H World Group - Q3 2024

Transcript

Operator (participant)

Please be advised that today's conference is being recorded. It is now my pleasure to hand you over to the Senior IR Director of the company, Mr. Jason Chen. Please go ahead.

Jason Chen (Senior IR Director)

Thank you, Amber. Good morning and good evening, everyone. Thanks for joining us today. Welcome to H World Group 2024 Third Quarter Earnings Conference Call. Joining us today is our Chairman, Mr. Ji Qi, our CEO, Mr. Jin Hui, our CFO, Ms. Chen Hui, and our CSO, Ms. He Jihong. 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 yesterday. As a reminder, this conference call is being recorded. The webcast of this conference call, as well as supplementary slide 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 third quarter of 2024. Mr. Jin, please.

Jin Hui (CEO)

[Foreign language]

Hello everyone, thanks for joining H World Group Third Quarter's 2024 Earnings Conference Call

[Foreign language]

In the third quarter of 2024, the domestic travel demand continued to demonstrate steady growth. The hotel industry saw some year-over-year pullback in RevPAR from a high base ADR last year. In addition, Shanghai and its surrounding regions experienced two typhoons right before and after the Mid-Autumn holidays, which affected travel demand in September. On top of this, in the quarter, we proactively adjusted our operational strategies, especially on optimization of our sales channels, which I will elaborate later. This proactive adjustment caused some negative impacts on the quarter's performance. However, it is strategically crucial to ensure the healthy, sustainable growth of the company in the long term. Please turn to page three on Legacy-Huazhu's operational performance in the third quarter.

In the third quarter, Legacy-Huazhu's RevPAR decreased 8.1% year-over-year to RMB 256, of which ADR was down 7% year-over-year to RMB 301 from a high base last year. Despite our rapid hotel network expansion, our occupancy rate still maintained at a healthy 84.9%, declined only marginally by one percentage point.

[Foreign language]

Please turn to page four. In the third quarter, we continued our accelerated network expansion in China, and the number of hotel openings reached a record high of 774 hotels in the quarter. At the same time, we uphold our philosophy of high-quality growth, putting quality ahead of pure quantity increase, and continuously raise the standard of our hotel. In the third quarter, we closed 217 hotels. Excluding the low-quality soft economy brand and Hanting 1.0 version, we closed 123 hotels.

Going forward, we will continue shaking out our existing hotels and phasing out low-quality ones to ensure further enhancements of the product and service quality of our overall hotel portfolio. As of the end of third quarter, the number of hotels in the pipeline decreased slightly year-over-year and quarter-over-quarter to 2,899, mainly due to the rapid opening pace in the third quarter, as well as the cleanup of some of the pipelines given we continuously raise our quality standards for not only new openings, but also pipelines. Our franchisee interest level and the new signings momentum remain strong. In fact, new signings in this quarter still exceeded 800 hotels.

[Foreign language]

We continue focusing on economy and midscale segment for mass market penetration and development. Please turn to page five. As of the end of third quarter 2024, economy and midscale hotels accounted for 91%, 80%, and 90% of our hotels in operation, hotels in pipeline, and hotel openings, respectively. We believe the mass market remains the largest and the most promising market in China, and it is also the foundation of our business. Going forward, we will consistently roll out high-quality and good value-for-money limited service hotels and products, expanding our coverage nationwide and solidifying our leading position in the limited service segment.

[Foreign language]

We keep penetrating into the lower-tier cities. Please turn to page six. At the end of third quarter 2024, around 42% of our hotels in operation were in tier three and below cities, up 2 percentage points year-over-year.

In the pipeline, hotels in tier three and below cities accounted for 53%, 11 percentage points higher than that in operation. At the same time, as the new signings picked up in southern China, along with our regional strategy, and as our upper-mid segment grew, the proportion of pipeline hotels in tier one cities increased 2 percentage points year-over-year. As of the end of third quarter, the number of cities we covered reached 1,324, around 117 more cities than a year ago.

[Foreign language]

Our upper-mid segment development continued in the third quarter. Our key upper-midscale brands have been gaining recognition and attraction among customers and franchisees. Please turn to page seven. As of the end of third quarter 2024, the number of upper-mid segment hotels in operation exceeded 800, up 33% year-over-year, and the number of hotels in pipeline reached 487, up 36% year-over-year.

One of our core brands in that segment, IntercityHotel, had 125 hotels in operation and in the pipeline.

[Foreign language]

Recently, Crystal Orange, the co-brand for our upper-mid segment, launched its 2.5 version. Please turn to page eight. Crystal Orange 2.5 version is an upper-midscale product that we designed and tailored for elite business travelers. The harmonious integration of lines and colors, the usage of high-quality bedding facilities, and the special Crystal-designed fragrance diffuser offers a comfortable, relaxing, and high-quality space for the busy business travelers working and living in the fast-paced metropolis. The hotel also has lounge space with special cocktail offerings, which is a public area that is suitable for guests either to enjoy their private time or to hang out with their friends.

[Foreign language]

After several years of development, our upper-midscale segment is starting to bear some fruit in this year.

However, we think there are still more polishing and improvements needed in areas such as branding, product, customer insights, customer experiences, and services, and so on, especially under the background of our service excellence strategy stated since the beginning of the year. Therefore, we will continue working and improving, and we aim to become one of the leading brands in the upper-midscale segment in the near future.

[Foreign language]

Please turn to page nine. Affected by the macro economy, the recovery of China's overall business travel demand is still relatively stagnant. To offset the impacts from some missing demand from individual business travelers and to maintain a relatively stable occupancy rate during the low season of leisure travel, we have been improving our direct B2B capabilities.

In the third quarter of 2024, the number of room nights booked directly via our B2B platform exceeded 7.5 million, up 41% year-over-year and 19% quarter-over-quarter. The number of active corporate clients exceeded 4,500, up 45% year-over-year and 23% quarter-over-quarter.

[Foreign language]

We have always been emphasizing the importance of membership and direct sales. Please turn to page ten. The membership base of our H Rewards continued increasing. As of the end of third quarter, H Rewards had close to 260 million members. As we rapidly expand our hotel networks, entering into new regions and breaking through in some new segments, it will naturally take some time for us to accumulate new members and improve the direct sales contribution for those new hotels. As a result, in the short term, we do need traffic support from other channels during the ramping-up phase of the new hotels.

Nevertheless, members and direct sales remain the most important and the most sustainable sales channel for us. In the third quarter, we rolled out a round of targeted optimization of our sales channel. We urged our hotel managers to improve their hotel-level customer acquisition and sales capabilities, and we re-emphasized the importance of membership and direct sales capability for the company's long-term sustainable growth. In the third quarter, our CRS contribution improved by 2.2 percentage points year-over-year and 4.3 percentage points quarter-over-quarter to 64.2%.

[Foreign language]

All above concludes our third quarter 2024 business updates for Legacy-Huazhu. Now I will hand over the call to our CSO Ms. He Jihong to give an update on Legacy-DH's business.

Jihong He (CSO)

Thank you, Jin Hui. I'm happy to give everybody an overview on the overseas business for H World. Please turn to page 11.

We are very happy to report that the blended ADR from DH increased 2.5% from EUR 114 to EUR 117 in the third quarter 2024, with a 0.8 percentage point increase in occupancy. RevPAR increased 3.7% from EUR 79 to EUR 82. Please turn to page 12. We restructured our economy brand Zleep business in this quarter as well. We exited a joint venture with entrepreneur Peter Haaber and took over 100% ownership of the Zleep brand. As a part of the asset-light strategy, we exited 14 leased and owned hotels in Denmark. This transaction has minimum impact on our financial statement. Please turn to page 13. In the third quarter, we also started a major restructuring effort in DH business. First of all, we streamlined the headquarters and reduced at least 30% of the headquarter non-operational staff. We stepped up our effort to reduce G&A non-personnel costs.

We continued to scrutinize hotel performance and optimize hotel operations. All these restructuring efforts incurred around RMB 81 million one-off expense in this quarter. The negative impact on financial performance of Deutsche Hospitality in this quarter is largely due to this restructuring cost, which you will see later. We will start to observe full-year savings in 2025, and we are confident that our overseas business is on a successful trajectory. With this, I conclude the overview of the international business and hand over to our CFO Chen Hui for the financial performance review.

Hui Chen (CFO)

Thank you, Jihong. Good morning and good evening, everyone. Let me talk you through our operational and financial review for the third quarter of 2024. Please turn to page 15. Our hotel network continues to expand.

The overall number of rooms increased 20% YOY to close to 1.1 million as of end Q3 this year, compared with 886,000 rooms a year ago. Hotel turnover for the third quarter of 2024 was RMB 26 billion, representing an 11% YOY increase, of which Legacy-Huazhu's hotel turnover grew 11% YOY to RMB 24 billion, and Legacy-DH's turnover grew 8% YOY to RMB 2.1 billion. Page 16. In the third quarter of 2024, our hotel revenue for the group increased 2.4% YOY to RMB 6.4 billion, in line with our guidance. Revenue from Legacy-Huazhu grew 1% YOY to RMB 5.2 billion, of which revenue from Huazhu leased and owned hotels decreased 10.4% due to the closure of leased hotels.

We net closed 22 leased hotels in the quarter, and the number of leased and owned hotels decreased by 38% or 6.3% on a year-over-year basis. Revenue from Legacy-Huazhu managed and franchised grew 14.7% YOY, driven primarily by our strong hotel opening, but was negatively affected by the decline in RevPAR from the high base last year. Legacy-DH's revenue rose 9% YOY to RMB 1.3 billion, which was attributed to both business recovery and hotel network expansion. Please turn to page 17. We have been committed to grow an asset-light model, expanding our hotel network using managed and franchised hotels. As a result, revenue from our managed and franchised hotels continued rising. In the third quarter of 2024, revenue contribution from managed and franchised hotels reached 50% of our Legacy-Huazhu's revenue, up from 44% a year ago.

We expect this trend to continue as we become more and more asset-light. We believe this will drive a gradual and continuous margin expansion, as well as help us to become more resilient when navigating through economic cycles. Please turn to page 18. Hotel operating costs were RMB 3.8 billion in the third quarter of 2024, up 5% YOY. The increase was due to rising personnel costs from our continued hotel network expansion. Pre-opening costs remained at a low level as we continue moving towards the asset-light model and staying selective on opening leased and owned hotels. SG&A expenses were RMB 975 million in the third quarter of 2024, up 18% YOY, of which Legacy-Huazhu's increased 9% YOY and Legacy-DH rose 42% YOY.

The 8% YOY increase in Legacy-Huazhu's SG&A was mainly due to a high share-based compensation to attract and retain core employees who are key to our sustainable long-term business growth. Excluding share-based compensation, SG&A expense for Legacy-Huazhu increased 2.5% YOY. The 42% YOY increase in Legacy-DH's SG&A was due primarily to RMB 81 million, one-off restructuring costs. Excluding the non-recurring restructuring costs, SG&A expense for Legacy-DH increased 7% YOY. As a result, our income from operations in the quarter was RMB 1.7 billion, which represented a 10% YOY decline but a 10% Q2 growth. Please turn to page 19 for our profitability and cash flow during the quarter. In the third quarter of 2024, our Adjusted EBITDA decreased 9.5% YOY to RMB 2.1 billion.

By segments, Legacy-Huazhu's adjusted EBITDA was down 7.5% YOY to RMB 2.1 billion due to the RevPAR decline from the high base last year and SG&A normalization. Our DH business generated RMB 21 million adjusted EBITDA, which was down YOY due primarily to the non-recurring restructuring costs mentioned previously. However, after this round of restructuring, we believe our DH business will be leaner, and its profitability should see some improvement next year. In the quarter, our group generated RMB 1.4 billion adjusted net income and RMB 1.7 billion operating cash flow. Page 20 for our liquidity position. As of end September 2024, the group had RMB 9.3 billion cash equivalent, restricted cash, and time deposits, and was in a solid net cash position of RMB 4 billion, including time deposits. We also had RMB 3.6 billion unutilized bank facilities as of end September. Next page, please.

As part of our total shareholder return plan, we continued buying back shares. As of September year to date, we have bought back roughly $270 million worth of shares from the market. In the first nine months, we have returned around $470 million to the shareholders through both dividend and share repurchase, which accounted for more than 80% of our free cash flow generated in the same period. Lastly, page 22 on guidance. For the fourth quarter of 2024, apart from the ongoing RevPAR pressure, we will continue closing some leased and owned hotels as we are committed to our asset-light strategy. The closure of more leased and owned hotels will definitely bring some negative impact on our revenue in the quarter.

Therefore, we expect our group revenue to grow between 1%-5% compared to Q4 2023, and also 1%-5% if excluding DH in the fourth quarter. With that, we are ready to take your questions. Operator, please open the line for Q&A.

Operator (participant)

Thank you. We will now begin the question and answer session. As a reminder to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. We will now take our first question from the line of Ronald Leung from Bank of America. Please ask your question.

Ronald Leung (VP)

[Foreign language]

Let me translate the questions in English. My first question is about RevPAR. May I ask what else the RevPAR trends in October and November, and, what is your expectation for the RevPAR growth in Q4?

My second question is about the management of the membership system. May I ask, what is the company's strategy to enhance the membership's loyalty so as to increase the direct sales ratio? Thank you very much.

Jin Hui (CEO)

[Foreign language]

Okay, let me answer your first question, see regarding to the RevPAR. So clearly, as you may see from the market, so on this year, the business traveling activity remained a bit weak compared to the leisure, and that caused a major ADR impact and the pressures for this year on a year-over-year basis, as well as the high base from the last year. And also we are seeing, you know, the upper-mid and upscale segment was underperforming, and the ADR has even higher pressures, which also going to have some of the pressures to our segments in terms of the ADR.

However, on the positive side, we still see a pretty good demand for the overall traveling, and therefore we still can maintain a relatively healthy and high occupancy rate despite our fast pace of hotel network expansion. And therefore we remain committed to ensure our high quality growth strategy. For the fourth quarter, according to our estimate, mainly due to the ADR pressure, the RevPAR for the fourth quarter will be around middle single digit year-over-year decline. Thank you.

[Foreign language]

So, in regard to your second question about membership, so, as we are penetrating into different regions as well as, you know, break through some of the new segment, so, it takes some of the time to create some of the synergy from our existing membership and the new regions and segment coverage from our membership program.

And also, there's you know, a lot of new demands from the leisure market as well. So, we are putting a lot of efforts to enhance our membership program, to provide more variety in terms of the products to different group of customers, and to ensure you know, the membership program further growth.

[Foreign language]

Okay, we are also working on you know, improving the membership's benefits and ensure the lowest pricing through our direct sales channel and the membership program, and therefore we can further improve the you know, the offline membership conversion as well as you know, improve the retention rate.

[Foreign language]

We are also seeking some cooperation with cross, you know, different segments such as, you know, working with the airline company, such as Juneyao Airlines, as well as, you know, the car hailing companies, which is Didi, to seeking more cooperation among different industries.

[Foreign language]

We have been putting a lot of efforts over the last several years in terms of the B2B direct sales and the corporate customers, and we believe, you know, a stronger capability on the B2B direct sales and the corporate customers, will further help us to improve the membership program.

Ronald Leung (VP)

[Foreign language]

Thank you.

Operator (participant)

Thank you. Our next question comes from the line of Simon Cheung from Goldman Sachs. Please ask your question, Simon.

Simon Cheung (Managing Director)

[Foreign language]

So let me translate into English. So two questions.

One, given, you know, the high base on the RevPAR this year, we have seen quite a weak performance, you know, in the last several quarters, continuing into fourth quarter, but you know, looking into next year, what is your expectation? And maybe in the longer run, what is your RevPAR expectations for the industry? And then secondly, just related to that, there's a lot of, you know, investors asking about, you know, investment or the supply situation in China. And we have heard from TCOM that, you know, their listing numbers in the fourth quarter has actually seen a quite noticeable deceleration. So wondering, you know, what management are thinking in terms of, you know, this supply situation going into next year.

Jin Hui (CEO)

[Foreign language]

Let me answer your first questions, in regarding to the next year of expectation.

I think, looking to this year's RevPAR performance, clearly, there was a high base from last year, especially during the summer holiday season, as well as some of the peak leisure seasons. There was a mix of the reasons for last year, either from the pent-up demand and the temporary shortage of the supply due to the reopening from the COVID. Overall, we think the RevPAR should gradually enter in a more stabilized and, you know, growth cycle starting from next year.

And we think China overall, the leisure market is going to have a very good potential going forward, and we are clearly seeing a very strong government support on the leisure traveling to boost and stimulate the domestic consumption, not only domestically, but also, you know, recently, you know, give a lot of, you know, visa-free policies to a lot of, you know, foreign countries, which both not only drive the domestic demand, but also the inbound, which is an incremental value or volume for us to further develop the leisure market in China. Therefore, overall, we think the RevPAR should going to be a stabilized and upward trend starting from next year. We think the RevPAR for next year for us should at least remain stable.

And to answer your second question in terms of the supply, and clearly, as we always mentioned, you know, China lodging market never lacks supply; it lacks high-quality supply. And we observed several clear trends happening in the market. One is those historically driven by the property booming. A lot of, you know, traditional old five-star hotels has been gradually exiting the market, like, for example, the Great Wall Hotel in Beijing and the Marriott, you know, Greenland hotels in Shanghai, which is showing good examples. And secondly, we think those low-quality, small-scale, and independent hotels are gradually going out of the market in the near future. But overall, the hotel market is a very, you know, market-driven, very mature market and always, you know, adjusted by demand and supply dynamics.

And we think there is, in the near future, the demand and supply will reach some equilibrium. And that's our view on the demand-supply, going forward.

[Foreign language]

Okay, let me add one more point. Through the economic cycle and over the last several years, clearly we are seeing another two trends. One is the investment is becoming more rational, and from the customer side, they are seeking for better value for many products. I think these two, you know, changes actually helped us to leverage on our cost efficiency, very high in terms of the operational capability, as well as the cost leadership capability, to remain a high-quality growth and further providing some of the good quality products but for a value for money-seeking customers. Thank you.

Operator (participant)

Thank you. Our next question comes from the line of Lydia Ling from Citi. Please ask your question, Lydia.

Lydia Ling (Director of Equity Research)

[Foreign language]

Hi, management, this is Lydia from Citi. So I have two questions. And so first one is on the store opening and, like, you actually accelerated the store opening in the third quarter. So could you share your latest target for your full-year opening for this year? And, how about the signing momentum in the fourth quarter to date? And, could you also share your plan for the opening and store closure for the next year? And my second question is on the competition landscape in the mid-scale and, and also the upper mid-scale segment. As we see, like, the, the supply in this segment, segment also increased due to expect some by the, pricing pressure looking ahead.

Also, do you face actually more competition on the quality of property resources for this segment? Thank you.

Jin Hui (CEO)

[Foreign language]

Let me answer your questions regarding the openings and the closures. For this year, as you may see, the new signings as well as the new openings have both reached a record high year. And also, as I mentioned previously in my prepared remarks, in the third quarter, we also signed up over 800, you know, new hotels during the quarter. Therefore, you know, for the full year, the new openings for 2024 should be somewhere around 2,400, which is slightly higher than our previous guidance of 2,200 new openings. And going into 2025, we think that the overall new openings should remain within a relatively healthy range.

That was benefited from, you know, our branding as well as our, you know, strategy on the regional penetration, and which is to further increase the brand recognition and awareness among the franchisees. In terms of the closures, under the background of high-quality growth as well as the service excellence strategy, so no, we're going to continue to clean up some of the low-quality, unqualified hotels in our existing portfolio. However, over the last several years, we have been doing this already. So the total closure pressures should be less going forward. Thank you.

[Foreign language]

In regard to the competition, firstly, I would like to discuss in the middle-scale segment.

In this particular segment, we have been established our, very, you know, industry leading brand, which is Ji Hotel and Orange, which have been gained a very strong brand recognition as well as the wellness, which we are very confident to compete in this segment.

[Foreign language]

Especially we are seeing that we are previously less penetrated areas such as the Southern China as well as some of other regions have been growing very rapidly.

[Foreign language]

Okay, in terms of the upper mid-segment, we are, thinking this industry is also doing a consolidation, and especially under the trend that the customers are seeking more value for money products. Our key brands like Crystal Orange, and Intercity actually are providing a very high-quality product, which is offering a very, very good value for money products to the customers.

And together with the property market changes, and some of the traditional, you know, upscale and some of the property-driven, you know, five-star hotels, some of the property has been released to the market, which is going to help us to, which is going to be benefiting us for further developing this segment.

[Foreign language]

Leveraging on our improvements on the branding as well as the management capability, we have been achieving over 30% growth in terms in that particular segment. And we believe, we are very confident that we can further develop this market in a relatively rapid speed.

[Foreign language]

From a mid to long-term perspective, we are also hoping to be one of the leading brands in this upper to mid-segment. Thank you.

Operator (participant)

Thank you. Our next question comes from the line of Dan Xu from Morgan Stanley. Please ask your question, Dan.

Dan Xu (VP of Equity Research)

[Foreign language]

Thank you, management. This is Dan from Morgan Stanley. My question is about Legacy-Huazhu's lease and operated businesses. We saw 25 hotel closures and selected closure of underperforming lease and own hotels. Can management share more insights on the lease and own business strategy? Is this proactive closing one-off, or is a longer-term planned strategy? If this is the latter, how many lease and own hotels in our current portfolio will get impacted? Thank you so much

Hui Chen (CFO)

[Foreign language]

Okay, let me answer your questions. First of all, our company is implementing an asset-light strategy from a more asset-heavy model. And also you are right, in the third quarter we closed the 25 lease and own hotels, which is more than the first half of this year.

Out of this 25 leased and owned hotels closures, around 8 of them are transferred to a managed hotel, and the remaining are basically closed due to, you know, the lease contract expired. Some of them are not meeting us, you know, in terms of the operational performance or some other issues that we are not able to renew the contract. In the fourth quarter and the next year, we're going to continuously close, you know, more leased and owned hotels, but in terms of the quantity, it should be higher than the first half, but less than the third quarter. Thank you.

Operator (participant)

Thank you. We have reached the end of the question and answer session. Thank you all very much for your questions. I'll now turn the conference back to the management team for closing comments.

Jason Chen (Senior IR Director)

Thank you, everyone, for taking your time with us today, and we look forward to seeing you in upcoming quarters. Thank you and bye-bye. Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.