H World Group Limited (HTHT) Q1 2016 Earnings Report, Transcript and Summary

Ladies and gentlemen, thanks for standing by and welcome to the China Lodging Group's First Quarter of 2016 Earnings Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today, Thursday, May 12, 2016. I would now like to hand the conference over to your first speaker today, Ms. Ida Yu, Senior Manager of Investor Relations for China Lodging Group. Thank you. Please go ahead.

Thank you, Vincent. Good morning everyone. Thanks to all of you for dialing in, and welcome to our first quarter 2016 earnings conference call. Joining us today is Mr. Qi Ji, our Founder and Executive Chairman; Ms. Jenny Zhang, our CEO; and Mr. Teo Nee Chuan, our CFO. Jenny and Teo will present the company highlights and the Q1 results. 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 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 slides 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 Jenny. Jenny, please.

Good morning everyone. Thank you for joining our call today. We are glad to report a good first quarter of 2016, marked by continued [inaudible] growth and improved profitability. At the end of Q1 2013, our network consists of 2,989 hotels or 304,428 rooms, covering 356 cities in China. With 12 brands under management, China Lodging is able to satisfy fragmented needs from our guests who seeks for the best value for money, whether it be economy, midscale or upscale hotels. On Page 3, I want to remind you of our strategic focus this year. And in the following pages I will report our progress in those fronts. The first one is to strengthen and differentiate HanTing, our flagship brand in economy sector. And secondly, we will continue our fast expansion through both organic and M&A activities. And thirdly, we will further boost our direct sales capability. I will further elaborate those points through the next few pages. Let's take a quick look at RevPAR first. RevPAR trend is always on the top of the question list from our investors. We are thrilled to report that the year-over-year growth of our blended RevPAR turned positive in Q1 as our geographical mix started to stabilize and our mix shifted towards an increased proportion of midscale and upscale hotels. The improvement in blended RevPAR was also driven by strong performance of our Ji Hotel, upgraded HanTing 2.0, and Hi Inn. During the first quarter, the same-hotel RevPAR grew 10% for Ji Hotel, 8% for HanTing 2.0, and 6% for Hi Inn. Our strong innovation capability drives our underlying strong performance. HanTing 2.0, as shown on Page 5, was highly rated by our customers and delivered strong RevPAR since the launch in 2014. In Q1, the same-hotel RevPAR for this group of hotels improved by 8%. Currently, above 18% of our HanTing revenues were contributed by HanTing 2.0 model at the end of the first quarter. We expect the new model will account for 35% to 40% of our HanTing inventory by the end of 2016. On the next page, we would like to report to you our expansion. We continue the fast expansion in 2016. In the first quarter, the number of newly-added hotels were 226, implying a year-over-year increase of 24%. We applied both organic and non-organic approaches in our expansion. Among the newly added hotels, 129 hotels are under our own brands and 97 are under Accor brands. On Page 7, financially, our Q1 net revenues grew 18.8% year over year, beat our guidance of 14% to 15% growth. About 52% of the incremental revenue growth were contributed by Ji Hotel. It's worth mentioning that in Q1, Ji Hotel continued to [inaudible] in the same-hotel RevPAR growth, as I mentioned earlier. As shown on Page 8, on the operating profit side, we achieved significant improvement in EBIT during the traditional low season. Similarly, Ji Hotel contributed 79% of the incremental EBIT. This is mainly due to the maturing of our leased Ji Hotel opened in 2015 and the lower preopening expenses. To summarize, we are optimistic about our solid development in Ji Hotel, the new HanTing 2.0 model, and are very positive on the fast hotel network expansion as we planned. With that, I will turn the call over to Teo, our CFO, who will walk you through our operational and financial results for Q1 2016. Teo, please.

Thank you, Jenny. Hello, everyone. I'm pleased to report our operational results for Q1 2016. As shown on Page 10, in Q1, we added a total of 226 net new hotels, including 96 hotels under Accor brand, which are merged into our platform in January. Among those new net openings, 11 [ph] are under lease and old models, while 215 are under manachised and franchised models. At the end of Q1 2016, we had a total of 2,989 hotels in operations, 21% of which were leased hotels, 79% were manachised and franchised hotels. Meanwhile, we had a pipeline of 632 hotels, with 25 leased hotels and 607 manachised and franchised hotels. As shown on Page 11, in Q1, our Group blended occupancy rate was 80%, a decrease of 1.1 percentage point year over year. The decrease was mainly due to lower occupancy in the lower tier cities. The blended ADR was RMB172, an increase of 2.5% year over year, as a result of the more favorable brand mix. Midscale and upscale hotel rooms accounted for 15.1% of the total number of rooms in Q1 2016, up from 12.1% in Q1 2015. Moreover, our midscale and upscale hotels saw a 5% increase in the same-hotel ADR due to pricing opportunity. At end of Q1 2016, approximately 76% of our hotel rooms were in the first and second-tier cities. In summary, for Q1, the blended RevPAR was RMB139, an increase of 1.1 year over year. Page 12 provides a detailed view of the growth trend of our same-hotel RevPAR for hotels in operation for at least 18 months. In Q1, our same-hotel RevPAR decreased by 0.3%, with a 0.8% increase in the same-hotel ADR and 0.9 percentage point decrease in occupancy. We think that our trend has been stabilized. Meanwhile, the midscale and upscale hotels continue growth trend in RevPAR on a like-for-like basis. Our same-hotel RevPAR improved by 8.8% in Q1. Move on to financial results. On Page 13, our adjusted operating margin came in at 5.9% for Q1 2016, a significant improvement compared to 0.1% of losses back in Q1 2015. The adjusted operating cost as a percentage of net revenue decreased by 4.1 percentage points year over year. This is mainly due to favorable impact from our maturing leased hotels as well as the growth in the Ji Hotel brand, HanTing 2.0 and Hi Inn same-hotel RevPAR. The pre-operating expenses as a percentage of net revenues decreased by 1.4 percentage point 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 revenue decreased by 0.3 percentage point, mainly due to lower marketing spending due to timing issues. And this is partially offset by increase in personnel cost as a result of our growth in hotel network and brand portfolio in Q1 of 2016. Move on to the cash flow status as shown on Page 14. In Q1 2016, our net cash from operation reached RMB375 million while the CapEx for maintenance and new development totaled RMB177 million. As a result, our free cash flow in Q1 totaled RMB148 million, in Q1, we sold a portion of our investment in Home Inns ADS for RMB79 million, records us a gain of RMB13 million in Q1. In Q2, we'll record another gain of RMB25 million from the disposal of the remaining balance of our investment in Home Inns ADS. In Q1, we continued our strategic investment of RMB79 million, including those in apartment and shared office services. In addition, we paid a special dividend of RMB276 million to our shareholders in February, which was already declared in December 2015. At March 31, 2016, we had a short-term loan balance [ph] of RMB600 million and a total credit facility available to the Company was RMB500 million. Turning to the next page, despite our core business of hotels, we are tapping into two promising markets: apartment and shared office through asset investment. So far we have invested RMB113 million in five companies in these two areas. Take apartment market for example, unlike the matured market in the west, apartments in China are mainly owned and managed by individuals rather than corporates. Consumers are looking for good products with appropriate services. The market potential for the apartment is huge, estimated to be over RMB1 trillion. Right now this market is still at its embryo and fast-growing stage with numerous smaller players. The concept of shared office is to provide small and medium companies a collaborative working space with full service including furniture, conference rooms, event, and biz [ph] support. This model is more flexible and cost-competitive than traditional offices. Similar to apartment markets, shared office market potential is sizeable especially in tier 1 and selected tier 2 cities in China. We believe we can apply our knowhow and expertise in brand building, site acquisition and development, as well as daily operations from our hotel experience to the apartment and office sharing business. These different product lines will help enhance our competitiveness in site acquisition and yield management, especially on a larger property. Finally, on Page 16, we are expected to achieve a year-over-year net revenue growth of 12% to 15% in Q2. With that, let's open the floor for questions.

Thank you. [Operator Instructions] Your first question today comes from the line of Yaoxin Huang from CICC. Your line is now open.

Well, thank you for taking my question. First, congratulations to the management for very, very strong results in the first quarter. I have three questions here. The first two questions goes to CFO, Mr. Teo. Hi, Mr. Teo, I have two questions here. First is about the tax reform in China. So, can we expect that going forward we do not have any business tax items in the financial statement, in fact, we will have a VAT effect? So going forward, the impact to our net margin. And the second question is about SG&A expense. If you were looking into the first quarter results, actually the SG&A expense ratio is actually declining in the first quarter. So what's your expectation for the full year of 2016? Thank you.

Okay. Hi, Huang. The first question is about the tax reform, basically is the conversion from business tax to the VAT. Going forward, from May 1 onwards, is that the business tax will be converted to the VAT. The line -- the tax expense and surcharge will still remain because the tax that we pay, the VAT that we pay to the government, can be deducted from -- sorry -- the tax that we pay, that there will be a net tax VAT paid to the government. As a result, this balance will still -- this line will still maintain. On the other hand, is that unlike business tax where the input VAT are not deductible, going forward from May 1, the -- while we are paying VAT on the revenue that we receive from our customers, we are also allowed to deduct the input VAT that we receive from our suppliers. For example, rentals, for example, utilities, consumables, and even CapEx. So this is currently, is that we expect that from May onwards, is that the net impact on our net margin will be approximately 0.2% to 0.3% of revenue. There is still a little bit of uncertainty because certain of the vendors will reevaluate their cost structures and, however, we expect that the government intention is to offset the tax increase on their part with lower tax that the suppliers need to pay to their own suppliers as well. So based on that, is that we see favorable tax impact going forward. This is question number one. The question number two is regarding the selling and general and administrative expenses. As we mentioned just now in the presentation, the lower SG&A expenses as a percentage of net revenue was lower in Q1, was mainly due to the timing issues. Certain of our marketing programs, which, as opposed to -- which we had planned, were actually started to kick in in Q2 to Q4. So overall is that we expect the overall percentage will go up to approximately 10% for the entire year.

Okay, perfect. Thank you. And my third question goes to Mr. Qi. [Chinese language spoken]

Okay, this question is for Mr. Ji. Franchisee are accounting more share in our business. So, going forward, what is your plan to help franchisees to grow and strengthen the cooperation with them?

[Chinese language spoken]

So first of all, franchisees are very important to our business. Right now we have 1,000 to 2,000 franchisees. Most of them are very rational businessmen, abide by the law. Personally, I'm friends to many of them. I even invite some of them to my house in France [ph] last summer [ph]. So we shared a lot of common topics. But on the other hand, there are some franchisees who has one-sided view. They are happy when making money but very unhappy and blaming a lot when they are making loss. But there are many reasons attributable to the profitability of the franchised stores, whether it be general economy situation, the location and etcetera, but our baseline and standard in the industries that we would only recruit franchisees who can make money based on the facilities, the criteria of their location. So we are probably the first one in the industry to retain that baseline. Hopefully we are not the only one. That's also the reason our RevPAR is higher than industry peers, is because we have higher standard of our franchisees. Our principle of franchisees is, number one, we shared common vision of the business. Second, the franchisee has to abide by the laws. And after that, we can go to either good times and bad times, we'll work out together hand in hand. So, at last, I would like to say that we are still fully trust our franchisees, but we will not compromise to irrational request to China Lodging. Personally, I got a lot of messages from those franchisees, some words I will not even mention here to you. So in short, we are still very confident in the franchisee model. We will work, you know, we will help our franchisees to do their business great and expand the network of China Lodging together. Thank you.

Thank you. Thank you, Ji-zong; thank you, Jenny.

Our next question today comes from the line of Justin Kwok from Goldman Sachs. Your line is now open.

Thanks, management. Good morning for taking my question. I guess I might have three questions, perhaps two for Jenny or Teo, and then the last one for Mr. Ji. Perhaps I'll ask the first two questions first. The first one is about the HanTing 2.0. I noticed that you have achieved a good improvement on your room rate RevPAR after the renovation. But can I check in terms of the CapEx for each of these hotel, and what are you seeing in terms of the return on investment in this upgrade? And the second question is actually a follow-up on the franchised side. I think I noticed that Home Inns actually lowered their fee structure at the beginning of the year. So, are we seeing more competition from the fees in terms of franchised segment or do you think there is actually not much change on a net basis? This the first two questions, thanks.

Hi, Justin, this is Jenny. On your question about HanTing 2.0, those are the new model, new design we rolled out in 2014. So, most of the new hotels opened in 2015 and all of new HanTing opened in 2016 are going to be under this new design. The product was very well-received by our customers. And in terms of investment per room, currently it's approximately RMB70,000 per room for a new hotel, and the RevPAR is meaningfully higher than our older design. We have seen different numbers at different level cities, but typically the range is -- it could be anywhere from RMB10 to RMB30, in terms of RevPAR improvement. So the ROI currently is very attractive. We are also rolling out remodeling of the existing hotels when they come to the renovation timing, and so we are also operating some of the older version of HanTing to this new model. On the question about franchise fee, I think the publicity about Home Inns' lower fee is quite misleading. To our knowledge, Justin, you could check with Home Inns for more clarity, but what we have learned is that the lower fee is in exchange for increased charge [on the] membership [point]. So all in, Home Inns was not really lowering their franchise fee. It was really a different structure of the franchise fee. And currently, Huazhu does not have any significant change on our future fee, but we may put in some new structures to motivate our franchisees to work together with us to improve the hotel performance.

Okay. Thanks for the clarification. I guess the last question I had is for Mr. Ji. Perhaps I'll use Mandarin and maybe you can help translate, or I will just use English as well. [Chinese language spoken] Maybe quickly in English. If you put side by side on your development -- current development history against Marriott for the past few decades, so at this juncture for the Company, what's the focus of the management for the next few years? How are you going to spend cash? What kind of business segment or opportunities that you will be spending a lot of time to evaluate? Thank you.

[Chinese language spoken]

Okay. Very long answer, but -- yes, let me divide them into a few parts. Okay. First of all, quickly summarize, as [regards] Marriott. We think Marriott, you know, the most successful hotel group in the world and we are starting Marriott as well. To us, one of the key success factors of Marriott is that the stability of majority, you know, a large family shareholder and senior management team. We think Marriott is not, you know, their core business is quite strong. M&A is not their main activity but rather than the complementary to their core business. China's hotel market is different than US. Marriott view their business on the midscale segment, especially during the crisis of US economic crisis. For example, the brand Courtyard is very successful. In China it's more economy hotel driven in the past few years, because China's consumption capability still lower than US, so, like our flagship brand HanTing is very successful. But we think China's speed in many other industries is much faster than mature markets. We -- take our shareholder [inaudible] as an example, they developed 3,000 hotels in 40 years, we managed to do the same number in 10 years. So it's basically China's speed is quite different. Back to our focus in the next few years. First of all, it's still continue to strength our core business hotel. As you can see, we acquired a lot of new brands into our portfolio. So this will be our main focus. Second is that we think apartment is the natural extension of hotel business. Right now we invested in two companies in the sector. The first one is we [cultivate] internally; second, we over 30% of the business. We foresee that the young generation in China, especially in metropolitan cities like tier 1 cities, they cannot afford skyrocketing house price, similar to New York and other big cities in the world. So [the return] for rental is going to be [inaudible] than before. We think we are naturally advantaged in a few things such as site acquisition, product design and daily operations. So we want to apply our current experience in this -- into the apartment area. That's number one. And for -- and also as the city develops, like e-commerce change the utilization of some property in the cities, we feel like that are still some properties need to change the usage, and the demand for shared office is actually quite high, because we don't have prior experience in shared office. There's [inaudible] concepts, you probably are more familiar the way it works in US. So we invest three startups in this area, and we are looking for more. So, people -- I'm sure people will have questions about ventures into this new business, but just like what happened to the Ji Hotel, we face the similar [doubts] in the past few years, but today we start to recoup our efforts for Ji Hotel. So in summary, we think China Lodging is a very innovative entrepreneurial company. We will not stop at where we are. We will not [constrain] ourselves just in hotel [venture]. So we are always looking forward and moving forward. We share the same spirit like those technology companies in US, for example Google. Thank you.

Thank you.

Our next question today comes from the line of Vivienne Mao from Ward Ferry. Your line is now open.

Hi, good morning management. Congratulations on a very strong first quarter results. I have two questions. The first question is for Jenny. So, Jenny, could you please comment on the second quarter guidance, the net revenue? Because the 12% to 15% growth is a bit slower compared to what you delivered in first quarter. And then second quarter should really be a stronger season in terms of traveling and also [consisting] the [inaudible]. So it seems that the second quarter guidance is not as -- like should be stronger than your guidance, so I'd just like to hear some comments. And probably I will ask the second question after you take care of this first.

I will ask Teo to add on this. The key point there is last year Q1 we had actually a pretty low base. If you ever want to remember, we had a 5% to 6% same-hotel RevPAR decline last year. So the first quarter, of course many brands performed very well, but we also have a lower base impact going into that. Maybe Teo can add on that.

Yes, sure. Hi. Actually what Jenny has mentioned is that last [inaudible] the first quarter was low -- has a very low base, so as a result is that, when we -- so in Q1 2016 we benefit from that, so our Group actually benefited from that low base last year. But for Q2, is that currently because, as what we have mentioned earlier, is that we see the RevPAR stabilize, so what we have been seeing is that we are remaining, I would say, cautiously optimistic. So we are thinking that the guidance that we provide of 12% to 15% are appropriate under our circumstances. So I suppose, is that if we move into end of May and June, then -- or early June, we'll have a better guidance. But based on our current outlook right now, we think that our guidance is appropriate.

I see. Thanks. And the second question is for Ji-zong. [Chinese language spoken]

[Chinese language spoken]

The question is about China Lodging's investment in apartments and shared office. So, are you a major shareholder or minority shareholder? Second, what is your involvement in the Company's daily operations? Or you're just like a pure financial investor? So, Mr. Ji's answer is that, first of all, we are strategic investors. So we invest in many early-stage startups because they are still young, so we are not sure about how they develop in the future. That's why we start to experiment in the minority shares, for example, from 10% to 30%, depends on the situation. And we will increase or just keep our share value, depends on the development of the companies. But there are two exceptions. One is [Qungjia] and [Xiyi]. We cultivate internally. We have larger shares than other startups. Our basic concept is that we bring others, outside entrepreneurs into China Lodging's platform and help them grow, rather than just utilize current employees of China Lodging. We want to [inaudible] their energy and entrepreneur spirit. And right now we actually have professional teams to help us to evaluate the investment target and [inaudible] portfolio management post-investment. Actually the translator who's helping me currently, Ms. [Ye], is joining up our Company recently and in charge of the [investment] activity, together with me and Jenny and other senior management team.

Our next question today comes from the line of Lin He from Morgan Stanley. Your line is now open.

Hi, good morning, management. Thanks for taking my question. Congratulations again on the very strong set of results. Just one question from me. On the RevPAR side, we have seen meaningful recovery on the RevPAR and [inaudible] trends, and my understanding is that's primarily driven by recovery in tier 1 cities. So, management, could you please talk a little bit more on the situations we are seeing in those lower-tier markets? Have we seen any signs for demand pick-up in those lower-tier cities as well? Basically I guess I'm asking whether the recovery in tier 1 cities can potentially be spread in lower-tier city as well. Thank you.

Starting from a couple of years ago, we started to see a weakness in the lower-tier cities. We are doing a few things to handle the situation. Number one, we shift our investment focus, both leased hotels and manachised hotels to tier 1 and tier 2 cities. So we strictly control and maintain more than 70% of our portfolio currently are still in tier 1 and tier 2 cities. And secondly, we are also keeping innovating into more brands which can cover different type of properties and different segments of customers that enable us to deeply penetrate into the bigger markets. And thirdly, we are also studying different business models and marketing and selling tactics that can be applicable to third and fourth-tier cities. And we expect those tactics to start to bear some fruit in second half next year.

Okay. Got you. Thanks, Jenny.

You're welcome.

Our next question today comes from the line of [Yang Chen] from HSBC. Your line is now open.

Hi, Jenny; hi, Mr. Ji; and hi, Teo. I think my problem has been asked previously, so, no problem for now. Thank you.

Thank you.

[Operator Instructions] Our next question comes from the line of Yaoxin Huang from CICC. Your line is now open. Hi, Yaoxin, your line is now open, please go ahead.

Hi. Can you hear me? Yes. A quick question. Hi, Jenny, can you elaborate more on the HanTing 2.0? What's the difference between the traditional HanTing 1.0? Thank you.

We have shown the pictures of HanTing 2.0 versus 1.0 last year. So every one of you, you are more than welcome to visit our new models anytime. Currently we already have a few hundred of them across China. The main change is on the design side. The color scheme has changed from the dark red to light gray and blue, to give people a younger feeling, more cheerful, and also fuse [clean] and lights. And we also introduced a new model of fully built-in bathroom into HanTing 2.0. This helps the bathroom to feel more clean, organized, and in terms of quality, also more stable. There are also other changes that improved the customer experience, including lighting and other features. So it gives people a much better experience, especially for the younger customers.

Okay. Thank you, Jenny.

You're welcome.

Our next question today comes from the line of Jake Lynch from Macquarie. Your line is now open.

Yes. Hi, management. Congrats on the good set of results. And apologize because I might have missed this a bit earlier. But the old Home Inns shares, were those actually sold into the privatization or are you still holding those?

Okay. The Home Inns shares, the one that we disposed off in Q1 was with the public market. The one that we had disposed off in Q2 was actually a buyback from the management.

Okay. So you currently have no Home Inns shares, correct?

That is correct.

Okay. Thank you.

Once again, thank you for taking your time from your busy schedules today to join our call. We look forward to talking to you in the next quarter earnings conference call. Goodbye everyone.

Ladies and gentlemen, that concludes our conference for today. We thank you for your participation. You may now disconnect.