, our hotel network expanded by 14% in Q3 to 723,000 compared with 634,000 in last year. Excluding DH, Legacy-Huazhu's hotel network expanded by 14% year-on-year to roughly 700,000 in the third quarter of 2021.

For our hotel turnover in the third quarter, our total hotel turnover grew at 15% year-on-year to RMB 12.2 billion in the third quarter. This was mainly due to our continuous network expansion in China and the recovery of DH operation while offset by the negative impacts of COVID-19 resurgence in Nanjing since late July. Excluding DH, Legacy-Huazhu hotel network grew 14% year-over-year to RMB 12.2 billion in the third quarter. DH's year-over-year growth is around 32%, more attributable to the improvement in hotel occupancy.

Turning to Page 17. Legacy-Huazhu's blended RevPAR for the third quarter 2021 declined 18% compared to 2019. The ADR in the third quarter was flattish compared to the one in 2019 at RMB 246 while occupancy in the third quarter is 16 percentage points lower compared to 2019. It was mainly due to the COVID-19 resurgence in Nanjing as mentioned above.

Turn to Page 18. Our Legacy-DH business saw a continuous recovery in the third quarter 2021. Therefore, our Legacy-DH blended RP, RevPAR, for the third quarter 2021 grew 36 percentage to the EUR 48 compared with the third quarter of 2020. The occupancy improved by 11 percentage points compared with the second -- third quarter 2020 and ADR improved by 6% to EUR 99. For the same period of 2019, actually, the RevPAR is EUR 74, so that means there is still a long way for the recovery.

Please see our financial results on Slide 19. Total net revenue grew by 12% year-on-year to RMB 3.5 billion in the third quarter 2021. Excluding DH, Legacy-Huazhu recorded a 7% year-over-year growth rate to RMB 2.9 billion, which was in line with our previous guidance. Legacy-Huazhu recorded slower revenue growth mainly due to the COVID-19 resurgence in Nanjing starting from late July and August.

Breaking down the revenue of third quarter. Lease and owned revenue increased by 10% year-on-year to RMB 2.3 billion revenue. Excluding DH, the lease and owned revenue of Legacy-Huazhu grew by 4% year-on-year to RMB 1.8 billion.

Net revenue from manachised and franchised hotel grew by 13% to RMB 1.1 billion, mainly driven by the strong growth of network expansion in China. Due to the further expanding hotel networks with asset-light model, the manachised and franchised revenue contribution enlarged to 32% in the third quarter of 2021 at the group level. Currently, we can say the main driver is due to the manachised and franchised business in China.

Now let's move on to the cost and profitability section on Slide 20. The hotel operating costs for the third quarter '21 was RMB 2.9 billion, increased by 17% year-on-year. For Legacy-Huazhu, it recorded RMB 2.3 billion hotel operating costs, indicating a 17% year-on-year growth. The increase was mainly attributed to, first, higher rental cost of the new upscale and upper mid-scale hotels and recently acquired CitiGO portfolio in May; second, higher hotel level personnel costs as well, as we keep growing hotel network rapidly; and third, some reclassification costs from SG&A to other hotel operating costs.

For Legacy-DH, it recorded RMB 630 million hotel operating costs, indicating a 15% year-on-year growth. The increase was mainly due to variable costs increased along with the business recovery such as short-term workers, food and beverage and consumables.

As we mentioned in the previous quarters, our future expansion of upscale will mainly use asset-light model. Therefore, our preopening costs declined by 64% year-on-year to only RMB 15 million in third quarter '21. Having said that with caution, we are still evaluating and investing in this hotel at good location and right price.

Our SG&A in the third quarter 2021 increased by 14% to RMB 577 million, mainly driven by the increase of Legacy-Huazhu. Excluding DH, the SG&A for Legacy-Huazhu increased by 29% year-on-year to RMB 435 million. This was mainly due to the more head count for various departments such as BD team to further penetrate into low-tier cities, corporate sales team to boost direct sales from corporate accounts, upscale business unit to support our leapfrog in this new era and largely technology team for various projects in both China and DH.

In third quarter 2021, the reported operating income was RMB 72 million compared to a loss of CNY 201 million last year and a positive CNY 629 million a quarter before. The year-over-year improvement was mainly driven by the DH business recovery and onetime noncash goodwill impairment of RMB 437 million booked in the third quarter 2020, but offset by the weaker China business performance.

Apart from COVID-19's impact for China business, the quarter-over-quarter profit decline was due to the RMB 20 million government subsidies received during the third quarter for DH compared with -- compared to over RMB 300 million booked in Q2.

Excluding DH, Legacy-Huazhu's operating income in the third quarter 2021 was CNY 239 million compared to CNY 523 million last year and CNY 763 million a quarter ago.

Turn to Page 21. Our adjusted EBITDA income was RMB 385 million in the third quarter 2021 compared to RMB 184 million a year ago. DH's EBITDA loss in the third quarter 2021 was RMB 115 million, narrowing from RMB 669 million last year, similar reason mentioned at the previous slide. Excluding DH, Legacy-Huazhu recorded an adjusted EBITDA income of CNY 500 million, declined by 41% in third quarter of 2020 due to the impact of COVID-19 resurgence in Nanjing.

In the third quarter of 2021, we recorded adjusted net loss of RMB 46 million, narrowed from a loss of RMB 218 million a year ago. Excluding DH, Legacy-Huazhu recorded an adjusted net income of RMB 117 million, declining RMB 476 million in 2020 third quarter. The non-GAAP pro forma adjustment mentioned on this page included unrealized gain or losses from fair value change of equities related to some of our investments.

Coming to the cash position on Page 22. Our net debt remained healthy at RMB 5.2 billion at the end of Q3 and there is no risk of reaching the financial covenants of the USD 1 billion syndication loans. Our cash balance is RMB 5.4 billion. And the unutilized bank facilities was RMB 7 billion. The cash position will allow Huazhu to further pay down the bank debt in 2022 and also be used to weather any unforeseen circumstances.

Now let's zoom in a bit into DH. As of November 23, 2021, 71% of the entire German population have received at least 1 shot, and 68 percentage of population was fully vaccinated. Along with the growing inoculation rate and the receding third wave of COVID since August, restriction was gradually eased for people who are fully vaccinated or who have recovered from the COVID. DH business recovery started in the second quarter and continued in the third quarter during the summertime. Now it's even stronger in October.

However, considering the reemergence of the fourth COVID wave in Europe right now, with dramatically rising 7-day incidence rates since early November, the recovery trend becomes unpredictable again. It was determined by the unfolding of the pandemic and future government policies and travel restrictions. As far as I know, the German government has urged the unvaccinated people to be vaccinated as soon as possible because there's still around 30% people in order to protect themselves and others.

Meanwhile, DH is continuing to implement further cost reduction and cash flow measures, especially regarding personnel and lease costs. The impacts of the further lockdowns will be partially offset by the extension of government subsidy. In addition to the subsidy recorded in Q2 relating to the 2020 lockdown, in October, DH has submitted a new application for government subsidy related to 2021 lockdown.

Turning to Page 24 on guidance. Considering the latest round of COVID-19 impact since late October and also the fourth wave in Germany, as we expect for the fourth quarter of 2021, the net revenue growth will be in the range of 6% to 10% compared to the fourth quarter of 2020, a reduction of 4% to 8% if excluding DH.

To provide a more meaningful guidance excluding the impact of COVID-19, Huazhu expects the net revenue growth will be in the range of 12% to 16% compared to the COVID-19 -- pre-COVID-19 results in the fourth quarter of 2019 or net revenue reduction to be in the range of 7% to 11%, excluding DH.

Referring to the above-mentioned impact, our full year revenue guidance is lower to the range from 22 to 26 percentage or a range from 26 to 30 percentage, excluding DH. To provide a more meaningful guidance, excluding the impact of COVID-19, as we expect, net revenue growth will be in the range of 11% to 15% compared to the pre-COVID-19 results of 2019 or a reduction from 0 to 4% if excluding DH.

With that, let's open it up for Q&A. Thank you.

[Operator]

[Operator Instructions] First question comes from the line of Billy Ng of Bank of America.

[Billy Ng, analyst]

I have two questions. The first question is we noticed the opening pipeline, the company now has 2,800 of hotels in the pipeline. I just wonder -- I want to get the view from the management that among the 2,800 hotels, how many of them could be opened within the next 12 months? And are there any hotels at risk given the current situation, some of the franchisees or sign-up may change their mind and to drop their project? That's my first question. And then I have a second question.

[Hui Jin, executive]

[Interpreted] Okay. I think in terms of our pipeline covered to the opening for the next year, as I mentioned previously, given the impact of the COVID-19 last year, both the supply chain as well as the construction progress has been impacted significantly. The previous planned construction period, which was roughly 6 to 7 months, which was delayed by the COVID impact, increased some of the uncertainties. However, for our total pipeline, we still think those -- majority of those can be converted without the COVID impact, but we'll still be very cautious to continuously evaluating the situation for the next year.

[Billy Ng, analyst]

My second question actually is related to the high-end hotel. It seems like the company already has at least 10 high-end hotels in operations. So like I just wonder if you can provide a bit more color and update on these hotels in terms of the RevPAR, the GOP and margin or -- and then also in terms of take rate, what kind of take rates can we get from them?

[Hui Jin, executive]

[Interpreted] Okay. In terms of our high-end hotels, in terms of the take rate, so given that our high-end hotel management are using the 2 management contracts, you can just refer to those international brands such as Marriott and IHG. We charge the similar rate compared to those international players.

In terms of the operation situation, as I mentioned before, given the COVID impact, those newly opened hotel has significantly impacted by the COVID, and we are still in a ramp-up period for those newly opened high-end hotels. However, in terms of the operation in the future, we're still going to leverage our Huazhu's core competency in terms of the high efficient operations to reduce the cost and IT empowerment -- IT capability to empower all those high-end hotels through the shared service. We believe that we can achieve the GOP 20% higher compared to other players in the future.

In addition, we are very happy to see that since the initial open of our Steigenberger hotels in Jinan, we achieved 100% occupancy rate within 1 month. And also, we -- our membership or our CIS contribution for the upscale hotels also achieved 30%. Thank you.

[Operator]

Next question will come from the line of [ Ruben Pang ] of UBS.

[Unknown Analyst]

[Foreign Language] Now the Chinese real estate enterprise has being suffering from a lot of issues. And will the cooperation between the company and Sunac be influenced?

[Hui Jin, executive]

[Interpreted] Thank you. So we -- actually, I personally discussed with the management team with Sunac recently. And undeniably, the Chinese real estate industry has been impacted quite significantly given the macro and political changes and new policies especially for the residential property. That definitely will cause some of the concern on the liquidity of those real estate companies, which is there is the likelihood that some of the real estate companies will select -- will choose to sell their commercial properties.

But I would remind a little bit because for the hotel property, it has relatively high liquidity compared to others. And given the current situation, the hotel property will concern more on the efficient operations, which is Huazhu's core competency. So therefore, we think at the current situation, Huazhu has the core competency to provide the high efficient operations, which could be potentially benefit from this.

The higher GOP, the higher portion from the Chinese customers and IT capability will be the key dimensions for those hotel operators or hotel owners to choose -- to consider. Yes.

Therefore, currently, our joint venture with Sunac, even though Huazhu -- this joint venture company has no impact from the current situation and the current market conditions, we still hope and confident that we can further enlarge our scale and provide a better operations through this joint venture management company.

I hope that there will be a relatively large scale for new hotel opening within this joint venture company next year.

[Operator]

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

[Simon Cheung, analyst]

I think I have two questions. Just on the first one, I understand the message about the difficulty to secure contract as well as opening hotel given the COVID situations. I just wanted to get a sense to what extent was also it driven by maybe the housing market downturn or to -- or -- and also the liquidity situation in China. And then I have another follow-up.

[Hui Jin, executive]

[Interpreted] Given the persistent COVID-19 recurrence over the last year, actually, we can definitely see the supply decline, especially for the independent hotel. Well, this actually provides some of the good opportunities for Huazhu posted currently to consolidate the industry.

As we can see, currently, I think since the late -- since November, currently, the situation in China gets much better. And we also see a strong business recovery currently. Therefore, in the future, we still believe that no matter the demand or the supply decline will also create a very healthy market condition for us.

Especially for the economic and the middle scale, limited service hotel segment, we still see there is a lot of demand coming through. And in addition, there is also within the province travel, the deliver traveling within the provinces still having quite strong demand.

In the upper middle and upscale hotel segment, we're also working hardly to trying to convert those existing hotels. We have been doing a lot of this kind of works since the year beginning. Thank you.

[Simon Cheung, analyst]

My second question is related to I guess the -- exactly to your earlier point about the opportunity to consolidate the markets. I wanted to get a sense how management is thinking about potentially using your balance sheet given the difficulty to gain more organically.

And also if you can provide us with some hotel ad guidance. Has that been changed for the full year? Or even if you can give some color for even next year, if possible.

[Hui Jin, executive]

[Interpreted] In terms of the M&A opportunities, Huazhu always keep open-minded to this kind of opportunity. We are very happy to see some of the potential opportunities which can help us [indiscernible] the brand, different hotel segment. And we are very proactively looking for this opportunity. For detail, I think Ms. Ye Fei could discuss more later.

Apart from very simple M&A, we also use different ways such as management and joint venture or cooperation in different area in China. We have been working on this for the entire 2021, and we have some -- great details can be shared to the market shortly.

[Operator]

Thank you for the question. In the interest of time, I would like to hand the call back to the management for closing.

[Unknown Executive]

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

[Operator]

That does conclude the conference call for today. Thank you for your participation. You may now disconnect your lines.

[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]