H World Group Limited (HTHT) Q2 2015 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the China Lodging Group Q2 2015 Earnings Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today, Tuesday, 18th of August, 2015. I would now like to hand the call over to Ms. Ida Yu. Thank you. Please go ahead.

Thank you, operator. Good morning everyone. Thanks to all of you for dialing in, and welcome to our second quarter of 2015 earnings conference call. Joining us today is Mr. Qi Ji, our Founder and Executive Chairman, Ms. Jenny Zhang, our CEO, and Ms. Hui Chen, our CFO. 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. China Lodging Group does not undertake any obligation to update any forward-looking statements except as required under applicable law. On the call today, we will also mention adjusted financial measures during the discussion of our performance. Reconciliations of those measures to the comparable GAAP information can be found in the earnings release that was distributed earlier today. As a reminder, this conference call is being recorded. The webcast of this conference call, as well as supplementary slide presentation, is available on the Investor Relations section of China Lodging Group's website, at ir.huazhu.com. Now I would like to turn the call over to Mr. Ji. Qi Ji, please.

Good morning everyone. Thank you for joining us today. As shown on Page 3, the number of manachised and franchised hotels in operation grew by 2.5 times over the past two years. While the pipeline grew at nearly two times, more importantly, we are glad to see our pipeline hit another record high of 721 after the quarter end. Above all, results show the recognition by our manachisees and franchisees. As the leading hotel group in China, we keep innovating our products and the cost models to deliver value to the customers and to drive return for our partners. Our continued product innovation is highly appreciated by our customers and franchisees. As shown on Page 4, our Ji Hotel, a middle-scale hotel brand is designed for business and leisure travelers who want a quality stay at a reasonable price at the premier locations. The guest room has evolved, providing a better balance between relaxing and flexible functionality. As a result, Ji brand has seen a fast rollout. The number of manachised Ji hotels grew by more than five times and the pipeline grew by more than four times over the past years. Moving to Page 6, our Hi Inn brand is also appealing to customers and franchisees. The innovated design and business model allow franchisees to adapt to small-sized properties in a cost-efficient way. As a result, the number of manachised and franchised Hi Inn grew by more than nine times and the pipeline grew by more than five times. As always, with focus on strengthening our diversified brand portfolio, building scale, elevating customer experience and generating profits to hotel owners, we look forward to delivering long-term value to our shareholders. With that, I will turn the call over to Jenny, our CEO, who will walk you through Q2 operational highlights. Jenny, please.

Thank you, Qi Ji. Hello everyone. I'm pleased to report our operational results for Q2. As shown on Page 9, in Q2 we opened a total of 207 net hotels, a record-high number for a single quarter. At the end of Q2 we had 2,384 hotels in operation, among which 26% were leased hotels and 74% were manachised and franchised hotels. We had a total pipeline of 740 hotels, with 19 leased hotels and 721 manachised and franchised hotels. We are excited about the growth of our core brand Hanting and the successful rollout of our new brands among customers and franchisees. As Mr. Ji has described and shared with you just now, the fast growth of our hotel network is attributable to the successful adoption of asset-light model as well as our new brand rollouts. As shown on Page 10, in Q2, our Group blended occupancy was 86%, a decrease of 5.3 percentage points year over year. The decrease was mainly due to soft macro-economy and a diluted impact from new opened hotels in lower tier cities. The blended ADR was RMB181, an increase of 0.6% year over year, as a result of more favorable brand mix. In summary, in Q2, the blended RevPAR was RMB156, a decrease of 5.3% year over year. Page 11 provides a detailed view of the growth trend of our same-hotel RevPAR for hotels in operation for at least 18 months. In Q2, our same-hotel RevPAR decreased by 4%, with 1.4% increase in ADR and 5 percentage points decrease in occupancy. The increase in same-hotel ADR was the result of a favorable brand mix, while the decrease in same-hotel occupancy was due to a soft economic growth in China. The midscale and upscale hotels registered a 6% same-hotel RevPAR improvement, mainly driven by an 8% increase in the same-hotel ADR. Looking into the second half of 2015, we remain cautious about the market prospects. However, we believe that our brand will still outperform peers in each respective segment, and that headwinds will not prevent us from further expansion. With that, I will turn the call over to Hui Chen, our CFO, who will walk you through our Q2 financial results quickly.

Thank you, Jenny. Hello everyone. I'm glad to talk to you for the first -- very first time over the call. In Q2, as shown on Page 13, our net revenue increased 16.9% year over year, exceeding the high end of our quarterly guidance. Leased hotels revenue grew 11%, while our manachised and franchised hotels revenue grew 54% from a year ago. Our manachised and franchised hotels revenue accounted for 17.7% of our total revenues in Q2 of 2015, up 4.3 percentage points from 13.4% in Q2 of 2014. On Page 14, the adjusted operation margin came in at 14.6% for Q2, an increase of 1.4 percentage points from Q2 last year. This is mainly due to a 1.8 percentage point decrease in preopening expense as a percentage of net revenues, resulting from fewer leased hotels opening in the pipeline. The adjusted hotel operating costs as a percentage of net revenues slightly increased by 0.1 percentage points year over year. The adjusted SG&A expense and other operating income as a percentage of net revenues slightly increased by 0.3 percentage points. Moving on to cash flow statement, as shown on Page 15. As of June 30, 2015, our cash balance closed at RMB893 million, including a short-term loan of RMB100 million. In addition, we had another credit facility of RMB400 million. For the second quarter of 2015, our operating cash flow reached RMB474 million, while our investing cash flow totaled RMB352 million. Our cash position remained solid to support our future rapid expansion. Meanwhile, since our announcement of share repurchase program, as of August 14, we had purchased 0.77 million ADS, with a total of $17.5 million from the open market. This further demonstrated management's confidence to return to our shareholders. Finally, as shown on Page 16 for revenue guidance we expect that net revenue for Q3 will grow 11.5% to 13.5% year over year. Meanwhile, we expect our full year net revenue to grow 11.5% to 13.5%, up from previous announced range of 7.5% to 11.5%. With that, let's open the floor for questions.

[Operator Instructions] The first question comes from the line of Justin Kwok from Goldman Sachs. Please go ahead.

Hi. Good morning. Thanks for taking my question. Perhaps I will start with a question for Mr. Ji. So I think in the market now, there's some news mentioning that a potential merger or alliance from among the two major economy hotel players in China, Jin Jiang and also 7 Days. I just want to get a sense on how management view the potential development, whether -- what's your view on the level of competition going forward, and also how will that affect the expansion or the growth strategy for the Company? And also the second question is just a follow-up on any progress update on the alliance with Accor. And I think the last question is also just a follow-up on management guidance in the previous quarter, that you are looking at new businesses, such as the serviced apartment and long-stay rental apartment, what's the progress now, and any update on that front will be very helpful. Thank you.

[Chinese language spoken]

Let me translate and also answer the second question. Regarding to the rumor in regards to the potential merge of [inaudible] and Jin Jiang Star [ph], we think it's not a confirmed news yet, so we don't want to make too many comments. Even if this becomes true, we don't foresee it become a major changing factor to the competitive landscape. Of course there may be some value creation by combining the booking system, but other than that, we don't see any major changes it will bring to the competitive landscape because those two brands and two groups have been in the market for a long time. And we don't expect any significant change to our own growth plan. And in terms of the alliance with Accor, the legal work is proceeding quite smoothly. So currently, we are -- we maintain confidence that we will be able to close the deal on schedule. As to the apartments new business we just entered into at the beginning of the year, we have opened the first site. But in general, this is still at a very early stage of the startup. We will be happy to report more details as we progress.

[Chinese language spoken]

[Chinese language spoken]

[Chinese language spoken]

[Chinese language spoken]

Justin, first of all, let me translate the question for the rest of the audience. Justin's question is in light of the increased rent and also the soft economy, is today a good time to go for merger and acquisition. And then Mr. Ji's answer is we see the valuation change in the Asia market. And that has created some cheap currency for the domestic listed companies. And we have seen some of them have taken a more aggressive approach in the merger and acquisition domain. But we haven't -- we are not in that market, at this moment. And we haven't spent too much time studying the potential there. And more directly, to the question of the general background of the industry, I think our position remain unchanged. First of all, we believe merger and acquisition is the path that this industry will go through naturally, with this background and the development stage of the industry. And secondly, for part two, we have a luxury that we have successfully implemented a market brand strategy, and that has opened us a very wide door and a long path of organic growth which you could also interpret as gradual consolidation of the market. So with that in mind, we remain quite disciplined and also open minded to all the M&A opportunities going forward.

Thanks, Ji-zong. Thank you.

Thank you. And the next question comes from Tian Hou from T.H. Capital. Please go ahead.

Good morning, management. I have several questions. The first one is related to your pre-opening expenses and your hotel opening plans. So I look at the financials in your 2Q, pre-opening expenses declined significantly on a year-on-year basis. So I wonder what's the opening plan for the rest of the year. That's the first question. The second question is related to macro economy. So the occupancy rate declined in Q2, so management said partially due to the slowdown in the economy. So I wonder what do you see in the third quarter so far and what's the impact on Huazhu's future performance? That's the second. The third, is there any update on your -- the hotel, Elan hotel with further more number of hotels opened? So can you give us some update on that? [Chinese language spoken]

Tian Hou, as for your third question, our leased and operated hotel opening currently is forecasted to be 20 to 30 in new -- these hotels during the year. So that's a smaller number compared with prior years. As you rightly point out, that's the main driver of the decrease of pre-opening expenses. And as for the occupancy decrease, as we mentioned in the earnings call, we remain cautious about the economic general environment in China. So currently we see a similar trend in Q3 compared with Q2. We haven't seen any major downturn or upside either. So it's quite kind of flattish from the prior quarter. As to the opening plan for Q3 and Q4, I think we are on track for the full-year plan. And we have a very strong pipeline in the franchised and the manachised side. We may slightly exceed the total manachised hotels to be opened this year.

So, updates on Elan hotel?

I'm not sure I get the question.

[Chinese language spoken]

You're talking about Elan? Okay.

Yes. Yes.

This brand has been very much welcomed in the franchisee community. So it has by now at least opened already approximately 80 hotels as of today and it has a pipeline of 100 hotels. So we expect this brand to continue to grow.

Okay. Thank you. That's all my questions.

Thank you.

Thank you. The next question comes from the line of Ryan Roberts from MCM Partners. Please go ahead.

Good morning and thanks for taking my question. I was wondering if management could give us some more discussion on how we see Q3 shaping up as well as going into the early part of next year as well.

Could you repeat the question? I'm not sure --

Yes. Sorry. Yes. I said I was wondering if management could give us some color on, first of all, the -- on Q3 and also how that looks going forward into the final quarter and the next year?

I see. Currently, we view the macro economy will remain soft. So we expect the same-hotel RevPAR we have been observing so far will continue into Q3 and Q4. At the same time, we continue to view the soft economy as a mature field of consolidation. So we will continue expand our various brands going forward with quite [inaudible].

Okay. If I could just ask a follow-up on that then. Given the cash flow position, which is quite significant, as well as the operating cash flow really coming online, looks like well above what we need for CapEx, is there a plan to do something different, perhaps more permanent, with cash on the balance sheet as opposed to the one-off nature of buy-backs?

We have been asked that question a few times. Last year was our first year turning cash positive and this year that trend continued. And we do foresee we are going to generate a significant net free cash flow this year, so the plan now is to continue our share repurchase program. And you have seen that we have already purchased more than $70 million of our stock back and we'll continue to execute that repurchase program. As for going forward, whether we will introduce a dividend plan to make the cash payback to shareholders a more consistent and continuous program, that's still subject to discussion of the Board.

Yes. Okay. And just curious, if I could ask one last question, does management have any view about the trend of companies going private. I know one of -- the owner of our major competitors is in the process of doing that, the listing from the U.S. And I was wondering if management could give us an explanation, a discussion about how they view the listing in the in the U.S. with respect to strategic alternatives and what that lets us do.

I think the different listing venues provide different advantages. Of course the recent spike of the Chinese stock market has triggered many U.S.-listed Chinese companies to go privatized. We fully understand their drive of pursuing a higher valuation. In our case, if we look at the China stock market not in this one year but in the five years domain and you compare the China stock performance with our performance in the U.S. stock market, we have seen that, aside from this year, for other years the two stock markets actually give a very similar valuation. So we need to think, watch and understand better whether this valuation spike is a one-time event or a continuing trend. That's number one. Number two, we do see that, as a consumer product, being closer to your -- the listing venue being closer to your customers do provide some advantage that of course being listed in the China market is better than in the U.S. However, I think the U.S. market provides deeper pockets once capital raising is needed. And also all kinds of regulatory environments is a lot more transparent and efficient. So currently, as of today, China Lodging does not have a definitive plan of privatization.

Okay. Sorry, if I could one -- one final question on that just to follow up. Was the Company's listing in the US was that part of the appeal -- part of -- was that part of -- was that a factor in the deal with Accor?

Could you repeat the question?

Yes. I'm just curious if the fact that Huazhu was listed in the U.S., if that -- if management has any view whether or not that was a factor for Accor to make the deal? If that was -- if that gave them more incentive or anything like that?

We haven't had discussion with Accor, so I don't think I can answer that question on their behalf.

Okay. Okay. Fair enough. Thank you very much for the answers today. I appreciate it.

Thank you.

[Operator Instructions] The next question comes from the line of Shang Koo from One North Capital. Please go ahead.

Yes. Hi. Good morning. Thanks again for the call and congrats for another good quarter of reflecting the hard work that you guys have been putting into the business. I just want to get a little bit more understanding of the nature of the same-hotel ADR increase. To what extent is that your mix effect from --

Excuse me.

-- or to what extent is it an actual raising of the Group prices that we saw for the last quarter? That's the first question. And the second question --.

Excuse me. Can I interrupt?

Yes.

Your voice is very low, so I cannot really hear clearly.

Okay. Sure. Is this better?

This is a little bit better.

Yes. Okay. All right. I just wanted to get a sense of the same-hotel ADR improvement year on year that we saw. To what extent is it a mix in shift -- sorry, a change in the mix and to what extent is it real on-the-ground room rate increases we saw?

We have analyzed our ADR trend. There are a few things driving that. One is the mix change by brand. And the second is the mix change by geographic location. Actually in the last quarter the increase due -- and thirdly of course the same-hotel ADR increase. As you can see from the 18-month hotel analysis, the same-hotel RevPAR growth was, let me see, is 1.4%. And you can -- as you can see, the geographic shift is driving for a lower ADR. And the brand mix change with the fast growth of our JI Hotel actually is slightly moving up. So if we blend the three factors together, that has come up with a very moderate increase of the blended ADR.

Right. Right. Thank you very much, Jenny. Just -- and the second question I have is the interest of potential hotel owners that want to engage you for management contracts. Help me understand -- I still don't understand why would hotel owners want to take on budget hotels or economy hotel formats. In this tough environment it seems oversupply. I'm just -- I just want to get a sense why aren't they more hungry to take on the mid-scale hotel format?

I'm not sure I fully understand.

Okay. What I see is you got a high proportion of your new hotel openings coming from management contracts or manachised hotels. But the format that is coming through is still predominantly economy hotels. I'm just wondering why aren't the hotel owners more interested in moving on to the mid-scale hotel format?

I see. First of all, I think we need to have a clear picture of the overall hotel consumption, the demand side. I think the demand for economy hotels is still significantly higher than the demand for the mid-scale hotels, mainly because of the general income level of the Chinese population. That's number one. So clearly for many years to come the total room supply of economy hotels will still be significantly higher than the mid-scale hotels. And secondly, more specifically for franchisees, many of our franchisees are small to medium-sized business owners and the investment into an economy hotel could range from a couple of million RMB to RMB7 million, which is quite affordable. However, if you move up to the mid-scale hotels, a fully renovated new mid-scale hotel could cost RMB10 million to RMB20 million, depending on the size of the hotel. So I think this is another reason why a lot more franchisees will be interested in investing into economy hotels.

I see. I see. Okay. Okay. But from what I can see is that the performance of the economy hotels has continued to be challenged, the economics of it and therefore the returns. I'm surprised that they would look more into bite [ph] size rather than the returns. I mean it's just about pooling resources to focus on the mid-scale which offers better economics.

We believe, even with the current soft economy, many of our -- actually most of our franchisees are still generating positive cash flow. And for those of them who have put their hotels in the right location with a reasonable lease are still generating quite decent profits. The reason so many franchisees are still enthusiastic about joining our network has demonstrated our strength in our brands as well as our operational capabilities.

Right. Okay. Jenny, just two quick follow-up questions. One is I noticed that your sales and marketing expenses as a percentage of revenues has declined quite materially quarter on quarter. Help me understand why is that. And I've got just one last question to wrap up. Thanks.

The fluctuation is mainly driven by the size of spending on the marketing programs. That's not stable from quarter to quarter.

Right, right, right. Okay. But for the full year you expect the sales and marketing expenses over revenues to be relatively flat year on year. Is that correct?

Yes. We do expect it to be reasonably stable for the full year.

Okay. Great. Great. And then just the last question. I'm intrigued by the upgrade in your revenue guidance for the year, for the full year. Can you help me understand your thought process or where you were at the start of the year when you provided initial guidance and what has prompted the change in your guidance?

We have seen positive changes on two things. One is that in Q1 we expected the same-hotel RevPAR to decline by 5%. And it turns out Q2 and Q3 is slightly better than that, so that has moved our number up positively. And secondly, our franchised and managed hotels has generated a stronger pipeline than initially planned, so we expect more new hotels will be opened this year. And our fee income also is quite strong, coming in with a more disciplined internal management in pricing. So generally we have seen a couple of positive things to move our forecast upwards.

Excellent. Thank you very much and all the best for the rest of the year.

Thank you.

[Operator Instructions] There are no further questions at this time. I would now like to hand the call back to the management team for closing remarks.

If we don't have further questions, please allow me to close the conference. Once again, thanks to everyone for making time from your busy schedule to join our call today. We look forward to talking to you in the next-quarter earnings call. Good bye, everyone.

Bye.

Thank you. Ladies and gentlemen, that does conclude the conference for today. Thank you for participating. You may all disconnect.