H World Group Limited (HTHT) Q1 2017 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the China Lodging Group Q1 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. [Operator Instructions]. I must advise you that this conference is being recorded today, Thursday, May 11, 2017. I would now like to hand the conference over to your first speaker today, Mr. [indiscernible].

Thank you, Operator. Good morning, everyone. Thanks to all of you for dialing in and welcome to our First Quarter 2017 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 Nee Teo [ph] will present the strategy overview and 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 U.S. 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 matter during the discussion of our performance. Reconciliations of these matters 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 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.

Thanks. Good morning, everyone. Thank you for joining us. Before starting to the details of quarterly results, which are very strong, I'd like to walk you through the strategic focus we set at the beginning of 2017 and how we have been progressing along those focused area. Looking forward into 2017, we are continuing the upgrade for economy hotel, accelerating the expansion of miscale hotels through a multiple brand strategy and driving further growth in same-hotel RevPAR. Let's take a look at the economy hotel segment first. On page 3, we are thrilled to see the continued HanTing same-hotel RevPAR growth. The same hotel RevPAR growth accelerated to 5.2% in Q1, after the encouraging turnaround of 1.1% growth in Q4 2016. We think the RevPAR growth were mainly driven by strategic product upgrades of HanTing 2.0, 2.5, as well as the successful branding and the sales efforts on top of the improving market conditions. By the end of Q1 2017, 32% of our HanTing root inventory are under 2.0 model or above, up from 17% in 2016. The improvement was a bit slow in Q1 mainly due to last new hotel opening during the Chinese New Year and the upgrade in progress hasn't finished due to the vacation. We are determined to further upgrade HanTing in the upcoming years. Another encouraging news coming from the ranking of Brand D [ph]. Every year, Brand D ranked top rank in China and across the world. HanTing has been on the top 100 list for China brands continuously for four years now. As shown on Page 5, HanTing's rank has moved up to number #78 across all brands in China and HanTing's brand value increased 25% to U.S. dollar RMB448 million in 2017; ranked 11 in terms of the growth of [indiscernible]. We aim to build HanTing into a hotel-for-everyone-everywhere. We are pleased to see our progress in this [indiscernible]. Let's move to the growth of midscale hotels. In the past month, we launched three new midscale hotel products. Including the first one, City Girl, which is an affordable luxury brand designed for young people in the city center. And we also launched the urban version of Manxin. We use this resource brand to enter into urban locations offering a lively and a colorful lifestyle choice. The third one, HanTing Class is an entry-level midscale brand derived from our flagship HanTing which offers a technology-enabled convenience and a high level of comfort. All three brands and products immediately excited and attracted many franchisees. We expect this new brand will [indiscernible] our extension in the midscale segment. In addition to the above-mentioned strong performance of HanTing, our mid and upscale hotels are also increasing the contribution to revenue. The revenue contribution from mid and upscale hotels now account for 31% of total net revenue, an increase of 4 percentage points a year ago. We are also proud of the progress we've made in terms of building our market share in this booming mid and upscale market. As shown on Page 8, during the past three years, we have increased our room inventories in midscale and upscale segment from 11% in 2014 to 19% in Q1 2017. Approximately, 50% of our room in pipeline are in the mid and upscale segments. With that, let me jump a little bit ahead to Page 14 to talk a bit about our progress on same hotel RevPAR growth. Our midscale hotels contributed more than 9%, same-hotel RevPAR growth in Q1 this year. Together with the performance of our economy hotels, we contributed approximately 5% in hotel RevPAR growth. The blended same-hotel RevPAR growth accelerated to 5.8% this quarter. This is our highest growth in number in the four years since Q3 2012. It's really a record-high and that we see the momentum partly supported by the market condition, consumption upgrade as well as the economy's stronger performance in the past quarter. And we also attribute this to our continuous effort in our direct sales including recruiting new members and they're upgrading their usage to midscale hotels. If you dive deeper, you will find the growth of same-hotel RevPAR is attributed to both ADR increase, as well as occupancy increase. The growth in the midscale segment are mainly due to the ADR growth and the economy segment, the growth mainly come from the increase in occupancy. We are very encouraged by the trend and we believe the strong RevPAR growth will continue into the rest of the year. With that, let me turn this to Teo who will walk you through in more details.

Thank you, Jenny. Good morning, everyone. Turning back to Page 12. This RevPAR continues to grow trends in 2016 and had accelerated to 9.8% in Q1 2017. This is an all-time high quarterly record growth since the China Expo in 2010. Turning to Page 13. The RevPAR growth 9.8% was driven by an increase in our occupancy rates by 3.5 percentage points and an increase of ADR by 5.2% year-over-year. The RevPAR growth was mainly due to the increasing mix of the midscale hotel room inventory as well as upgraded hotels. Turning to Page 15, moving on to the financial results. Our revenue grew by double digits year-over-year at 10.8%, higher than our Q1 guidance. Our revenue book was driven by 20% increase in our manachised revenue and an 8% increase in our lease and owned hotels. We continue to see an increasing mix of net revenues from our manachised hotels, increasing from 20.9% in Q1 2016 to 22.7% in Q1 2017 of net revenue. Move on to Page 16. Our adjusted operating margin came in at 11.5% for Q1 2017, increased by 5.6 percentage points from Q1 2016. The SG&A expenses in Q1 included a one-time transaction cost related to Crystal Orange acquisition, totaling approximately RMB45.2 million. Excluding this one-time transaction cost, our normalized operating margin would have been extended by 8.4% to 14.3% [ph]. The adjusted hotel operating costs and other operating cost as percentage of net revenue decreased by 8.2 percentage point's year-over-year. This is mainly due to our improved blended RevPAR and a favorable VAG impact on certain cost such as rental and utilities. The adjusted SG&A expenses as percentage of net revenue increased by 3 percentage point's year-over-year due to RMB45 million increase to Orange-transaction related fees that I mentioned earlier. We excluded this one-time effect to normalize SG&A expenses as percentage of net revenue would have been at 9.1% of net revenue. Move on to our cash flow status on Page 17. In Q1, our net cash from operations reach up RMB196 million or the CapEx for maintenance and new development total RMB186 million. As a result, the free cash flow in Q1 2017 total remain to be RMB11 million. Comparing to Q1 2016, our cash flow from operations was lower by approximately RMB130 million. This is mainly because of the mix to the large rental repayments to secure the leased hotels at a more favorable rate. So as the timing [indiscernible] settlement of salary, taxes and payables as we had a good quarter in Q4 2016. And you also see that our customer had also been increasing their use of prepaid cuts to pay for their stays in our hotels. Included in the RMB870 million cash out flow was a deposit of RMB700 million for the Crystal Orange acquisitions and the balance, are our striking investment into mobile and departments of this company. Finally, our guidance on Page 18, we are excited to achieve a net revenue growth rate of 10% to 12% year-over-year in the second quarter of 2017. We revised our net revenue growth guidance upwards in the range of 10% to 15% given the stronger RevPAR. Our hotel opening target remains the same. Last but not least, we expect the Crystal Orange acquisition to close in May 2017 as we have received - review approval earlier this month. With that, let's open the floor for questions.

Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Yaoxin Huang from CICC. Please ask your question.

Yes, sure. Thank you for taking my question. Congratulations for the good results and I have three questions. First two questions goes to Qi. Hi, Qi. First, I saw in the report that the full year revenue growth was revised up to 10% to 13%. I just want to make sure that is this estimate include Crystal Orange acquisition? And second question is that what's the wrapout trend recently in April and May? Thank you.

Okay. The growth estimate [indiscernible] go back 10% to 13% does not include the Crystal Orange acquisitions. It's number one; and number two is that the growth, the RevPAR growth in April is still better, positive. We'll say that it's a double-digit growth and the momentum moving forward to May as well. But the main [indiscernible] April due to the holidays.

I see. When you mentioned double digit growth, you mean blended RevPAR or same hotel? Blended, right?

Blended.

Okay, I see. Thank you. A third question goes to Qi Ji. How do you view the China acquisition after one to two years operation. [Speaking Foreign Language]

[Speaking Foreign Language]

Let me translate for Qi Ji's answer to Mr. Huang. First of all I think we are very fortunate to have a course brand. Most of the midscale and above, for example EP Star [ph]. And even for the EPs [ph] itself is at the high end of the economy segment. When we have difference from a core group, we take the ride of the high growth of midscale market and we see a very positive progress lately. Although we haven't disclosed a core separate number, but we are very satisfied. The results are very good.

Thank you.

And our next question comes from Justin Kwok from Goldman Sachs. Please ask your question.

Hi, good morning. Thanks for taking my question. Perhaps, I have two questions. One on the medium term opening outlook and then the other one on the previous quarter expenses. On the medium term opening side, as you mentioned in your slide, you continue to look for roughly 500 gross openings for the hotels in this year. I want to check how much visibility you have further down the road into the next two or three years? Would you think that this opening target is sustainable or you think it's actually been more upside given that you have already started to stabilize your franchise operation? And together with the fact that you have actually start to see a lower stop of your lead 10 operated hotels, do you think that this continue into the next few years? Maybe you have more expiry than net opening? This is the first question on the outlook - an opening. And the second question on the expenses that would be related to your comment on favorable VAG treatment for some of the item like utilities and all these, is it one-off or is it already a new normal for lower number going forward? Thank you.

Let me address the first question and we will ask Teo to comment on the VAG expense. We plan to open 450 to 500 new hotels this year and then we also expect some hotels to expire and that the lease term will expire and that there will also be some controlling up of low quality properties. So, we also expect a 100 deduction from the existing network. Net opening, we are expecting 350 to 400 this year. We expect the coming years, the net opening will increase meaningfully from this level mainly because we have launched quite a few new product as I just mentioned, HanTing class, City Girl, Manxin. We are also entering into the upscale markets through Mercure, Grand Mercure and Novotel. All those efforts are going to accelerate our extension next year and onward.

Hi, Justin. I'll take on the second question on the VAG, the favorable VAG impact. The VAG [ph] back in May in 2016 and the result was greatly trickling in the second half of 2016 and comparing in 2017, we have a favorable impact because in 2016 Q1, the VAT reform has not started yet. But having said that [indiscernible], you will see that the impact will continue to have some favorable impact continue on that gradually into this year, later this year because the transition for the VAG invoice was a gradual process. In fact, it was only fully implemented at the end in the last quarter of 2016. So I suppose it's that these we'll continue to enjoy some favorable impact from the VAG reform in the later part of this year as well.

Thanks for the clarification. Thank you.

[Operator Instructions] And our next question comes from Jessica Hong from Haitong International. Please ask your question, Jessica.

Hi, good morning. Thank you for taking my call. I have one follow-up question on this door openings. You just mentioned that the net opening will be 350 to 400. Does this number include the Crystal Hotel? Remember they have 125-126 hotels already, so does this number exclude or include the Crystal Orange? Thank you.

Hi, Jessica. Our net openings of 300 to 400 hotels does not include the hotel openings or acquisitions of Crystal Orange.

Okay, great. Thank you.

[Operator Instructions] There are no more further questions at this time. I'd like to hand the call back to the speaker for any closing remarks. Please continue.

[Indiscernible] with two more minutes if anyone wants to two more questions. If there's no more questions, we can end the call.

[Operator Instructions] And our next question comes from Lin He from Morgan Stanley. Please ask your question, Lin.

Hi. Good morning, Management. Congratulations again on a very strong result. One follow-up question from me. On the operating cost side, we found that the operating cost is down on year-over-year basis. Is that just that the favorable VAT [indiscernible] orders anything else? Thank you.

The percentage of the operating cost compared to the decrease and it does have a couple of impact - number one, the VAG impact, I will say is coming up to approximately 2.3%, but the balance is actually related due to the increase in [indiscernible], due to the improvement in our blended RevPAR.

Okay, got it. Thank you. My second question is on your brand portfolio. Jenny mentioned that you have recently launched three more new brands and expect this will help you to accelerate going forward. With that, you already have a pretty strong brand portfolio. Jenny, from your point of view, is the current brand portfolio, do you think it has reached the optimal size? Or you think you can actually manage more new brands going forward? Thank you.

We feel currently we have got a portfolio of good economy in the midscale brand. Especially with the launch of the few new products, as well as the acquisition of Orange, we are particularly strong in the midscale to upper midscale segment now. In the future, I think we will need to seek opportunities to strengthen our position in the upscale and the luxury segment, which we don't have much there yet. If we are to a new brand, I think we probably will add in those segments.

Got it. Thank you, Jenny.

Thank you, Lin.

Thank you. The next question comes from Leon Chik from JPMorgan. Please ask your question, Leon.

Hi, good morning, everyone. Congrats. I'm just wanting for the ADR increase, the 5.2% also strong in first quarter. How much of that is like-for-like increases and how much is relating to renovations and HanTing 2.0? Thanks.

We do not have an exact breakdown on the impact, the RevPAR growth in [indiscernible] due to various factors, but from what we can see is that from a world trend that with the increasing mix of the upgrade of accounts, the upgraded hotels actually deliver higher RevPAR that contributed to the improvement in the occupancy in the economy segment.

If you look at our data received, you will find our blended RevPAR actually grew 9.8% and with the same-hotel RevPAR grew 5.8%. So the difference between those two numbers are the mixture. So we have a bigger portion of midscale hotels. The second, in ratio to 5.8%, can we break it down to before renovation or after renovation? That's actually very challenging because we have been doing a lot of fine touch work on all of our properties. So it's very difficult to classify those changes from major renovation because we have been doing the work at full levels. But as the 5.8% accurately reflects, the same property RevPAR performance this year compared with last year, I think you know the main part are not from the up rate. It's really the performance improvement.

That's fantastic. Can you let us know what proportion of the HuaZhu brand has been upgraded from 1.0 to 2.0? What's the number? Thanks.

You mean HanTing? Okay.

Yes, the HanTing percentage. Yes.

At the end of Q1, we had 32% of HanTing at 2.0 above.

Okay, thank you.

You're welcome.

[Operator Instructions] And our next question comes from Justin Kwok from Goldman Sachs. Please ask your question.

Hi, it's me again. I actually have another question for perhaps Mr. Ji or Jenny in terms of the geographical expansion set. We have seen the company in the number of cities in China stabilizing around 300 plus cities for some time, but in the very recent parts you have opened a new hotel in Hong Kong, which is a high end. I want to get a sense on the overall strategies, how do you look at the geographic expansion? Are you prepared to pursue more growth beyond mainland [ph] China like going through the cities like Hong Kong or other cities where there is a huge amount of Chinese [indiscernible] tourist coming in or you think that the one in Hong Kong is more like one opening? Thank you.

Qi Ji, do you want to comment on that? Okay, I'll comment. Yes, we are happy that we have our first hotel offer in the mainland [ph] China. We are exploring various opportunities going beyond mainland China, but in the near term, we don't expect those efforts to be [indiscernible] or kept bringing a lot of additional growth in the near term. But in the long term, I think entering a new market will further give us growth opportunities. And that we also - that our technology, our sales platform are very strong and they are likely across different countries. So we are definitely more confident than ever that we will enter into the international market at some time.

All right. Thank you.

[Operator Instructions] There are no more further questions in this queue. Please continue.