H World Group - Q1 2024

Transcript

Operator (participant)

Good day, thank you for standing by. Welcome to H World Q1 2024 Earnings Conference Call. At this time, all participants on the listen only mode. After the speaker's presentation, there'll be a question and answer session. To ask a question during the session, you need to press star one on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star one again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Jason Chen, Senior Investor Director. Please go ahead.

Jason Chen (Head of Investor Relations)

Thank you, Maggie. Good morning, and good evening, everyone. Thanks for joining us today. Welcome to H World Group 2024 First Quarter earnings conference call. Joining us today is our Chairman, Mr. Qi Ji, our CEO, Mr. Jin Hui, and our CFO, Mr. Jun Zou. 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 provision 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. H World Group does not undertake any obligations to update any forward-looking statements, except as required under applicable laws.

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 our earnings release that was distributed last Friday. As a reminder, this conference call is being recorded. The webcast of this conference call, as well as supplementary slides presentation, is available at ir.Hworld.com. With that, now I will hand over the call to our CEO, Mr. Jin Hui, to discuss our business performance in the first quarter of 2024. Mr. Jin, please.

Jin Hui (CEO)

[Foreign language]

Speaker 9

We had a relatively good start for 2024. Let's firstly review our Legacy-Huazhu's operational performance during the quarter. Please turn to page 3. In the first quarter of 2024, Legacy-Huazhu's blended RevPAR reached CNY 216, representing a growth of 3.1% on a year-over-year basis. ADR grew by 1% to CNY 280, and occupancy rate grew by 1.6 percentage points to 77.2%. The business performance was quite stable during the quarter, and it was within our expectation at the beginning of the year.

Jin Hui (CEO)

[Foreign language]

Speaker 9

In terms of hotel network expansion, we are happy to see that some important strategic adjustments and the changes we made in the past few years, such as organizational upgrades, establishment of regional headquarters, and a sustainable quality expansion strategy, are rapidly achieving positive outcomes. Please turn to page four. On hotel opening front, Legacy-Huazhu opened 569 hotels in the first quarter. The number of hotel closures was 148 in the first quarter. 61 hotels declined from the same period of last year. If excluding low-quality economic soft brand and Hanting 1.0, we closed only 72 hotels, 15 hotels less than the same period of last year.

Our future hotel closures should gradually reach a more normalized level after rapid cleanup and upgrade process over the last few years and our sustainable quality growth strategy. More importantly, our pipeline further grow to a record high of 3,138 at the quarter end, despite our 569 new openings during the quarter. It further demonstrated our strong brand power and increasing attractiveness to franchisees.

Jin Hui (CEO)

[Foreign language]

Speaker 9

Our Limited Service segment, which serves the mass market, remains our key strategic focus. Our economic and mid-scale products continue to be the key driver for our rapid network expansion. Breaking down our hotels in operation, hotels in pipeline, and hotel openings in the first quarter of 2024, the proportion of economic and mid-scale hotels were 92%, 84%, and 92% respectively.

Jin Hui (CEO)

[Foreign language]

Speaker 9

It is critical to constantly upgrade products in a timely manner in order to better meet and satisfy customers' needs. As we are seeing, our customers' consumption, behavior, preference, and tastes are changing rapidly and frequently nowadays. It is also one of the most important building blocks to enhance the competitiveness of our brand and gain attractions from franchisees. In the past years, we constantly introduced new upgraded versions of our major brands. Using our Iron Triangle brand in the Limited Service segment as examples, please turn to page 6. The proportion of Hanting 3.5 and above steadily increased from 11.8% as of 2020 to 29.8% as of 2023, and further to 33.2% as of the first quarter of 2024.

Jin Hui (CEO)

[Foreign language]

Speaker 9

Please turn to page 7. For our Ji hotels in operation, the proportion of Ji Hotel 4.0 and above products increased from 30% as of 2020 to 65.7% as of 2023, and further rose to 69% in the first quarter of 2024. Please turn to page eight. For Orange's latest lifestyle products, in Orange pipeline hotels the proportion increased from 58.4% at the end of 2023 to 75.7% in the first quarter of 2024. In summary, the Iron Triangle brands composed of Hanting, Ji, and Orange, through continuous product iterations, product strength and brand strength are continuously strengthening. Please turn to page eight. As of the first quarter of 2024, the latest lifestyle versions of Orange Hotel brand accounted for 75.7% in its pipeline, increased from 58.4% as of 2023.

In conclusion, our Iron Triangle brands, including Hanting Hotel, Ji Hotel, and Orange Hotel, has been further strengthening their brand and product power through consistent product upgrades.

Jin Hui (CEO)

[Foreign language]

Speaker 9

As we continued penetrating into lower-tier cities and the new markets, some new demands and a new group of customers emerged. Therefore, in addition to our Iron Triangle brands, as we mentioned above, we are also constantly developing new products to better meet the needs of different customer group and the market conditions. In the first quarter of 2024, based on our very mature and successful experiences of Hanting, we launched a new version of Ni Hao Hotel. The new Ni Hao is positioned as a complementary brand for Hanting in the economic segment, especially in the lower-tier cities, and it is also positioned to cater to the accommodation needs of the younger generations. Please turn to page 9.

The brand new Ni Hao 2.0 integrates traditional Chinese color and texture symbols with contemporary aesthetic, showcasing the Chinese ethnic confidence and providing consumers with additional choice for different aesthetics. At the same time, through reinvention of new service scenarios, Ni Hao Hotel has integrated many value-added services such as health preservation concept, popular modern Chinese tea, and snacks into the self-service modules at the hotel lobby. This is in line with the current consumption philosophy of young customers, who seek good value for money products, but with good experiences. The new Ni Hao will strongly align with our flagship brand, Hanting, to further solidify our leading position in the economic hotel market. In terms of our geographic expansion, we keep penetrating to lower-tier cities in China. Please turn to page 10.

As of the first quarter of 2024, 40% of our hotels in operation were located in Tier 3 and the below cities, representing a one percentage point increase year-over-year. At the same time, 54% of the hotels in pipeline were located in Tier 3 and below cities. The proportion of Tier 3 and below cities in pipeline was a bit lower compared to the same period of last year, while the proportion of the Tier 1 cities was a bit higher year-over-year. It was mainly due to a much faster new signings in upper mid-segment as well as in the Southern Region. In fact, the pipeline in Tier 3 and below cities was still growing in absolute number terms. As of the first quarter of 2024, the number of city coverage was 1,290, with 158 new cities added compared to the same period of last year.

Please turn to page 11. Our upper mid-scale segment development is continuously progressing. As of the first quarter of 2024, there were 686 upper mid hotels in operation, representing a 28% year-over-year increase and a 6% quarter-over-quarter increase. There were 430 upper mid hotels in pipeline, representing an 81% year-over-year increase and an 11% quarter-over-quarter increase. The fast growing pipeline further demonstrated that our upper mid brands, especially our key brands, including IntercityHotel and Crystal Orange Hotel, were increasingly gaining recognitions and popularity among customers and franchisees. Since last year, the business traveling has been recovering relatively slower due to weaker than expected macroeconomic. Nonetheless, our direct B2B business was growing quickly, which partially offset some recovery gaps from individual business travelers. Please turn to page 12.

In the first quarter of 2024, the number of room nights booked directly via our B2B platform was more than 5 million, representing a 34% year-over-year increase. The number of active corporate clients surpassed 2,700, representing a 57% year-over-year increase. We believe that by continuously strengthening our direct B2B sales capability, we could better cope with the potential volatility of business traveling and achieve a more sustainable business development in the long run.

Jin Hui (CEO)

[Foreign language]

Speaker 9

Moving to our overseas business, please turn to page 13. DH's blended RevPAR grew 4.5% year-over-year to EUR 58 in the first quarter of 2024, which was driven by 0.2% increase in ADR to EUR 104 and a 2.3 percentage points increase in occupancy rate to 55.8%.

Jin Hui (CEO)

[Foreign language]

Speaker 9

Last quarter, we mentioned that one of our DH strategic focus in 2024 is to seek growth opportunities internationally. We are pleased to see that DH has made some initial progress. Please turn to page 14. As of the first quarter of 2024, 53% of hotels in operation were located in Germany. However, only 38% of pipeline hotels were located in Germany, and the remaining hotels were located in other European countries, APAC regions, and Africa, which accounted for 41%, 15%, and 6% respectively.

Jin Hui (CEO)

[Foreign language]

Speaker 9

All above conclude our first quarter 2024 business updates. Now, I will hand over the call to our CFO, Mr. Jun Zou, to discuss our operational and financial performance during the quarter.

Jun Zou (CFO)

Thank you, Jin Hui. Good morning and good evening to everyone. Let's go through our operational and financial review for first quarter of 2024. Please turn to page 16. In the first quarter, we continued to expand our hotel network. Our overall number of rooms increased 17% year-over-year to over 955,000 rooms as of first quarter, compared to over 820,000 rooms as of first quarter last year. Our hotel turnover for the first quarter of 2024 was CNY 19.7 billion, representing a 21% increase compared to first quarter last year. Including DH, Legacy-Huazhu's hotel turnover grew 22% year-over-year to CNY 18.1 billion. Now, please turn to page 17.

In first quarter 2024, our total revenue for the group increased 18% year-over-year to CNY 5.3 billion, exceeding our previous guidance of 12%-16% year-over-year growth. Legacy-Huazhu achieved 18% year-over-year revenue growth to CNY 4.2 billion, and DH grew 17% year-over-year to CNY 1 billion. The revenue growth of Legacy-Huazhu surpassed the high end of our guidance, mainly driven by a higher-than-expected hotel openings. For DH, its revenue growth was attributable to market recovery and a favorable exchange rate. Please turn to page 18. Hotel operating costs were CNY 3.6 billion in the first quarter of 2024. The year-over-year increase was primarily attributable to increase of staff costs from our continued network expansion and reduced the rental reliefs in China.

The increase of hotel operating costs was slower than our revenue growth, reflecting operating leverage of our business. Pre-opening expenses remained at a low level as we continued to focus on our asset-light expansion strategy and become more selective on opening leased and owned hotels. SG&A expenses were CNY 769 million in the first quarter of 2024 and accounted for 14.6% of total revenue. The year-over-year increase in both absolute number and percentage of revenue of SG&A expenses were primarily due to continued business growth, as well as return to a normal level of selling and marketing expenses, headcount number, and compensation from the relatively low base of the same period of 2023, especially our for our Legacy-Huazhu business.

As a result, our income from operations in the quarter achieved CNY 1.0 billion, representing a 51% year-over-year growth increase. Now, please turn to page 19. In terms of our profitability and cash flow during the quarter, I'd like to firstly highlight that we have redefined our non-GAAP measure of Adjusted EBITDA and adjusted net income in the quarter in order to better reflect the profitability from our core business operation. The new Adjusted EBITDA and net income now excluded share-based compensation expenses, gain or loss from fair value exchange of equity securities, foreign exchange gain or loss, net and gain loss on disposal of investments. Similarly, we also have restated our Adjusted EBITDA and adjusted net income for the first and fourth quarter of 2023 to provide a comparable basis.

Under the new definition, in the first quarter of 2024, Legacy-Huazhu Adjusted EBITDA achieved a 32% year-over-year increase to CNY 1.5 billion. Thanks to continued this growth in our asset-light strategy. Our DH business reported a loss of Adjusted EBITDA of CNY 66 million, which narrowed down from a loss of CNY 98 million in the first quarter of last year. Adjusted EBITDA margin for the group and Legacy-Huazhu achieved 27% and 35% level, representing 4% and 3.5% year-over-year improvement, respectively. Our group Adjusted Net Income were CNY 771 million in the first quarter of 2024, representing a 101% year-over-year increase. Our first quarter operating cash flow decreased year-over-year, mainly due to increase in payable to franchisees in first quarter of last year, post reopening.

The quarter-over-quarter decrease was due to timing difference of compensation and franchisee fee payments. Now, please turn to page 20 on liquidity position. As of first quarter 2024, the group had CNY 8.9 billion cash, cash equivalents, or restricted cash and time deposits. That was in a solid cash position with CNY 3.1 billion, including time deposits. Our cash balance and net cash decreased compared to the previous quarter, which was primarily driven by payments of dividends in the first quarter 2024. We also had CNY 2.4 billion unutilized bank facility as of first quarter 2024. Now, let's turn to page 21. During the first quarter of 2024, we paid roughly CNY 300 million cash dividend and repurchased roughly $75 million worth of shares from the market.

As we become more asset-light and cash rich, we'll continue to reward our shareholders through dividend and buybacks. Finally, please turn to page 22 on our guidance. For the second quarter of 2024, we expect our revenue to grow between 7%-11% compared to second quarter of last year, or 7%-11% including DH. With that, we're ready to take your questions. Operator, please open the line for Q&A.

Operator (participant)

Thank you. We will now conduct a Q&A session. As a reminder, to ask a question, please press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. Please stand by as we compile the Q&A roster. Our first question comes from Ronald Leung of Bank of America. Please go ahead.

Ronald Leung (Director of Gaming and Lodging Sectors)

[Foreign language] Hello, management, good morning. Thank you for giving us an opportunity to ask questions. I have two questions. Let me translate my questions in English. I have two questions. My first question is about RevPAR. What is management expectations for RevPAR growth for domestic China business in 2Q? My second question is on DH. For DH, management targets to adjust the business to asset-light business, and target to sell the asset-heavy business gradually. How's the progress of the disposal? Does management have a timeline for the disposal? Thank you very much.

Jin Hui (CEO)

[Foreign language]

Speaker 9

Okay, let me answer your first question. As you may know that last year, the second quarter actually was a bit high base, especially during the May holiday. As you may know that the May holiday last year was the first long holidays post to the recovery, post to the reopening from the COVID. There's a lot of revenge traveling, pent-up demand in the second quarter. Also on the supply side, the supply recovery was a bit slower at that time in the second quarter of last year. Therefore, given the high basis of last year second quarter, we are facing a little bit challenges for the RevPAR in the second quarter of this year. Therefore, we are expecting the RevPAR for this quarter will be flat to slightly negative, as of now.

However, given the traveling activities, especially the number of travelers during the holiday, we are still quite confident, because the population number of travelers are still growing quite healthily during the holiday and in the second quarter as well, which give us more confidence that the leisure traveling demand is actually sustainable in a longer term perspective, and becoming a inelastic demand for the Chinese consumers. Even though the RevPAR might have a slightly negative in the second quarter, but through the hotel network expansions, we still could achieve a 7%-11% year-over-year revenue growth.

Jin Hui (CEO)

[Foreign language]

Speaker 9

The asset-light strategy for our DH business, which we mentioned in last quarter, is our long-term target. DH we want, we want DH becomes a more international brand and hotel brand and management company. As you may know that transforming from asset heavy to asset light takes a bit longer time, and a lot of complicated and complex negotiation with the potential counterparties. The long-term strategy won't change. So far, the progress is still within our expectation. In terms of the closure time, so as long as there is a milestone, then we will just release to the market on time.

Jin Hui (CEO)

[Foreign language]

Speaker 9

Thank you.

Operator (participant)

Thank you. Our next question comes from Dan Xu of Morgan Stanley. Please go ahead.

Dan Xu (Managing Director)

[Foreign language] Please allow me to do the translation. Thank you management for the opportunity and congratulations on first quarter's results. I have two questions. First question is about leased and owned hotels. We saw the L&O hotels' operating performance outperformed franchise business. L&O RevPAR growth rate year-over-year was faster than the group's RevPAR growth rate by six percentage points. The same is happening to same-store RevPAR growth, also outperformed franchise hotel and also the group overall performance. We're wondering what has management done to improve both occupancy and ADR, especially occupancy?

For lease and own hotel and its sustainability, and is it replicable towards the franchise, hotel management? My second question is about Franchise Hotel business. We saw that take rate for, F&M, increased by 7%, which is about, zero point five percentage point. We know that our take rate, sometimes get, impacted by seasonality. We're wondering, is this take rate increase, sustainable? Any other reasons, such as, recurring, franchise fees or CRS? That's all for my questions.

Jin Hui (CEO)

[Foreign language]

Speaker 9

Okay, in terms of the lease and own hotels, their performance actually is better than the group franchisees. That was because, over the last two years, we have been investing quite a lot of management resources into the lease and own hotels, because running a lease and own, in terms of the operation and the management is quite complicated. Therefore, from the initial investment period to the operational period for the entire life cycle of this hotel business, we have been investing a lot of management capability. For example, we have assigned a good staff hotel manager. This is, basically in conclusion, the improvements of our management capability for running a hotel. We believe that the discount of capability which has been demonstrated from the leased and owned can be replicated to other hotels, which is, as you mentioned, in the franchised or managed hotel.

Jin Hui (CEO)

[Foreign language]

Speaker 9

Okay, in terms of the increasing take rate, there were mainly three reasons. Firstly, is continuously increasing the CRS as we continuously focus on our direct sales capability through our H World app. That's one of the reasons. Secondly, is because of the wage increase or the staff cost increase, especially at the hotel level, for both our lease and own and the franchise hotel, which is the hotel managers. Thirdly is, we are doing a deeper dive and going into more details in terms of the management for our managed hotels, which we reduce the discount rate for our management fee, as well as one-time franchise fee, which also contributes a little bit to the improvement of the take rate.

The take rate increase is a result from many factors, but the staff cost increase is kind of not able to avoid, because the salary increase is the general trend in the market. Thank you.

Dan Xu (Managing Director)

Thank you, Mr. Jin Hui and Jason.

Operator (participant)

Thank you. Our next question comes from Simon Cheung of Goldman Sachs. Please go ahead.

Simon Cheung (Managing Director)

[Foreign language] Let me translate into English. My first questions is in relation to the stronger than expected hotel addition, 569 hotel adding the first quarter, already representing over 30% of the original guidance of 1,800 for the full year originally. On top of that, we have a RevPAR, according to management, in the second quarter, it would be likely going to be softer. Wondering whether they would have any revised guidance for both the hotel ADR as well as the 8%-12% full year revenue guidance. My second question is, for the business travel, we've been hearing from other operator sharing that, you know, business travel so far still been quite weak. What is the trends they expect looking in the second half and, because they obviously doing quite well on the B2B strategies, with 2,700 clients up sixty percent almost.

How did they think about the long term opportunity on, on, on the business travel or B2B, uh, segment in general? Thank you.

Jin Hui (CEO)

[Foreign language]

Speaker 9

OK, so in terms of the hotel openings, before answering these questions, we want to remind you guys that since two years ago, we started our sustainable high-quality expansion strategy. Our hotel network expansion will be only focusing on flagship hotels as well as the high-quality expansions. This year, as you remember, last quarter, we also introduced a service excellence strategy, further up stepped from the high-quality expansion, and to be more focused on both products quality and service quality improvements. For H World, in terms of the network expansion, we again will focus more on the quality and better services instead of only focus on the scale. Therefore, even though we have a pretty good hotel openings in the first quarter, we still maintain our full year growth opening target unchanged. Thank you.

Jin Hui (CEO)

[Foreign language]

Speaker 9

OK, in terms of the B2B business. Firstly, if you are talking about entire business traveling market, we have to say the business traveling market is a bit slower in terms of the recovery. This is mainly due to the impacts from the weaker than expected macroeconomic development since the reopening last year. However, over the last two years, we have been putting a lot of efforts on the B2B direct sell business and catching up some of the new demands, new scenarios, such as the MICE and the conferences, which we were not very good at... previously, we have been continuously improve our capability in this front and trying to grab as much as new customers through our, you know, continuously enhanced B2B sales capability.

Secondly, it's hotel-centric on the ground, the sales capability enhancement. We will use the hotel itself as an offline channel to attract more and more local small business clients. Just to cover, as we mentioned, to cope with the volatility of the entire business traveling market. Thank you.

Simon Cheung (Managing Director)

[Foreign language]

Operator (participant)

Thank you. Our next question comes from Lydia Ling of Citi. Please go ahead. Lydia, please go ahead.

Lydia Ling (Director of China Consumer Sector)

[Foreign language] My first question is on the store opening, and we see actually accelerated expansion in the first quarter. How actually, the management look at the supply, industry supply as a whole? Also what's actually like the background for the new franchisees, and what could be the mix of the new franchisees versus the existing franchisees? A little bit more color would be very helpful. My second question is on expense. We saw that actually, the selling expense increased a lot in the first quarter. As, like CFO, just explained during the presentation. How do management look at the like the full year expense trend? Also what could be the margin trend for 2024? Thank you.

Jin Hui (CEO)

[Foreign language]

Speaker 9

Okay, let me answer your first questions. Over the last several years, the chain ratio in China has been rapidly improving in China. At the end of last year, the chain ratio firstly exceeded 40% in China. We believe that the chain ratio improvement would be even faster in the future because of the digitalizations capability, the integration of the industrial capability in China was very outstanding. It has the potential to even higher than the very mature U.S. market in a near future. China hotel groups has been gaining benefits from this trend with continuously chain ratio improvement. However, in different segments, we are seeing some of the differences.

For example, the mid-scale is much faster in terms of the chain ratio improvement compared to the entire market. For the economics, it might be need for further efficiency, operational efficiency improvements to further catch up the chain ratio improvements. This is the first part. The second part in terms of the background of the franchisees, in conclusion, it is quite diversified at this moment. We focus on two aspects. One is for our old franchisees, we also focus on the repurchase rate for our older franchises. We want our franchises to be profitable wherever they open the old hotel. They used to open hotel, and they are opening the new hotels.

At the same time, when we are penetrating into the lower-tier cities, some new market and new segments, we are seeing a lot of new franchises, new type of franchises, for example, the local government, for example, the property developers. On both sides, from the H World Group, from the company's perspectives, we take care of both parts of the franchisees. Thank you.

Jun Zou (CFO)

[Foreign language]

Speaker 9

Okay. In terms of the increase in sales and marketing expenses in the quarter, so firstly, because we are penetrating into the new market and we are penetrating into the new segment and introduce a lot of new, new products. Especially when we open a new hotel in new markets, at the very initial period, we need the resources and the supports from the OTA. However, that should be a temporary impact, because on a longer term perspectives, we will continuously focus on our direct sales capabilities through our own channels. This is one.

Secondly, we purposely added some of the budgets on the marketing expenses, especially for some of the new brands and new brand, new segments, that we want to further improve the brand awareness and the recognitions, for these particular brands into the market, in order to get more attraction from the customers and the franchisees as well. Thank you.

Operator (participant)

Thank you. Our last question comes from Sijie Lin, from CICC. Please go ahead.

Sijie Lin (Executive Director and Research Analyst)

[Foreign language] Thank you, management. I have two questions. The first is that, we mentioned before, we aim to penetrate more into lower-tier cities and regions with low density. How's the progress? Is there any operating data in these markets you could share with us? My second question is that we, we also mentioned before that one of our key strategy is to upgrade supply chain and to improve service quality. How's the progress? Is there any indicator that can prove this progress, maybe such as per room CapEx or RevPAR? Thank you.

Jin Hui (CEO)

[Foreign language]

Speaker 9

Okay. In terms of your first questions, I'm very happy to let you know that we have been progressing pretty good into those previously less penetrated areas as well as the weak segments previously. The entire improvements and the process are satisfying, are meeting the management's expectation.

Jin Hui (CEO)

[Foreign language]

Speaker 9

Okay. In terms of the service excellence we mentioned last quarter. Previously, H World used a high efficiency, low cost, as well as scale, to maintain the leading position. In the future, if we want to further enhance or strengthen our leading positions in China or even in the world, definitely we need to focus on more service, more user experiences and management, customer centric management capability enhancement as well. Just give you several examples, because of the time limits. For the service excellence, we are focusing on the customer satisfaction rate, and whether it is improved or not, but more details we will be sharing in a near future. Thank you.

Operator (participant)

Thank you. This concludes the Q&A session. I will now hand back to Jason for closing remarks.

Jason Chen (Head of Investor Relations)

Thank you, everyone, for taking your time with us today, and we look forward to see you in upcoming quarter. Thank you and bye-bye.

Operator (participant)

Thank you. This concludes today's conference call. Thank you all for participating. You may now disconnect.