H World Group Limited (HTHT) Q3 2016 Earnings Report, Transcript and Summary

Welcome to the China Lodging Group's Third Quarter 2016 Earnings Conference Call. [Operator Instructions]. I must advise you that this conference is being recorded today, Tuesday, 15 November, 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, Operator. Good morning, everyone. Thanks to all of you for dialing in today and welcome to our third 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's strategy overview and the Q3 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. Recalculations of those measures to comparable GAAP information can be found within 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 Jenny. Jenny, please.

Thank you, Ida. Hello, everyone. Thank you for joining our call today. Our Q3 results continue to demonstrate our strength in brand development and execution. As we approach the year end, I would like to review our strategic focuses for this year and to summarize our achievements so far. By now you're probably already familiar with these three lines, strengthen and differentiate HanTing; continue fast expansion; further boost direct sales. Let me talk about HanTing first. As shown on page 3, thanks to our product upgrade and our strong performance in tier 1 cities, HanTing's blended RevPAR came in at 0.4% year-over-year growth in Q3. This is an encouraging turnaround after quarters of decline. At the end of Q3 about 30% of HanTing's rooms were under HanTing 2.0 model, increasing from 17% at the end of 2015. To make HanTing the preferred and trusted hotel choice for mass market travelers, we will launch next week the Stay Clean, Stay in HanTing campaign. We trust that a commitment to cleanness will significantly differentiate HanTing from other economy hotel brands and attract more traffic to our hotels. HanTing has long enjoyed the reputation of a better and a cleaner economy hotel. Building on that, we challenge ourselves with a higher and more comprehensive set of standards of cleanness and have rolled out the best tools to enable our cleaning staff to work more efficiently and effectively. We trust that this careful positioning will support HanTing's further improvement of RevPAR in 2017. Our second strategic focus is to continue fast expansion. As shown on page 6, in Q3 we opened 171 new hotels and closed 87 hotels, mainly to remove low-quality properties to strengthen our brand. In addition to that, we anticipate to open 183 new hotels and close 51 in the coming fourth quarter. So for the full year, we anticipate the new openings will amount to 772 and the closure at approximately 205 hotels. The new openings in 2016 continue to be phenomenal after a record high year of 2015. We took the opportunity of the fast expansion to also accelerate the exit of low-quality, low-performance hotels on top of the due expirations of leases. More than half of the exits this year were due to the onetime effort of quality enhancements across several brands. We expect the exit number next year will come back to the normal range of 100 also. Globally, China Lodging has been and continues to be a leader in terms of organic growth, as shown on page 7. In 2015, we added more than 68,000 rooms, making us the fastest by organic growth globally. In 2016, we estimated to add about 53,500 rooms, possibly still on the top of the list by organic growth. In 2016, for the first nine months the midscale and upscale hotel rooms added accounted for 35% of total net openings compared with 23% in the same period of 2015. This quick up-rate of our new openings, will also bring a higher quality revenue base going forward. Our third focus is to further boost our direct sales capability. On page 8, in Q3 about 88% of room nights were sold through our direct channel. The total number of members reached approximately 69 million as a result of our most favored loyalty program. On November 11, just last Friday, we launched a very exciting new campaign, the best price guaranteed when booking through direct channels. We're committed to refund price if members ever book a room at a lower price from OTA channels. We trust this campaign will further boost our direct sales and strengthen our relationship with our members. Looking forwards, on page 10, we have also set the goals and also our strategies for the next three years. We will continue to grow both our network and the profits by turning primarily three keys. First, we will continue to upgrade our economy hotels portfolio and to dominate the upper part of economy hotel segment. Secondly, we will accelerate the expansion of midscale hotels. And thirdly, we will continue our efforts in quality improvements and grow the same-hotel RevPAR. On page 11, as I've reported already, the upgrade to HanTing 2.0 has been a key to drive HanTing brand RevPAR growth and profitability this year. We will continue those efforts and expect the new version of products will account for a bigger portion in the next three years and that by the end of 2019, the old model will be less than 10% of the overall network. Also in 2016, we introduced a new feature to further upgrade the HanTing lobby. We launched a cafe bar called Niiice Cafe in HanTing which helps our customers to get refreshments and to restore energy. We also made the atmosphere in the lobby more interesting. We expect to achieve 35% of rooms under a HanTing 2.0 model by the end of 2016 and 20% more each year of the next two years. The other exciting brand is Ibis which is redesigned by China Lodging based on the prototype provided by Accor. Since the first flagship store opened in the middle of the year, we have already signed up a few dozens of new projects under this new model. Secondly, we will accelerate the expansion of midscale hotels. As shown on page 12, during the past three years we have increased the proportion of midscale and upscale hotels in our new openings. We expect to increase the new openings of midscale hotels in 2017 to 40% in terms of hotel comps and 47% in terms of room comps. To help you better understand the impact of the midscale brand versus our original base of economy hotels, we have shown our comparisons between a typical JI Hotel versus a typical HanTing hotel. JI Hotel is 1.4 times bigger than HanTing in terms of room count and also per room the RevPAR is also approximately 1.4 times of HanTing at a similar location. With that, we generate 2 times revenue per hotel for a JI Hotel versus HanTing that leads to a 2.7 times EBIT for JI Hotel versus HanTing. Therefore, we expect despite we will open less number of hotels in 2017 but we expect to generate still a very significant amount of revenue and profit through this upgrade of brand portfolio. In addition to the well-established JI Hotel, we will further develop Starway, Manxin, Mercure and Ibis Styles in the next three years. We call them our five golden flowers in the midscale segment. In spite of the smaller number of net openings this year compared with last year, our better quality and higher mix of midscale hotels has led to better RevPAR performance. On page 13, in the first nine months of 2016, we added 435 new hotels compared with 593 in the same period last year. However, the blended RevPAR for the first nine months of 2016 came in at RMB157 compared with RMB153 in the comparable period last year. With that has generated a significant amount of incremental profit from our large mature hotel base. And thirdly, we will drive the same-hotel RevPAR to grow continuously through our quality improvement programs. On page 14, through our efforts this year, our same-hotel RevPAR already started to go back to the positive zone in Q3. It increased 0.5% year-over-year this quarter and we have observed very encouraging trends that the positive growth continued in October. We have a run a quick calculation about how the improvements in RevPAR impacted our profits in 2016. Page 15 illustrates that in terms of hotel income. The hotel income from mature hotels turned positive with the same-hotel RevPAR appreciation of 0.5%. That makes a significant contribution to the bottom line compared with the profit decrease of the mature hotels last year. Looking forward, we believe by turning the three keys we just mentioned, our product quality and also mix will continue to improve for long term profitability. As shown on page 16, if we look at the incremental profit year-over-year for 2015, our estimation for 2016 and the next year, 2017, you are going to see we will generate increasing amount of additional profits from our mature hotels going forward and we will not solely rely on the new hotel openings to increase our overall profitability. That we believe is a more sustainable growth path in the coming years. With that, I will turn the call over to Teo, our CFO, who will walk you through our Q3 operational and financial results with more details. Teo, please.

Thank you, Jenny. Hello, everyone, good morning. I'm pleased to report our operational results for Q3 2016. On page 18, at the end of Q3 2016 we have a total of 3198 hotels or 322,785 rooms in operation covering 365 cities in China. On page 19, our Q3 net revenues grew by 10.9% year-over-year in line with our guidance. We're excited to report that our midscale hotels recorded a year-over-year revenue growth of 35% in Q3. As a result, the revenue contribution from midscale and upper-scale hotels has increased to 28% of the total net revenue in Q3 2016, an increase of 4 percentage points from 24% a year ago. On page 20, in Q3 our blended RevPAR growth for all hotels accelerated to 3.2%, compared to 1.1% in the first half of 2016. This was mainly driven by our hotel ADR growth. On page 21, in Q3 our Group's blended ADR was RMB194, an increase of 3.6% year-over-year, mainly due to a more favorable brand mix. The blended occupancy was 89%, reflecting a 0.3 percentage point year-over-year decline. The slight decrease was mainly due to lower occupancy for our newer hotels and partially offset by improved occupancy in our more mature hotels. At the end of Q3 2016, approximately 77% of our hotel rooms are located in first and second-tier cities. In summary, for Q3 the blended RevPAR was RMB173, an increase of 3.2% year-over-year. Page 22 provides a detailed view of the growth trend of our same-hotel RevPAR for hotels in operation for more than 18 months. In Q3, our same-hotel RevPAR increased by 0.5% with a 0.4% increase in same-hotel ADR and 0.2 percentage point increase in occupancy. Excluding hotel rooms under renovations or product upgrades, the normalized same-hotel RevPAR would have shown a 0.9% year-over-year growth in Q3. We think that overall RevPAR trends have been stabilized. Meanwhile, the RevPAR for midscale and upscale hotels contributed high single-digit growth at 7.5% on a like-for-like basis in Q3. Move on to financial results on page 23. Our net revenues from leased hotels grew by 7% while revenues from manachised and franchised hotels grew by 24% from Q3 last year. In Q3, revenue contribution from manachised and franchised hotels accounted for 21% of the total revenue, an increase of 2.2 percentage points from the prior year. On page 24, our adjusted operating margin came in at 20.4% for Q3 2016, an increase of 2 percentage points from Q3 2015. The adjusted hotel operating cost and other operating costs as a percentage of net revenue decreased by 2.3 percentage points year-over-year. This is mainly due to our improved blended RevPAR and a favorable VAT impact on certain operating costs such as [indiscernible]. The pre-opening expenses, as a percentage of net revenue, decreased by 0.8 percentage points from a year ago. This is the main result from the fewer leased hotels open and under construction. The adjusted SG&A expenses as a percentage of net revenue was 8.3% in Q3 2016, the same as Q3 2015. The other operating income as a percentage of net revenue increased by 1.1 percentage point year-over-year, mainly due to the timing differences on government subsidy received. Move on to cash flow status, as shown on page 25. In Q3 2016, net cash generated from operations totaled RMB620 million. We spent RMB114 million on CapEx related to upgrade maintenance and new developments. As a result, the free cash flow in Q3 totaled RMB506 million. As of September 2016, we have cash balance of RMB3 billion, a short term loan balance of RMB287 million, our total credit facility available to the Company was RMB550 million. Finally, our guidance on page 26. We expect our net revenue to grow between 9% to 11% year-over-year in Q4. For the fully year of 2016, we projected our net revenue to grow between 12.7% to 13.3%. With that, let's open the floor for questions.

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

I have two quick questions. First is about the store closure; we will see close to 200 hotels to be closed this year. And what's your expectation for the store closure in 2017? And how many stores -- how many hotels will be rental -- rental term will be renewed in the next year? Thank you.

As I just indicated in the call, a lot of the closures this year is onetime due to our new standards of quality. So next year we expect the closure to get back to the normal range of approximately 100 hotels.

Close to 100, okay. Thank you. And next question, we have seen a slogan for the Stay Clean, Stay HanTing, the new slogan. Do we have any specific new quality control measures for the new HanTing 2.0? Thank you.

We rolled out the new cleanliness standards not just to HanTing 2.0, it's across all hotels, our new standards. We have been implementing those standards and making internal improvements for more than a quarter. So it will take too long to explain them in detail; if you are interested, we might set up a time later to discuss it.

Our next question today comes from the line of Billy Ng from Merrill Lynch. Your line is now open.

I have two questions. The first one is, when we look at the same-hotels RevPAR in the economy segment, I think it's still down year-on-year. But would you be able to break down between the 1.0 and 2.0? Is 2.0 outperforming the 1.0? If we're talking about same-hotel -- we're not talking about the conversion from 1.0 to 2.0, but compared to just 2.0 and 1.0 on the same-hotel RevPAR growth, the 2.0 outperforming 1.0 as well?

Right, if you break down actually [indiscernible] information is that the economy hotels, the overall [indiscernible] decline of same-hotel RevPAR for the economy segment. As I mentioned before, that this was mainly due to huge barriers of the older HanTing 1.0. With the 2.0, in fact we have seen that there is a continuous growth during the last three quarters for HanTing 2.0. In fact, this trend has been continuing. And we expect that, with the increasing proportion of our room numbers under HanTing 2.0, that we will finally turn the trend one day.

Yes, actually if you watch the same-hotel RevPAR trend for HanTing quarter-by quarter, the brand has been making significant improvements in the past few quarters and the decrease has been shrinked. And in October we already see the same-hotel RevPAR growth of HanTing, so we're reasonably optimistic that HanTing will get back to RevPAR growth next year.

So can we assume actually that 2.0 is already growing on a year-on-year basis, as of now, right?

Correct.

The same-hotel, okay. Then second question as well, you probably just talked about that a little bit. For fourth quarter, traditionally it's a slow season and RevPAR trend, if you look back in the last few years, normally perform not as well as the third quarter. So what do you see in the fourth quarter? And you just mentioned even HanTing is turning positive, the HanTing brand is turning positive. So what's the latest you can share for the fourth quarter numbers?

Okay, the fact is that, for quarter 4, we came up to like our October and November. In fact, there is still some -- I would say that the trend has been stabilizing. The fact is that we continue to see the big trend has been in previous quarters. For HanTing 2.0, the trend has been -- the RevPAR has been increasing, while the HanTing 1.0 has been declining. So we think that the overall RevPAR trend for Q4 will continue the trend of the previous quarter.

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

My first question is around the situation of the franchisee business. Is there any downward pressure on the franchisee fees?

We're not seeing any meaningful change of our franchise fee. We provided some one-time subsidy to some of the hotels in cities that are hit very badly by the economic downturn. That's a limited amount, limited terms. So our general fee scheme remains quite stable.

My next question is around competition side. Since both Home Inn and 7 Days are right now in the ISOE's hand, so do you guys see any change in competition such as the pricing or the pace of the opening?

We have seen some slowdown in the past nine months of their new openings. In terms of their day-to-day operation, they are generally stable from our perspective.

Just one last question, in one of the page you already briefly touched upon it, so just want to get more elaboration on it. Because right now there's evolving trends on the social media front, such as the WeChat and they have already started to offer the service such as travel booking. So how do management see the potential opportunities, as well as risks?

We're one of the earliest adopter of WeChat as one of our direct booking channels. Our WeChat channel now has more than four million members using them daily. So it's the increasingly preferred channel of our members today. It also provides a lot of convenient tools for us to communicate with our members.

Our next question today comes from the line of Leon Chik from JP Morgan. Your line is now open.

Just a few quick questions, first, for these -- I think there's 87 closures, this must be like a record high for a quarter, is that correct? Secondly, are there costs associated with these closures? We notice other costs I think were up about 40% and G&A costs also up 21%. So just trying to explain why these costs are rising faster than revenue, thanks.

Okay, now the closures of the 87, as was mentioned earlier by Jenny, was mainly due to a couple of factors. Number one, it's mainly due to the one-time closures on poorer qualities of products that we like to remove from our hotel network because they do not comply with our brand standards. This is one. Number two is that there is also a certain [indiscernible] -- more a routine kind of transaction where there is a hotel expiry, so this is on our hotel closures. Number two is that pressures on the [indiscernible] operating expenses, for example the SG expenses has been coming down. The main reason is because there is a one-time adjustment on the membership cost accruals, so there is a reversal. If you move that away, the percentage point will be the same as what's in previous quarter and previous years which is like approximately 2.5% to 3%.

So what are these reversals for?

Sorry, the reversals of the membership cost accruals.

Okay and is that one-off, it's just only in third quarter? Like it's just extra cost in the third quarter, like it doesn't happen again later?

It is an adjustment. Basically it sets out -- we have been continually making accruals on membership costs, as and when our customers direct deposit their memberships [indiscernible] consumed in our hotels. But having said that, is that we reflect that when counting how the points are being used and whether they are expiring. So for the membership point that has been expired, then -- or perhaps the consumption of the membership points on items which are less than the cost of the original input, then you make adjustments.

Okay. But you just did a massive clean-up of these costs and accounted for them in third quarter? You just cleaned them all up, is that what happened?

We have been continuing, in fact, every quarter it has been a continuing thing.

Every quarter.

Yes.

Okay. Then just last quick one. I think you mentioned that most of the HanTing would be renovated, I think only 10% remaining. What's the timeframe for that? Is that end of 2017 or 2018? I couldn't hear you guys. So when is the HanTing 2.0 finished?

The renovation will continue for the next three years and the new model will reach more than 90% by the end of 2019. So it's --

Our next question today comes from the line of Timothy Lam from Macquarie. Your line is now open.

I understand on the call earlier that you mentioned HanTing 2.0 already 30% of the rooms have been upgraded. I know that you have mentioned that 35% is going to be completed by 2016. I just want to see if there's room for that to be completed faster and see if there is room that this Company will likely to be exceeding that target? Second question I have is regarding the RevPAR expectation in the midscale. I want to know that -- I mean this year certainly the Company has done very good job to improve the RevPAR for midscale and upscale. I just want to see if the Company see that trend to continue into 2017?

First off in regard to HanTing, we believe our current pace is reasonable and we don't expect that we would have significant deviations from that, either to go much faster or much slower. In terms of the midscale hotels, we continue to see increasing demand [Technical Difficulty] upgrade. We expect the midscale hotel, same-hotel RevPAR continue to grow in 2017.

In terms of the midscale hotel, I remember back in a couple of calls earlier, Company were looking at some of these planned midscale new hotels to be more back-end loaded. Would you be able to give us some breakdown on how many of these mid to high-end hotels will be open in 2017 or 2018? Thank you.

Okay, the fact is that you see it in the first presentation by Jenny, that in our pipeline we have like 39% of our new hotels are actually for the midscale. So we expect that the trend will be growing. But in terms of room numbers, is that there will be approximately 50% of our pipeline hotels. So we expect that the trend will be increasing going forward.

Sorry, can you repeat that? 50% of your pipeline, basically you're saying the new hotels, 50% are in midscale, is that what I hear?

[Technical Difficulty] we have approximately 39% of our pipeline hotels under the midscale. That will give us -- it will contribute approximately 50% of the room numbers, in terms of room numbers for our pipeline hotels.

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

Two questions from me. Firstly is the new opening target next year. I know that you mentioned about the expected closure next year will normalize. Can you talk about -- can you share with us the gross opening targets next year as well? That's the first question. The second question is regarding the market size, potential market size, for midscale segments.

Before Qi Ji answers that, I would ask [indiscernible] to translate the second question and we will address [Technical Difficulty].

Okay, the second question is about the future market size of midscale segment. She wants to know Qi Ji's view about the tier 1 market and the non-tier 1, meaning tier 2 and tier 3, market of the midscale hotels. Specifically, for example, Ji Hotel has 50% exposure in tier 1 and she's wondering whether Ji Hotel can be replicated to tier 2 and tier 3 as well.

Okay, I'll quickly address the first question. Our gross opening target next year is 500. The decrease from 2016 mainly comes from the economy hotel brand across Hi Inn, Elan and HanTing and the increase will mainly come from our midscale brand, such as Manxin, Ibis Styles, Mercure. We also are going to open more Ibis hotels next year. So the overall mix of new openings next year will be of higher quality, higher RevPAR and higher profit. With that, let me turn the call to Mr. Qi for the second question.

Okay, many of you see my drawing of the pyramids. You know, China has a big chunk of people from mid-class or new middle class [indiscernible]. And we think the hotels allocation among upscale, midscale and economy should reflect the population structure as well. So my first viewpoint is that we will stick to economy hotel as one of the bread-butter business, although there is some negative publicity about economy segment by some of our peers. But HanTing, as a late mover to this economy hotel, we still stick to this segment and we continue to view this as an important revenue and profit stream to our business. Second, regarding to the midscale segment, right now we have five brands in this segment and Ji Hotel is one of the very promising ones. Right now Ji has 200 to 300 hotels. I mean I don't feel surprised to see that Ji will open 1000 hotels in the future. For other brands, I think it's also possible for them to have 500 to 800 hotels per brand. So I think the next three to five years is a golden time for the mid hotel segment and of course you see there are a lot of people and capital rushing into this segment. But I think, in the end, the really good ones' persistence and experience [indiscernible] will survive and thrive. That's my few cents and welcome her to Shanghai and I will discuss you more in details. Just a few more comments on Ji Hotel. Our original thinking is that Ji is very Zen-like oriental, tranquil. We think this brand will be very well accepted in metropolitan city like Beijing and Shanghai quite readily. People want to find peace in where they stay. We're not sure about how it's going to be in second tier and third tier. But, in reality, let me just give you example. There is a third-tier city called Hanzhong in Shaanxi province. One of our franchisees insisted to have a Ji Hotel in that city and we make it happen and the RevPAR turned out to be RMB200 which is quite good in third-tier city. I think for a city like Hanzhong, typical third-tier, like two Ji Hotels in one city is totally doable, 150 rooms per store. So I'm confident we can expand more Ji Hotels into second-tier, third-tier and even some fourth-tier cities. You know, it's pleasing to me that we find that the Ji Hotels is quite widely accepted from very tasteful, artistic designer, to even more mass market. But of course, having said that, we will be prudent in Ji's expansion in smaller cities. Not as many as in Shanghai, but maybe one, two, three in smaller cities. Thank you.

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

I have a question about the syndication and the merger with Accor and I'm wondering how is the status from now after you take over all their hotels in China? Thank you.

So just let me rephrase -- let me check if I understand your questions. You try to ask how is our cooperation so far with Accor in China, is that correct?

Yes.

Okay, in fact, since the closing of the transaction on January of 2016, the fact is that we have been -- the transition has been pretty smooth. In the sense that we have been integrating our booking systems and then is that we have actually co-posted --that China Lodging Hotels has been posted on Accor's portals and vice versa. So in addition to that, we have been working together in developing the brand and China Lodging has also been getting help from Accor in terms of [indiscernible] developing the branding for like Ibis, the Mercure, et cetera. We have been doing on very -- the progress has been on schedules. On the other hand is that, as you may actually like to ask, is that there is the closures of certain Accor hotels, in particular Ibis, in the quarter 2. This is actually mainly due to the actual problematics of franchisees which in quarter 2 has been inherited from Accor because as part of the transaction, we had to take over the entire midscale and economy hotels from Accor. And then that we would try to -- we would need to remove them and take action against them after these hotels have been transferred to quarter 2. So, in a nutshell, our cooperation with Accor has been on schedules. And, in fact, we have been looking forward to work together with Accor in other areas as well. Including, but not limited to co-development of the Novotel and Grand Mercure brands.

Ladies and gentlemen, that concludes the question and answer session for today's call, I would now like to hand the conference back to Ms. Yu for closing remarks.

Thank you all for your time on the call today. We look forward to speaking to you next March, good bye.