H World Group Limited (HTHT) Q3 2015 Earnings Report, Transcript and Summary

Thank you for standing, ladies and gentlemen, and welcome to the China Lodging Group Quarter-Three 2015 Earnings Conference Call. At this time all participants are in a listen-only mode. Today's presentation will include a question-and-answer session. [Operator Instructions] Please note, today's conference is being recorded. I would now like to hand the conference over to your host speaker, Ida Yu. Thank you, please go ahead.

Thank you, Kelly. Good morning, everyone. Thanks to all of you for dialing in, and welcome to our third quarter of 2015 earnings conference call. Joining us today is Mr. Qi Ji, our Founder and Executive Chairman; Ms. Jenny Zhang, our CEO; Ms. Hui Chen, our CFO; and Mr. Teo Nee Chuan, our Deputy 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 risk 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. As you all know, Huazhu has already a multi-brand since 2012. Today I'm glad to show you the results. Four of our younger brands have already hit the 100-hotel milestone, as show in page 3. These brands are Hi Inn, Ji Hotel, Elan Hotel and Starway Hotel. The successful change is a proof of our leadership in brand innovation. In the following pages, I will show you their growth. This accelerated growth of Hi Inn brand [technical difficulty] in China. Ji Hotel brand is well positioned in this [chain]. Move to page 6. We launched the Elan hotel brand just one year ago, and now it has exceeded the 100 hotels in operation. Thanks to our strong operating platform and a deeper knowledge on economic hotels, we are able to introduce a new brand and have a lot of franchisee interest. At the end of Q3, we had 116 Elan Hotels in operation and 83 in pipeline. With the Elan Hotels, Elan Hotel brand is a great brand to consolidate the economic hotel market over the long run. On page 7, Starway Hotel. They other midscale brand has resumed its growth with the improved business model in the past three years. At the end of Q3 we had 101 Starway Hotels in operation and 67 in the pipeline. With the wider range of established hotel brands, Huazhou were leaders in hotel expansion going forward. With that, I will turn the call over to Jenny, our CEO, who will walk you through Q3 operational highlights. Jenny, please.

Thank you, Qi Ji. Hello, everyone. I'm pleased to report our operational results for Q3. As shown on page 9, in Q3 we opened a total of 204 net new hotels. At the end of Q3, we had 2,588 hotels in operation among which 24% were leased hotels and 76% manachised and franchised hotels. We had a pipeline of 696 hotels, with 16 leased hotels and 680 manachised and franchised hotels. As Qi Ji mentioned earlier, on top of Hanting Brand, our younger brands have demonstrated their growth capability, which is supported by our strong operational platform and a motivated team. As shown on page 10, in Q3 our Group's blended occupancy was 89%, a decrease of 3.3 percentage points year-over-year. The decrease was mainly due to soft macro economy and a dilutive impact from newly opened hotels in the lower tier cities. The blended ADR was RMB188, an increase of 0.3% year-over-year as a result of more favorable brand mix. Midscale and upscale hotel rooms accounted for 13.6% of total number of rooms in Q3 2015, up from 11.2% in Q3 2014. Moreover, our midscale and upscale hotels show a 5% increase in same hotel ADR due to pricing opportunities in higher tier cities. In summary, for Q3 the blended RevPAR was RMB167, a decrease of 3.3% 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 Q3 our same hotel RevPAR decreased by 3%, with 0.3% increase in ADR and 3 percentage points decrease in occupancy. The increase in same hotel ADR was a result of new management, 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 a 5% increase in the same hotel ADR. In the first nine months of 2015, our same hotel RevPAR decline had been shrinking. The trend also continued in October. Although the overall market has not shown a sign of recovery, our hotels in higher tier cities outperform those in lower tier cities. Shanghai in particular provides more favorable pricing opportunities as driven by more exhibitions this year. At the end of Q3 we had 305 hotels in Shanghai, accounting for 12% of our total network. With that, I will turn the call over to Hui Chen, our CFO, who will walk you through our Q3 financial results. Hui, please?

Thank you, Jenny. Hello, everyone. As shown on page 13, our net revenues increased by 15.3% for the third quarter from a year ago, exceeding the high end of our last guidance. Revenues from leased hotels grew by 9%, while revenues from manachised and franchised hotels grew by 49% from the third quarter of 2014. Now revenue contribution from manachised and franchised hotels accounted for 18.8% of total, an increase of 4.2 percentage points from prior year. On page 14, the adjusted operating margins came in at 18.4% for Q3, an increase of 4.6 percentage points from Q3 last year. The adjusted hotel operating cost as a percentage of net revenues increased by 2 percentage points year-over-year. This is mainly due to the impairment loss from a few leased hotels, the increased rental cost from a higher portion of midscale hotels and the increased personnel cost. Since reopening expanded, as percentage of net revenues decreased by 1.5 percentage points from a year ago. This mainly results from fewer leased hotels in the pipeline. The adjusted SG&A expenses and other operating income as a percentage of net revenues decreased by 3.1 percentage points. The adjusted SG&A expense as a percentage of net revenues decreased by 1.8 percentage points, mainly due to less spending on online marketing activities in Q3 of 2015. In addition, we received an amount of government subsidies during the quarter as another operating income. Moving on to cash flow statement, as shown on page 15. As of September 30, 2015, our cash balance closed at RMB1.4 billion, including short-term loan of RMB595 million. In addition, we had another credit facility of RMB413 million. For the third quarter of 2015 our operating cash flow reached RMB512 million, while our investing cash flow totaled RMB982 million, among which RMB580 million was due to the cash related to our offshore bank loans. During Q2 and Q3, we used the offshore bank loan to purchase 12 million ADS from open market, equivalent to RMB435 million. For a brief update on our own share repurchase program as of September 30, we have purchased 0.77 million ADS with a total of $17.5 million from the open market. Finally, as shown on page 16, for revenue guidance, we expect the net revenue for Q4 will grow by 15.5% to 18% year over year. As a result, we project the full-year net revenue will grow in the range of 16.1% to 16.8%. This is higher than the previously announced range of 11.5% to 13.5% thanks to the better-than-expected RevPAR performance and our record high new openings. With that, let's open the floor for questions.

Hi. Good morning, management. Thanks for taking my call. I have two questions. First is on the impairment loss. Second is on your purchase of Home Inns stake. So on the impairment cost, I'm not sure if I understand it correctly, but does that mean that this is for hotels -- leased and operated hotels that you think future cash flow is not enough to cover original CapEx? And which brands? Which cities do you see more risk of this impairment loss? Secondly, a second question on Home Inns stake purchase. Can you talk about your rationale and what you want to achieve from this investment? Thank you.

Let me translate for the audience [Foreign language].

[Foreign language]

[Foreign language]

[Foreign language]

Lin, let me just add on that. In the third quarter we altogether had impairment loss on nine hotels. Those hotels spread across a few brands, but mainly concentrated on the low-tier cities. And in terms of your question on the purchase of Home Inns ADR, we cannot make further comment at this moment. But it's in general in response to the privatization of Home Inns, which is still ongoing.

Understood. Thanks a lot.

You're welcome, Lin.

Thank you. Our next question comes from the line of Hou Tian from T.H. Capital. Go ahead, thanks.

Yes. Good morning, management. Congratulations on a good quarter. So I have a couple of questions. One is related to the OTA consolidation. And recently Ctrip invested in eLong and also invested in Qunar, so that becomes as one of the biggest OTA entity. So as a channel, OTA played a major role in distributing the hotel inventory. So what do you see the impact going forward on your hotel distribution commission rates?

Thank you, Tian Hou, for the question. I think that OTA consolidation will bring the market competition to a more orderly status. We haven't seen any immediate changes yet. For us, our strategy remains unchanged. We will still focus on our direct sales and provide more favorable experience and terms in our direct sales channels.

Okay. So what's the percentage of your hotel distribution is from OTA channel? And that's the follow up. And also as a second question, your sales and marketing this quarter down year-on-year at 29%. What's this part of spending going forward could be? So shall we expect this part of the spending to be continued decline or maintain at the current level? So what's the outlook of this part of spending?

Currently, as for Q3, the OTA accounts for 9% of our room night sales. And so we still maintained a direct channel as our main sales channel. As for your question on the sales and marketing. Yes. This year we were a lot more conservative compared with last year in terms of marketing programs. But we don't plan to remain that way going forward. We feel to support our fast expansion of network as well as there is a need to strengthening our brand image in the market to enable us to achieve a higher occupancy and being able to claim a higher price, we still need various kinds of the marketing programs. So we would expect a reasonable increase of spending in the marketing expenses going forward from this year's low level.

Okay. So you mentioned the expansion plans. I wonder what's the outlook for remaining year's? And also is there a possibility to give a preliminary view of the expansion plan in 2016?

Currently we expect to exceed our annual guidance in terms of new openings. We indicated 680 to 730 new openings. Now it seems that we will get to above 750 this year. In terms of the 2016, we are targeting a similar level of new openings, I mean net openings. So we are expecting about 750 to 800 new openings in year 2016.

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

You're welcome.

Thank you. Our next question comes from the line of Billy Ng from Bank of America. Go ahead, thanks.

Yes. Actually my first question is I know it's very hard to say in some cases, but do you guys have a RevPAR improvement as coming from the market condition improved or is just seasonality? And also do you get a sense that the industrial supply and the industry supply has slowed down?

Billy, let me confirm that I fully understand your question. There was some noise coming in the background. So you are asking why the same hotel RevPAR decline has been slowed down. Is that the question?

Yes, yes. Right.

Okay. Yes. Despite the general macro economy has not changed much, but we do in certain cities, we see improved demand situation. Shanghai in particular has performed very strong in the past two quarters. So that has led our RevPAR improvement.

But do you have data or do you get a sense the industry supply has slowed down too, the growth of the industry supply?

We don't have data to support that view yet. We see that we have remained quite active. We have a very dynamic pipeline and continue to increase our own brand scale. But in terms of competitors, we see Home Inns has a quite flattish number of new hotels openings. For other hotels who do not disclose their public numbers, we don't really have the access at this moment.

I see. Thanks. And my second question, I know you may not be able to comment directly but for your Home Inns investment, can we categorize that as a strategic investment or as a financial investment? And if this is a financial investment, what was our general policy or guideline for financial investment?

If you go to our cash flow statement, I think most of the investments we have made there is strategic. In the early years we made a couple of financial investments. But all the investments we made in the past 12 months I think all have a strategic implication.

Okay. Thank you. Thanks a lot.

You're welcome.

Thank you. Your next question comes from the line of Nelson Wong from Goldman Sachs. Go ahead, thanks.

Hi. Thank you for taking my questions. I think I mainly have three questions. The first one is there's a RMB19.7 million other operating income. I'm just wondering what this number is?

That is a subsidy income from the government.

And do we expect this number to maintain at the same level going forward?

This subsidies income, we expect that to grow in the coming years. But the amount that to be received quarter by quarter may differ.

Okay. Thank you. And I think my second question is we see that there's a RMB580 million restricted cash in the balance sheet and I'm just wondering what this number is about?

This 580 million of restricted cash is for the security deposits for an offshore US dollars loan.

Okay. Got you. And I think my last question is about the investment, and I think you already briefly talked about it. But besides our strategic investment, I guess, that will be mostly some hotel investment. What are the other investments that the Company had spent in the past year and in year to date?

Excuse me, can you repeat your question?

Yes. So we see there's a lot of -- there's some short-term and long-term investments in the cash flow and balance sheet. And I'm just wondering, besides some hotel investments, what are the other investments has the Company then?

There are a few things. One is that we have -- as we mentioned in earlier calls, we invested into startups who are doing the apartment and office business, which we expect to have a similar business model as hotels. And they can leverage our capability in terms of [train] operation and development experience in acquiring all kinds of properties. So that's one category. And the other one is we have provided some loans to our franchisees at -- but for interest. And those loans are provided to repeated franchisees who are supporting our new brands or new versions like here the newer version of Hanting. So we have some money loaned out to those repeated franchisees. We also invested in one or two companies who have developed technologies which may have a synergy with our network experience. So those are the three different types of investments we have made in the past 12 months.

Got you. Thank you so much.

You're welcome.

Thank you. Our next question comes from the line of Jake Lynch from Macquarie. Go ahead. Thank you.

Yes. Thank you, management. And congratulations from the good set of results. On page 14, we have the adjusted hotel operating cost, and we see it kicked up 2% from Q3 of 2014. I'm sure there's a lot of moving parts within that, but I wonder if you can give us a sense to what extent is that attributable to a higher mix of mid and high end hotels and what extent is it attributable to simply inflation on a same hotel basis?

Okay. [Foreign Language] [Technical difficulty]

Okay. Thanks very much.

The next question comes from the line of [Technical difficulty]

Thanks for taking my questions. My first question is regarding the general macro and RevPAR trends. Can management comment on the RevPAR trend in 4Q and management current view on the overall macro trend going into 2016? How do you expect that would impact the travel demand and the Company's RevPAR trend? Also just wondering if the management can talk about some of the key trends in general of China's lodging market going forward. What do you see some of the like key drivers that could drive the growth of the sector? Thank you.

In the past few quarters, as well as continue into October, we see the decline of same hotel RevPAR has been shrinking. So we don't want to be over optimistic, but we feel going into 2016, we will not see continue to see dramatic same hotel RevPAR decline as we have seen at the beginning of this year. In terms of the potential growth opportunity, we see a quite favorable trend in Shanghai area. Not only that's the city receiving a significant number of new exhibitions, we also are expecting the opening of Disney next year. We have about 12% of our inventory located in Shanghai. We also expect Disney may lead to some spillover of tourism destinations nearby. So in general, if you the trend in the Shanghai and nearby cities are going to be quite positive in next year.

Okay. Thanks. So for the general key trends in like basically in the longer term for the China's lodging market, can you give some more color on that?

We continue to see the general increase of the tourism spending in terms of as percentage of GDP. So the general demand growth I think is already there. And we feel there is a clear trend. The customers start to segment and people who have deeper pockets are demanding a better product. So we have seen a very favorable same hotel RevPAR trend for our midscale products. And we are also upgrading our own Hanting hotels by rolling out the second the newer version of Hanting. We are also adding certain auxiliary services to our current network to enable us to capture more revenue per customer in the future. We still remain quite positive on the long term trend on the demand side. We feel we have opportunities to gather RevPAR sooner or later, or blended RevPAR, not only the room revenue but the blended revenue, into a growth trend in the future.

That's very helpful. Thank you. My second question is regarding some of your cost -- some of your key cost items. Since you have expanded your midscale hotels, just wondering, can you talk about the trend of some of your key cost items, particularly the rental and labor costs going forward and how that impacts your margin outlook? Also if you can talk about your current staff/room ratio, thanks.

Our operating cost as a percentage of revenue is a blend of the [technical difficulty]. Our merchandised and franchised hotels, as you can see, has been taking a higher portion of our revenue in the past couple [technical difficulty].

Okay, that's very helpful. My next question [technical difficulty].

[Technical difficulty].

[Technical difficulty].

[Technical difficulty].

Okay. Thanks. That's all my questions.

You're welcome.

Your next question comes from the line of Sophie Chiu from Credit Suisse. Go ahead, thanks.

[Technical difficulty]. The first one is I just want to know the rationale behind the [technical difficulty]. The second question is [technical difficulty].

[Technical difficulty].

[Technical difficulty].

Okay. So [technical difficulty] so I just want to know why [technical difficulty] year.

We have always said the expectation is [technical difficulty] next year. So the time to -- timeline is well in line with our original expectation. We have already cleared all the regulatory approvals that we did [technical difficulty].

And [technical difficulty]

Nelson Wong from Goldman Sachs.

Hi. I just had one last question. [Technical difficulty]

[Technical difficulty].

Okay. Thank you.

You're welcome.

[Technical difficulty]

[Technical difficulty] Number two is that they have to secure their future cash flow as well.

Just to add on that, the interest, which is higher than the prime loan rate, and then we also control the terms to be between one to three years.

Okay. Okay. Good. [Foreign Language] The nature of this government subsidy is actually tied to the local community in terms of tax contribution as well as employment.

Right. Okay. Excellent. Okay. Thank you very much.

Thank you. Our next question comes from [Indiscernible].

Hi. Good morning, management. Thanks for taking my questions. I've got two questions here. Number one is regarding the impairment cost. So for how many more hotels do you think there's a need to book impairment? And the second question is with regard to the alliance with Accor. After the deal gets closed in early next year, will the Accor financials be consolidated into our financials starting from maybe first half next year? And if so, would that be an impact on our margins? Thanks.

[Foreign language] We actually -- we continue to review the performance of our hotels on a routine basis and regular basis. So the thing is that we will only make a provision for impairment if the performance of the hotels is repetitively below our expectations. So we would -- for this quarter, we made a provision for the nine hotels that we have identified and we will continue to look at -- review these hotels in the next couple of quarters as well.

Vivien, the review of impairment loss is a regular procedure we have been performing for many years. And we do that every quarter. If you -- it has not been a very significant number in the quarterly reports in the past, so we never specifically disclosed that. And it's quite significant for this quarter, mainly because this year we have seen a significant same-hotel RevPAR decline. So that made us believe that we need to be more conservative in kicking out the hotels that have not been performing very well. So on an ongoing basis, we will continue to review all the hotel performance every quarter. And whether there may be some future impairment loss really are subject to the RevPAR performance of various hotels. It's a very dynamic process. And in terms of your second question on the Accor consolidation, we currently expect to close the deal at the beginning of next year. So yes, we will consolidate their financial statement into ours next year. We haven't fully completed the budget for next year for this part of the business yet, so I cannot comment very specific in terms of margin. But in general, given the size of the business and our experience with the model of mainly franchised and managed business in the part we acquired, we believe it will not have a significant impact on our current cost structure.

Thank you. Your next question comes from the line of Sophie Chiu from Credit Suisse. Go ahead, thanks.

Hi. I just want to follow up with one more question. This question is for Mr. Ji. [Foreign language].

[Foreign language] As the -- okay, the hotel operations in -- the hotel funding. There are two -- mainly two source of fundings for the hotel industry in China. One is privately owned companies like [Erste] actually source the funding from the market. And the other one is state-owned company that actually source their funding from many other sources as well. So from our perspective is that we currently do not have sufficient resources to make acquisitions for the offshore hotels, although that we very much wanted to, but the source of funding is mainly not sufficient. So but as the Chinese, we are very proud to be see that Chinese hotel operators started their acquisitions in for the offshore and premium hotels.

[Foreign Language]

I think on the current situation for the Chinese hoteliers, we are currently lacking in terms of capability and financial resources to acquire hotels and own up hotels in developed world, like even in the US, UK, in expensive cities such as New York, London, etcetera. However, I think it is more appropriate for us to use our capabilities and financial resources to set up hotels in developing countries, such as Vietnam, Thailand and Malaysia, etcetera, which is more feasible based on our capability inactive on our capability. Okay? Last year this year we our cooperation with Accor actually gives us a significant boost in terms of our strategy to penetrate the developed countries. By hooking up our booking systems, that allow us to actually have access to the US markets as well as the European markets, but through their booking systems. So the financial impact for this strategy, it may take time to flow through. But we definitely that there will be more meaningful financial earnings that will actually flow to us in the coming years.

Thank you. Your next question comes from the line of Yaoxin Huang from CICC.

Hi. Thank you for taking my question. I have a small question. It goes to Mr. Ji. [Foreign Language]

Now the question is that there is the question for Mr. Ji is to see if the plan for Huazhu in development of the middle and upper scales of hotels, what is the trend going forward? What is the outlook? And then what's the percentage of the hotels that is related to medium and upper scales going forward?

[Foreign Language] Mr. Ji's view is that in the coming 10 to [15] years, the main driving force or the main demand for Chinese hotels is actually the medium and economy brands because of the economic capabilities of -- for the Chinese citizens. So Huazhu, our Company has the four brands, high brands, Elan, Hanting -- sorry, [indiscernible] has been focusing on that. We do see that our aim to -- we have actually have a clear visibility to open up at least 500 hotels for these economy brands. And we aim to open up 1,000 hotels for these four brands. As for the [JI], [JI] is one of the best brands in -- best medium-cost -- medium-scale brands in China in terms of ROI, in terms of the speed, in terms of the returns for the investors. So what we plan to do with that is that we do see very clearly that we could at least have 500 hotels for [JI] and then 1,000 -- and aiming to open up 1,000. We hope to open up 1,000. As for the others, like we have other brands such as Manxin, like Zingcheng and [Joya] that we would -- with Accor, which actually top their own class in terms of middle-scale hotel, and we hope to open up at least 500 hotels for these three brands. We actually, for the upper-scale brands, we remain cautious in terms of our hotels development, but we do see that we will actually be very cautious in that and our opening will be based on the actual -- the market demand at a given market. On the other hand, we have actually -- we acquired for Huazhou, we actually have three-stage plan for our development and our investment horizon when we look at three to five years into the future. And with the economy brand as the main driving force for now, and then the actually development aggressively in terms of the medium-scale brand, such as [JI], which should actually help us to -- in terms of our view, and we do see a significant demand in the medium-scale brand. And we also look at other investments that other investors have asked office sharing as well as short term apartment sharing business, which we think that we should capitalize on the properties in China. [Foreign Language] In the face of the trends for the OTAs, etcetera, we I keep looking at opportunities that to capitalize on, number one, our own hotel network, number two, is that the properties around the China market. Okay? And we do see that there is an increasing is the assets [Indiscernible] we do see that there's increasing demand for standard apartment, standard accommodations. So and as a result, we decided to go into the short term hotel sharing which we could actually utilize the excess properties around each community to actually use the to capitalize on the excess properties in the residential market. As for the office sharing is that we have we do see that we have a lot of excess space, etcetera, in the hotel wings as well as the dormitories for the hotels. So what we plan to do is that we would like to convert those excess spaces in the hotel wings as well as dormitories into office sharing. And we welcome you to visit us when our property is ready.

With that, let me thank everyone for making time from your busy schedules to join our call today. We look forward to talking to you in the next quarter earnings call. Goodbye, everyone.

Thank you, ladies and gentlemen. That does conclude our conference for today. Thank you for your attendance. You may all now disconnect.