H World Group Limited (HTHT) Q2 2017 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the China Lodging Group Q2 2017 Earnings Conference Call. At this time all participants are in a listen only mode. [Operator Instructions] I must advise you that this conference is being recorded today, 17 of August 2017. I would now like to hand the conference over to your first speaker today, [Hai-Ming Xu]. Thank you. Please go ahead.

Thank you, operator. Good evening, everyone. Thanks to all of you for dialing in, and welcome to our second quarter 2017 earnings conference call. Joining us today is Mr. Ji Qi, our Founder and Executive Chairman; Ms. Jenny Zhang, our CEO; and Mr. Teo Nee Chuan, our CFO. Jenny and Teo will present the strategy review and Q2 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 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 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, [Hai-Ming]. Good evening, and thank you for joining us. Before diving into the details of the quarterly results, which are very strong, I would like to share with you our thoughts on the lodging landscape in China. On Page 2, let's take a macro view first. The domestic travel market demand remains strong despite a softening of macroeconomy. From 2011 to 2016, disposable income per capita growth was 7%, while the domestic travel expenditure grew at 14% CAGR. In 2016, domestic travel expenditure grew at 14%, significantly outpaced the growth of disposable income per capita. The strong demand of travel has been driven by a lifestyle change of Chinese people who favor travel and other life-enrichment activities. This trend is often called consumption upgrade. In particular, we see increasing adoption of the annual lease system and a higher frequency of short-distance leisure travel. If you look at the supply side on Page 4, we'll find that the net addition of branded hotel, for the first time, slowed down in 2016 and is expected to further slowdown in 2017. The hotel investors have become a lot more rational and new openings of economy hotels dropped sharply. While the demand for travel remains strong, the slow down of supply will increase the pricing power of the industry. We expect the overall inventory growth to remain lower than the peak years of 2014 and 2015 in the coming years despite of the boom of midscale hotels. Part of the reason is that the qualified properties and locations are limited, which constrains the new addition of midscale hotels. This favorable supply-demand situation helped our same-hotel RevPAR growth, which recorded at 8.3% in Q2 2017. The highest one in 4 years since Q2 2012. Page 4 provides a detailed view of the growth trends of our same-hotel performance. In Q2, our same-hotel ADR increased by 3%, and the occupancy increased by 4.5 percentage points. Looking further ahead, we believe Chinese consumers' purchase power is going to build long-term hotel ADR growth. On Page 5, we performed a comparison of consumer product price between China and the U.S. The price ratio between U.S. and China for most consumer products are in the range of 1times to 1.6 times. While for hotels, both economy hotel and midscale hotel, the price ratio is 2.4 times. Clearly, the hotels in China are underpriced, and we expect the price of hotels to gradually move up as the Chinese consumers already have the purchase power. Further, as shown on Page 6, overall speaking, China's hotel market is still highly fragmented which offers a huge potential for branded hotels to penetrate. We expect the market consolidation to continue in both economy and midscale segments. At the same time, the consumption upgrade will also drive the midscale boom since the inventory in this segment is currently very small. As shown on Page 7, our RevPAR growth trend reflects such expected ADR growth at same-hotel level as well as through mix upgrades. Our blended RevPAR growth for Q2 2017 was 14%. So after that macro review, now let's take a look at how we have been progressing at our strategic focus areas. In our Q1 results call, I outlined our strategy focus for 2017. So I'd like to give you an update how we have progressed, in particular, on the upgrade for economy hotels and the fast expansion of our midscale hotels. Let's turn to Page 10. First, our upgrade for economy hotels. Our HanTing brand, in particular, has an accelerated growth of hotel -- same hotel RevPAR, which was 8% in Q2, a historical high. The growth was mainly driven by strategic product upgrades as well as successful branding and the sales efforts. We also owe part of their success to the improved market conditions. About 62% of our returns are under the HanTing brand at the end of Q2, so the strong performance of HanTing contribute significantly to our overall strong financial results. In addition to the upgrade in HanTing Hotel, our cleanliness is also, as shown on your program, well received by our guests. This branding effort including setting higher standard of cleanliness, categorizing hotels by their level of cleanliness rating and encouraging housekeepers to continue to deliver quality service. 80% of guests surveyed indicated that their booking preferences are influenced by the cleanliness rating on our direct channels. Now guests can easily reward housekeepers for quality service with their membership points on the Huazhu mobile app. As you may remember, Huazhu is the first hotel group to firmly execute the midscale strategy. As shown on Page 12, we led the historical major event for our midscale brand. In 2010, the JI Hotel was incepted, thus, our first and the most favorite midscale brand in China. And during the past 7 years, we have continuously expanded our market share by leveraging more brands. We acquired Starway in 2012 and rebranded it this year. Manxin which was incepted in 2013 and it rebranded in 2017 too. These 2 brands are lease-adjusted to meet the customers' evolving needs. In 2015, we embraced Novotel, Mercure, ibis Styles and ibis to our family. Following our second strategy, we are also focusing on staff expansion along with our healthy and diversified brand portfolio. So in 2017, we launched 2 more new brands in the midscale segment, CitiGo and HanTing Plus. As you can see in later pages, all those new brands are very well-received by our franchisees. We are proud of the progress we have made on building our shares in the growing mid and upscale market. As shown on Page 13, during the past 3 years, we have increased our room inventory in the mid- and upscale segment from 11% in 2014 to 24% in Q2 2017. Currently, approximately 57% of our rooms in the pipeline are mid- and upscale inventory. Let's turn to Page 14. Here, we show a further breakdown of our mid- and upscale pipeline. Our multibrand strategy serves us very well in this segment. As you can see, we not only have a strong pipeline with JI Hotel, we also have a pretty sizable pipeline for Crystal Orange as well as Starway. For the Accor alliance brands such as Novotel, Grand Mercure and ibis Styles, we also have a pipeline of 43 hotels. For the newly launched or rebranded ones such as Manxin, HanTing and CitiGo, they already have accumulated a very meaningful pipeline to be opened very soon this year or in next year. Another major move in the midscale segment for Huazhu is the acquisition of Crystal Orange. Page 15 provides some details of the integration progress. First of all, the hotels performed very strong after the acquisition. In June 2017, the same-hotel RevPAR grew 12.4%, which is very strong among our portfolio. In addition, through this acquisition, we enriched our talent pool by having a more skewed experience hotel managers into our leadership team. We just appointed Mr. Wu Hai as the EVP of high-end product innovation, in addition to his existing responsibility as the CEO of Crystal Orange. Amy Liao, the Chief Architect and designer of Crystal Orange, also expanded her responsibilities to cover more high-end brands in Huazhu portfolio. At the same time, the booking system of Crystal Orange is already integrated into our platform. As of today, 84% of the 140 Crystal Orange hotels are already bookable through the Huazhu channel. The remaining will also be linked in, in the next few weeks. In addition to the strong performance of HanTing, our mid- and upscale hotels also have an increasing contribution to our revenue. As shown on Page 16, the revenue contribution from mid and upscale hotels is now 33% of total net revenue, a further 3 percentage point increase from 29% a year ago. We are happy with our progress on our major strategic focus. With that, I will turn the call over to Teo, our CFO, who will walk you through our Q2 operational and financial results in more detail. Teo, please?

Thank you, Jenny, and good evening, everyone. As for Q2 2017, China Lodging has a total number of hotels of 3,541. The net opening hotels for this quarter is 205. We opened 272 hotels, which includes 138 hotels consolidated from Crystal Orange acquisition. In this quarter, we also closed 67 hotels. Turning to Page 20. In Q2, we have seen a strong recovery of our hotel pipelines back above the 500 mark. Our pipeline has reached a total of 612 hotels in Q2. This includes 57 pipeline hotels on the Orange brand in this quarter. Therefore, we are positive in achieving our new opening target in 2017. Turning to Page 21. As mentioned by Jenny earlier, our blended RevPAR growth has reached 14% in Q2. This was driven by a strong improvement in both our occupancy and ADR. The occupancy increased by 4.9 percentage points, and the ADR increased by 7.9% year-over-year, mainly due to strong travel demand and popularity of our brand. Moving on to the financial results of Page 22. Our revenue grew by 20% year-over-year or 12.9% year-over-year if excluding the Crystal Orange. This is higher than our Q2 guidance range. Net revenue from our franchisees was up 26% year-over-year. The contribution from our manachised and franchised revenue has increased by 1 percentage points from 21% of the total revenue in Q2 2016 up to 22% in this quarter. We believe the revenue contribution from manachised and franchised will continue to rise going forward, given our asset-light growth model. Our net revenue from our leased and owned hotels also grew by 18% in this quarter, due to the impact of Crystal Orange acquisitions and the better RevPAR performance. As shown on Page 23, our operating margin came in at 22.3% for Q2 2017, increased by 6.4 percentage points from Q2 from 2016. The hotel operating costs and other operating costs as percentage of net revenue decreased by 5.7 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 rental. The preopening expenses, as percentage of net revenue, increased by 1.4 percentage points due to an increase in our hotels under construction. The SG&A expenses and other operating income as percentage of net revenue, decreased by 2.1 percentage points, mainly due to improved blended RevPAR. Turn to Page 24. This page tries to demonstrate the impact of the improved RevPAR and operating efficiencies to our bottom line. Excluding the impact on investment gains recorded in Q2 2016 and 2017, our EBITDA and net income growth would have been at 48% and 68%, respectively. Our EBITDA margin has expanded by 6 percentage points from 27% to 33%, while our net income margins has expanded by 5 percentage points from 13% to 18%. Move on to the cash flow status on Page 25. In the first half of 2017, our net cash from operations had reached RMB986 million, while the capital expenditure for maintenance and new developments totaled CNY343 million. As a result, the cash flow came in first half of 2017 totaled CNY642 million. On the financing part, we reached $500 million loan financing for the acquisition of Crystal Orange, and we put in another CNY467 million of restricted cash, partially to finance acquisitions and also a repayment of the bank borrowing. On the investment front, we paid CNY3.65 billion for the acquisition of Crystal Orange. On top of that, we also made an investment into a shared bicycle operator, mobile and an apartment service company. Finally, our guidance on Page 26. We expect to achieve a net revenue growth of 30% to 34% year-over-year in the third quarter of 2017 or 13% to 16% year-over-year, excluding Crystal Orange. For the full year of 2017, given the strong RevPAR momentum, we revised our net revenue growth estimates to 23% to 26% or 13% to 16% year-over-year if excluding the Crystal Orange. We also revised up our hotel opening target to 500 to 550, taking into considerations of the Crystal Orange. With that, let's open the floor for questions.

[Operator Instructions] Your first question comes from the line of Yaoxin Huang from CICC.

And I have two questions on for Teo Chuan. The first question is the long-term view of the store openings guidance and long-term views of the RevPAR.

Okay. So let me try to answer the question about the number of stores. So I think it's notable that last year, our net openings, actually the growth of net openings declined. It's mainly because the macro economy and some underperformance of some brands results. And looking forward, we think it's always a balance of quality and expansion fee. We would put the quality as a priority. Therefore, even though we can open 1,000 hotels every year, we are trying to keep the number in the range of 500 to 800 net additions every year without considering acquisition. It's organic growth. We think expansion too far, it's a little bit too stretched for main resource, and it will cause unnecessary competition in the market. RevPAR.

RevPAR.

Okay. So overall, we are confident about the RevPAR growth, both in economy and midscale sector. Although when the midscale hotels expanded to Tier 1 -- sorry, from Tier 1 cities to Tier 2 and Tier 3, the RevPAR will be lower than Tier 1. So you will see probably the blended RevPAR will be affected by the expanded network. But if we look at the Tier 1 cities, where the midscale hotels have very strong foothold, we are confident that RevPAR will continue healthy growth.

Okay. Great. I have another question. If assume -- assuming that you can have the same rental expenses comparing to -- or same as the franchisees, will be more willing to open -- lease and operate hotels of franchised stores.

Let me translate the answer first. So if we can get the same rental as our franchisees, we are also willing to open leased hotels because, first of all, we are very focused on hotel factor. With very strong cash flow, it has every investment opportunity in good locations. And as the hotel market escalate up, the investment for a large party is actually increased as well. For example, each investment can be up to RMB 40 million to RMB 50 million, which is a little bit too high for normal franchisees. So this is the place how we can play in the game. So overall, if we can find good locations in Tier 1, Tier 2 cities, we are open to have more new hotels from [indiscernible] up to our upscale sector.

So in the primary locations like Nanjing Road or Jiujiang Road Shanghai and Xingjiao Road to Beijing, we are actually opening leased hotels with investment over like CNY 10 million per hotel, which can generate very good cash flow. With these opportunities, we are definitely going to grab it. Having said that, in reality, our competition with the franchisees is actually very limited because all these locations are actually scarce resources.

Thank you. Your next question comes from the line of Billy Ng from Merrill Lynch. Please ask your question.

I also have two questions. The first question is regarding to the Crystal Orange acquisition. Would you be able to breakout like the earning contribution and the EBITDA contribution for this quarter from Crystal Orange? Also, would you be able to provide a little bit more guidance on the Crystal Orange growth for the next years and also, the EBITDA contribution from Crystal Orange? And I will ask the second question later.

Billy, this is Teo. Crystal Orange, because the acquisition was completed on May 25, so right now, we only have like slightly more than one month in the Q2 results. Just for information is that the revenue for Crystal Orange during this one month is approximately 120 million and with EBITDA of approximately 35 million. This is actually, and there is actually interest expense related to the acquisition, which is 500 million, so that would be approximately 10 million on the interest cost. In addition to that is that the amortizations for Crystal Orange are there due to acquisitions -- due to the appraise in tangible asset is approximately 1.5 million. Crystal Orange is actually, just has significant growth because from a pretty low base. So from where we can see that the RevPAR growth for the June itself is like more than 12%. And with the rates of opening, we expect that the growth will be much higher than the China Lodging's Group growth going forward.

Okay. And also, would you be able to comment on the Q3 RevPAR so far the current trend? Traditionally, during summer, RevPAR trend should be quite strong. Do you see an acceleration of the growth of RevPAR in Q3?

For the Q3, so far, we have seen that the RevPAR trend has been pretty positive. And it shows that the growth is actually, is pretty healthy and it's not less than the growth rate in Q2. Yes, but the idea is to be early in this stage because, yes, you want to have more months to go.

Your next question comes from the line of Justin Kwok from Goldman Sachs. Please ask your question.

Perhaps I want to ask a question, which a lot of investors were interested. It's about competition. So I mean, this year onwards, two of your former U.S. listed peers is now being consolidated into the kind of local SOE background operators. How do you see this competition dynamic evolve in the past year in terms of your competitors' opening appetite in terms of their progress, or their intention to go multi-branding, or compete against you in the midscale segment? Or at least do you mind to kind of walk us through what are you seeing in the landscape?

We see our peer companies in the same industry, very active. Jinjiang has only acquired Plateno but also acquired Vienna, so we see both companies have a very aggressive growth in terms of their pipeline. Similarly, we also see a lot of efforts from the combination of Inns and BTG. At the same time, you see we are pursuing somewhat different strategic focus. Huazhu has been focusing more on profitable growth. So we are not only laid on strong strategy about different segments and have a very solid execution, we also make sure we have created a healthy ecosystem that we're generating growing RevPAR, growing profit and where our franchisees are also seeing very strong results for their hotels. That I think draws the line between us and the other sizable players. Our profitability performance has been much stronger than them.

Perhaps a follow-up is on -- actually was on same side. As you mentioned these names also have been quite aggressive in doing M&As onshore. So you just finished the Crystal Orange deal. Is this something that it's still on your table that you are still open for further M&A to grow? Because I guess, Teo Chuan comment just now 500 to 800 hotels opening is not a small number already, so how do you see your growth in terms of organic versus inorganic?

We clearly are open to acquisition opportunities. But as we always say that you have to be, first of all, in the strategy map. And second, reasonable price. And the third, is at a level that our capability can integrate. If you look at the current Chinese players, actually, they are not as many interesting targets to look at. So we will continue to explore various opportunities. But as of now, we don't have any meaningful results to share with our investors yet.

Your next question comes from the line of Chun Choi from 86Research.

So my first question is on the -- so recently, one of the high-end hotel brands is partnering with an OTA Alitrip. So I'm just wondering what would be management thought on this? What's the implication to HanTing? And do you think a deepening partnership with a large OTA is important to your business?

Maybe, let me allow -- please allow me to clarify the question first. Are you talking about alliance between Marriott and Ali?

Yes, correct.

Okay. Huazhu has a clear strategy about our distribution. We like to strengthen our direct sales channel, and we are actively cooperating with various OTAs. So we don't have any plan to favor one OTA over the others. And we are actively recruiting new members into our lodging program. As you can see, our members have been increasing. We expect the total size of our lodging programs will be over 100 million member before the end of this year. And we expect -- we also just launched our new app couple of days ago. So we aim to provide our members better services, more convenient technology solutions to attract them back to our hotels in their future trips.

Got it. And then, I have another question on -- actually, I'm curious on why the HanTing brand can achieve 8% growth in the same-store -- same-hotel RevPAR beside the reason management just mentioned at the very beginning that there's a phase of growth is high and demand situation there. So -- and also, as a follow-up question on that is, what's the percentage of the HanTing 2.0 in the second quarter?

Okay. So first of all, the HanTing brand has been consistently over performing the comparable economy brands in the market for about 9 years by now. And our recent effort to further enhancing the quality as well as our investment into the branding effort -- branding of HanTing further enlarged the gap between HanTing and its competitors. By the end of Q2, the newer version of HanTing accounts for 33% of the total inventory.

Your next question comes from the line of Michael Wu from CITIC Securities.

Two questions here. First, compared to 2016, we have seen even stronger RevPAR performance in economy hotel from a like-for-like perspective. Do you think what are the key drivers? Is it more driven by demand recovery or supply-side offering? And is this strong performance sustainable going forward? This is my first question.

I believe, the recovery of economy brands is driven both by the demand recovery, the stabilization of supply as well as our own efforts in quality and the branding. So if you look at the data across the industry, I think, all the economy brands also see some recovery in their RevPAR. But we clearly show significantly higher same-hotel RevPAR growth as compared with our competitors.

Okay. And my second question is what are the profit margins of a typical economy and a midscale hotel under your brand? And how sensitive it is to RevPAR change?

The profit margin, I would say that the EBIT margin for economy hotel currently runs more than like 20%. But what we were seeing is that because a significant part of the operating cost is actually pretty fixed. Number one is rental. Number two is the amortization of the fixed assets. And the third part is the hotel staff. So basically, what we can see is that for every $100 of increasing -- I'm sorry, for every $10 increase in RevPAR, you can see that it's approximately $7.50 that goes to bottom line.

Thank you. Your next question comes from the line of Leon Chik from J. P. Morgan. Please ask your question.

I just want to know, did you -- when you mention 500 to 800, that's a net add even after subtracting the closures?

I think the 500 to 800 opening target Qi Ji just described is general expectation for the next five years. This is not our specific guidance for next year opening yet. We will share with our investors what kind of growth we expect for next year for both gross opening as well as net opening later.

Well, maybe another way -- the question would be, in terms of closures are we kind of settling down at a lower level at the end of this year, like 20 to 25 per quarter?

This year, our opening expectation is 450 to -- 500 to 550, including Orange. Yes, and our closure is expected to be somewhere around 140 to 160. So 1-7, okay. So roughly, so we are expecting a net opening approximate 350 this year.

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

I have two questions for Teo. Teo, I'm looking through our profit tables and there was two numbers. First, the other income net is like CNY 74 million in this quarter. And there was another number that other operating income net CNY 29 million in this quarter. So what is this numbers -- what are these two numbers?

The other operating income is actually the reversals of accruals, which is -- that is on expenses that we had previously over-accrued in the previous years -- I mean, in the previous year. And the other income is actually comprised of two components. One of them will be the CNY 38 million of investment gain from our disposal of certain investments and another CNY 30 million is actually from subsidy income.

Thank you. Your next question comes from the line of Angela Han Lee from China Merchants Securities. Please ask your question.

I have three questions here. The first one is about the opening guidance. So how many will be from new opening of Crystal Orange in the guidance? And can you share with us the split of leasing and manachising? Or will Crystal Orange expansion happen later? And the second question is about how many hotels do you expect -- how many hotels of Crystal Orange do you expect to see in one or two years? The third question is about, it would be good if we have some opening schedule split by economy and midscale hotels for this year too?

Sorry. Can you repeat your question again? Let that go one question by another. Let's start with first question.

Yes. So the first question was about the opening schedule of Crystal Orange. So I would like to know how many do you expect to open this year? And please share with us the split of leasing and manachising?

Okay. The Crystal Orange has opened up like two hotels since we took over in May. So it's like in the month of June they opened up two hotels. In the second half of the year, they expect to open between like 35 to 40 hotels. So they'll be giving you approximately like 37 to 42 hotels in this year.

Okay. So the second question was about a longer plan, say, like how many economy hotels of Crystal Orange do you expect to see, say, at the end of next year?

Well, next year, we are actually in the planning stage in opening up in the hotel opening plan. But definitely I'll just give you a shot that this year, we expect to open approximately, let me see, 642 -- actually, we expect to open approximately 50 Orange hotels this year. So next year, we expect that, that will be higher than 50.

Okay. So the last question was about, can you share with us the opening schedule split by economy and midscale hotel, please?

For Crystal Orange?

For the overall one, like HanTing and JI Hotel like.

Okay. The hotel opening plan for lease and operating is approximately -- let me share -- let me see that. Our opening plan is that we have approximately like 12% to 15% of the new openings are actually leased and owned. The balance are manachised and franchised.

Your next question comes from the line of [Jay Li] from Benchmark Company. Please ask your question.

My question is last quarter, you disclosed that 42% of HanTing rooms were upgraded to HanTing 2.0. And what's the updated progress in the second quarter?

Okay. The HanTing room inventory for the quarter two -- up at the end of quarter two is approximately 33% of the total HanTing room inventory.

Okay. My another question is that your presentation mentioned Chinese hotels ADRs are underpriced compared to the U.S. Do you have any plan to increase the price step by step to the U.S.?

We clearly see that in China, the branded hotels, of course, all the hotels are generally underpriced compared with the U.S. as well as benchmarks with our general purchasing power in this country. So we see the room for ADR. Our consumers already have the affordability. I think it's up to us to offer them the products they want. And I think we will gradually increase our ADR to realize a more reasonable price level.

Your next question comes from the line of Michael Wu from CITIC Securities.

So my question is, among your newly opened franchise hotels, how many of them are from independent hotels or franchised hotels under other brands?

Our conversions are from the old hotels, other franchise hotels into our own brand. The percentage is approximately 50%.

[Operator Instructions] There are no further questions at this time. I would now like to hand the conference back to today's presenters. Please continue.

Thanks, operator. Thanks, every investor, for dialing in today, and that concludes our call. Goodbye.

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