H World Group Ltd (HTHT) 2016 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the China Lodging Group's second-quarter 2016 earnings conference call. (Operator Instructions). Please note this call is being recorded today, August 16, 2016. I'd now like to turn the call over to your first speaker today, Ms. Ida Yu. Please go ahead, ma'am.

Thank you, Operator. Hello, everyone. Thanks to all of you for dialing in, and welcome to our second-quarter 2016 earnings conference call. Joining us today is Mr. Qi Ji, our Founder and Executive Chairman, Ms. Jenny Zhang, our CEO, and Mr. Teo Nee Chuan, our CFO.

Jenny and Teo will present the Company highlights and the 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 United States Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks, and uncertainties. As such, our results may be materially different from the views expressed today.

A number of potential risks and uncertainties are outlined in our public filings with the SEC. China Lodging Group does not undertake any obligation to update any forward-looking statements except as required under applicable law.

On the call today we will also mention adjusted financial measures during the discussion of our performance. Recalculations of those measures to comparable GAAP information can be found 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 the 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?

Hello everyone. Thank you for joining our call today. We continued our solid growth and achieved record high net profit in Q2 thanks to the strong operational result and other income from investment activities.

On page 2, at the end of Q2 2016 we had a network of 3,114 hotels, or 314,811 rooms in operation covering 357 cities in China.

With top brands under management, China Lodging is able to satisfy needs of a wide range of guests, whether it be economy, midscale or upscale hotels.

As shown on page 3, our Q2 net revenues grew 13.7% year over year in line with our guidance. We are excited with the year-over-year revenue growth for midscale and upscale hotels, which was 46% in Q2. As a result, the revenue contribution from midscale and upscale hotels was 29% of total net revenue in Q2 2016, an increase of 7 percentage points from 22% a year ago.

In Q2, our blended RevPAR for all hotels continued to grow at 1.1% year over year. This is the second quarter for us to show a RevPAR growth. As shown on page 4, we are positive that this trend will sustain as driven by our upgrade in hotel quality and hotel brand mix.

On page 5 I'd like to reiterate our three strategic focus for this year, and update you on the progress. The first one is to strengthen and differentiate HanTing, our flagship brand in the economy sector. Since the beginning of 2015, we have rolled out a redesign and upgrade for HanTing brand.

Page 6 shows you the new model of our HanTing 2.0. The new product includes an all-in bathroom module and a new high-quality bedding. The new bathroom module is designed for smart use of space and improvement of operational efficiency. The new bedding is to guarantee our guests a sounder sleep that makes a big difference for frequent travelers.

The new HanTing is very much favored by customers. Not only did the HanTing 2.0 achieve higher RevPAR than the older version, it also showed positive same hotel RevPAR growth year over year.

As shown on page 7, HanTing's blended RevPAR trend also shows improvement since the first quarter of 2015. In the most two recent quarters, decline has almost been stopped.

At the end of Q2 about 24% of HanTing rooms were under HanTing 2.0 model, increasing from 17% at the end of 2015. With those efforts, we aim to bring HanTing's RevPAR back to growth mode in 2017.

Our second strategic focus is to continue fast expansion. As shown on page 8, in the second quarter we added a total of 125 new net hotels, including 174 openings and 49 closures. The number of closures, compared with the previous quarters, has increased. That demonstrated our determination to remove low quality properties to strengthen our brand.

Among the net new openings in Q2, midscale and upscale hotels accounted for 33%. Manachised and franchised hotels accounted for 80% of our hotels in operation today. Meanwhile, we had a pipeline of 586 hotels with 23 leased hotels and 563 manachised and franchised hotels.

Among these hotels in the pipeline, midscale and upscale hotels accounted for 36%.

We will continue to grow our network firstly -- first with an upgrade in product quality in a higher portion of midscale and upscale hotels. Our first focus is to further boost our direct sales capability. On page 9 you will find in Q2 about 89% of room nights sold were through our direct channels.

The total number of members reached a new record high of 61 million as a result of our most favorable loyalty program.

With that, I would like to turn the call over to Teo, who will walk you through more details in operational and financial results in Q2. Teo, please?

Thank you, Jenny. Hello, everyone. I'm pleased to report our operational results for Q2 2016. As shown on page 11, in Q2, our Group's blended occupancy rate was 85%, a decrease of 0.6 percentage points year over year. The slight year-over-year decrease was mainly due to lower occupancy rates in the lower tier cities.

The blended ADR was RMB184, an increase of 1.8% year over year, as a result of a more favorable brand mix.

Midscale and upscale hotel rooms accounted for 16.4% of our total number of rooms in Q2 2016, up from 12.8% in Q2 2015.

At end of Q2 2016, about 76% of our hotel rooms were in the first and second tier cities.

In summary, for Q2, the blended RevPAR was RMB157, an increase of 1.1% year over year.

Page 12 provides a detailed view of the growth trend of our same-hotel RevPAR for hotels in operation for at least 18 months. In Q2, our same-hotel RevPAR decreased by 1.2% with a 0.7% decrease in the same-hotel ADR and 0.4 percentage point decrease in occupancy.

As Jenny mentioned earlier, we accelerated our HanTing upgrade in Q2, so the mature hotels' performance has been negatively impacted during the upgrade process. If excluding the rooms under renovation and upgrade, our normalized same-hotel RevPAR decreased by 0.1% year over year. We think that the overall trend has been stabilized.

Meanwhile, the RevPAR for midscale and upscale hotels continues its high single digit growth on a like-for-like basis. The same hotel RevPAR improved by 8.6% in Q2.

Shanghai Disney was officially opened to the public on June 16. This has helped bring additional leisure travelers to Shanghai. At end of Q2 we had 15% of our hotels and rooms in Shanghai. Approximately 11% of our hotel pipeline is in Shanghai.

Move on to the financial results. On page 13, our net revenue increased by 13.7% for Q2 from a year ago, hitting the midpoint of our second quarter guidance. Revenues from leased hotels grew by 5% while revenues from manachised and franchised hotels grew by 29% from Q2 last year.

In Q2, revenue contribution from manachised and franchised hotels accounted for 20.8% of our total revenue, an increase of 3.1 percentage points from the prior year.

On page 14, our adjusted operating margin came in at 16.9% for Q2 2016, increased by 2.3 percentage points from Q2 2015.

The adjusted hotel operating cost and other operating costs as a percentage of net revenue decreased by 1 percentage point year over year. This is mainly due to our improved planned RevPAR and the favorable VAT impact on certain of our operating costs, such as rental.

The pre-opening expenses as a percentage of net revenue decreased by 1.4 percentage points from a year ago. This mainly results from the fewer leased hotels under construction.

The adjusted SG&A expenses and other operating income as a percentage of net revenue increased marginally by 0.1 percentage point. This is mainly due to provisions for franchisees to be refunded to certain franchisees and partially offset by lower selling expenses, mainly contributed by lower membership point cost.

In addition, we recorded in other income one-time gains of RMB56 million from our disposal of Home Inns ADS, and also a gain of RMB49 million from selling part of our stakes in our apartment businesses to a venture capital firm.

Move on to cash flow status, as shown on page 15. In Q2 2016, our net cash from operations reached RMB660 million while CapEx for maintenance and new developments totaled RMB107 million. As a result, the free cash flow in Q2 totaled RMB553 million.

In Q2, we sold the remaining of our Home Inns ADS for RMB451 million. Also in Q2, we made strategic investments totaling RMB52 million in the apartments business.

As of June 30, 2016, we had term loan balances of RMB617 million related to the purchase of Home Inn ADS in 2015 and dividend payments made in early 2016.

Our total credit facility available to the Company was RMB545 million.

Finally, on page 16, we reaffirm our full-year net revenue to grow by 12% to 15% year over year and we expect to achieve a Q3 net revenue growth of 10% to 12.5% year over year.

With that let's open the floor for questions.

(Operator Instructions) The first question comes from the line of Justin Kwok from Goldman Sachs. Please ask your question.

Hello. Thanks for taking my questions. Perhaps I would have two housekeeping questions and then one on a more medium-term trend. I guess the first one is do you mind just tell us a little bit more on what's the disposal gains, the RMB46 million sales of the apartment business, that you talk about, and why are you selling it now? I thought the Company is trying to expand into more business lines along the value chain.

The other housekeeping question is about the rental expense. I saw that there's actually a q-over-q decline in your rental expense. Do you also watch this as well?

I'm sorry, Justin, can you repeat the first question?

The first question is that I heard from your call that you have a disposal gain of RMB46 million related to the apartment business. So I just want to get a sense of why you're selling it and why you're not further investing into a new business line?

Okay.

Hi, Justin. Actually, I would like to clarify, this is not disposal gain per stock exchange. This is because we originally invested in an apartment business and we actually had an investment by a venture capital firm into our business. So we actually -- we are actually diluting our share in this apartment business.

So we are not selling out per se, but we are actually -- it's what we mentioned in the call during the last quarter, is that we would like to go into this business together with some venture capital funds. So this is an accounting gain for realizing part of our -- for inviting the investment from this private equity fund because they provide a higher evaluation than our original cost.

I see. Thanks for the clarification. The other one is about the rental expense quarter-over-quarter decline.

Okay. Now for rental, for the rental cost, we actually get some benefits from VAT reforms in China. So previously, we received the, for example, rental costs of RMB100 of which -- 6% of which is there, so we need to capture that as our cost. But following the VAT reforms in China, the VAT portion of the rental cost can be used to offset against our VAT debt on invoices that have been issued to our customers, so effectively, our rental cost has been reduced.

I see. Thanks. Thanks for this clarification. I guess more like the strategic and medium-term question I have -- I want to ask is that when we look at your pipeline, it seems that there has been two consecutive quarters of decline already. So could I check, what's the management thinking about the growth in terms of number of hotels that you open into next year or the year after? Are you thinking roughly 500, 600 hotels as a normal level? Or do you think that it is actually going to be going down even further as I think Jenny also mentioned in the call that you guys are more focused on the quality of the projects now? Thank you.

Our new openings this year is still on track to target 700 to 800 hotels. However, we have accelerated the closure of some of the lower quality hotels. So currently, our forecast is the net opening this year which is the new opening minus the closure will be somewhere around 600 to 700 hotels, which is still fairly close to what we indicated at the beginning of the year.

As for the coming years, we are considering a mix adjustment that we are going to further increase the portion of midscale hotel openings and likely to reduce some of the lower-end brand new openings to improve the overall quality of our portfolio.

Okay. Thank you.

You're welcome, Justin.

The next question comes from the line of Yaoxin Huang from CICC. Please ask your question.

Hi. Thank you for taking my question. I have two questions here. First, as previously mentioned, some hotels or some rooms are closed for renovation or upgrading. Can I ask for how many rooms -- how many percentage rooms are closed for renovation and upgrading and what's the renovation plan going forward in the second half?

My second question is I see there is other income which is RMB110 million in second quarter. I realize that part of the other income comes from the disposal of Home Inn and what else? What else does other income include? Thank you.

Okay. Now, you're right, regarding your first question is that we have actually accelerating the number of rooms under the renovations for product upgrade purposes. So the fact is that we had, as we have mentioned in the earlier call in the last quarter is that we have actually showcased our HanTing 2.0 to our franchisees last year. They started to buy in since the Q4 in 2015 and they have gradually put their rooms into -- under the renovations for the product upgrade.

So we expect that this process will be moving on for a number of periods, even going forward for the next couple of years, because our plan is not to close down entire hotels for renovations, but rather is that we are going to renovate -- actually suggest our franchisees and our own renovations to be done in stages even by floors in each hotels.

So I do not have exact numbers as for what -- how many rooms are under renovations right now. But it is undergoing a very hectic process and the speed of renovating all depends on the seasonality, because we would accelerate renovations on products, which is like in the lower season versus the higher season. This is number one.

Number two is that, as I explained to Justin Kwok earlier, is that the RMB110 million of other income, it comprises of two parts. The first part is the RMB56 million related to disposal of the Home Inn ADS. The second is actually accounting gain from deconsolidations of our investment in one of our apartment businesses.

This is because we previously -- we invest 100% in that apartment service, in apartment business. But with investment of a private venture, private equity firm into our apartment business, we realized a portion of the gain. This actually gives rise to approximately RMB49 million direct orders in Q2.

Okay, got it. Thank you.

The next question comes from the line of Billy Ng, Bank of America. Please ask your question.

Hi. Good evening. I have a question for Jenny Zhang. Can you share with us what you see so far in July and August about the RevPAR trend?

Also, the recent improvement in RevPAR, will you be able to quantify how much is due to the upgrade of our room, how much is due to the middle and brand contribution and how much is due to maybe if Shanghai Disney is the factor?

Let me try to confirm that I understand your questions. So you're asking about a RevPAR trend and you will like to understand what are the main factors contributing to that. Is that the question?

Right. Right. The recent pickup, the ramp-up trend. Like this year so far we saw RevPAR trends turn positive, yes.

Yes. In the past two quarters, we have shown a positive blended RevPAR growth. It's 1.1% for Q2 this quarter. The main drivers are the following.

Number one, our midscale hotels performed very strongly, as you can see. On a same-hotel basis, it has been increasing at 8.6% for Q2. We also showed a very strong number in Q1. So that's the first one.

And then secondly, our economy hotel brands such as HanTing, 2.0 of course as well as Hi or Hi Inn, also showed positive same-hotel RevPAR growth. So they also made a contribution to this improvement.

On a blended basis, the portion of our midscale hotels as well as the HanTing 2.0 also gradually account for a higher portion of the overall portfolio.

So those are the main contributors of the trend we have seen in this quarter.

The Disney impact is negligible in Q2 because there's only two weeks and the visitors in the first few weeks were mainly locals. So they don't -- they didn't really contribute much to the room consumption.

Thanks. And how about the recent trend so far in summer?

We have seen the travelers start to pick up, and especially the eastern part of Shanghai, the RevPAR trend is very strong. For July, we have on the whole country basis, we are already seeing some positive same-hotel RevPAR number. So we are quite confident that we are going to have a very strong summer.

I see. Thanks. Then you mentioned Shanghai, particular strong. Was that related to Disney or it's just seasonality and how strong was that? Would you mind to share?

Shanghai, Disney definitely had some contribution in this, but I think it's still the warmup phase. I don't think the Disney impact has already fully shown in our numbers in July. It's expected to gradually climb up as more visitors come in the next few months.

Okay. Thank you. Thanks a lot.

You're welcome.

The next question comes from the line of Timothy Lam from Macquarie. Please ask your question.

Hi. Thank you for taking my questions. I have a few questions. The first question is about HanTing 2.0 upgrade. Just want to confirm with management that the target is still 35% by year-end, or is it going to be a bit higher by the year-end?

Then the second related to that is what's the depreciation expenses the Company would expect going forward on a quarterly basis?

The second question I have is regarding to the Company's strategic alliance with Accor. Just want to see if the Company can give us some color on the long-term about Huazhu's alliance with this other hotel operator in China. Thank you.

Okay, hi, Timothy. Let me address your questions on the target on HanTing 2.0. We still maintain our target of 35% of the rooms that are upgraded at the end of this year. But having said that, is that because we have to -- it depends on the seasonality and the occupancies on each area, so to determine, to fine tune the number of rooms that we are going -- putting into renovations for upgrades. This is number one.

Number two is that the depreciation cost is in Q2 our depreciation cost is approximately RMB117 million. We expect that although with the HanTing 2.0 upgrade, it is actually part of the -- our heavy [expense] that we expected to happen with the -- so we expect that the depreciation cost would maintain approximately with marginal increase on our current level, which is number two.

And number three, can you repeat your questions on number three?

Yes, the first question was about the strategic alliance with Accor. Just want to see if the Company can share some highlights on the long-term strategy with China Lodgings Alliance with this other hotel operators in China, trying to work in the same -- with the same Group?

Let me confirm if I get your question right. Do you want to understand more about the Accor/China Lodging alliance, or you want to get comments on other hotels in collaboration with other international companies?

More on China Lodging, please. Thank you.

Okay. As we explained earlier, Accor, Chandler Lodgings collaboration with Accor is exclusive in the Greater China area. We have currently been exclusively managing three brands, Mercure, Ibis Styles and Ibis. We are having a co-development agreement with Accor on Novatel and Grand Mercure. We also have a JV with Accor for Sofitel, Pullman, as well as the Novatel Grand Mercure that has already been opened in the past. So it's a full range collaboration with Accor across China.

Does that answer your question?

Sorry. And finally, just one other -- just a cleanup question is to understand the full year CapEx at this stage. I'm wondering if the Company has still any changes on that? Thank you.

Can you repeat that again, sorry?

Just trying to understand the Company's full-year capital expenditure plans at this moment after including all these upgrades and your own hotels investments?

Okay. We budgeted, as we mentioned earlier, we budgeted in approximately RMB650 million for our maintenance as well as CapEx for this current year.

Including new hotels.

Sorry?

Including new hotels.

Including hotels.

The next question comes from the line of Leon Chik from JPMorgan. Please ask your question.

Hey, hi, guys. One quick one on the RMB109 million gain. Does that just include the RMB49 million from the apartment sale and the rest from the Home Inn stock?

Can you repeat your questions again?

So it's a RMB109 million gain, right, in the second quarter? Is that just the apartment sale and the Home Inn shares? Is there anything else in there?

There's nothing else in that. I just want to reiterate that this is not a sale of our apartment business. It is actually a gain from -- it is a gain that has been realized from our investments because there is additional investment by a venture capitalist firm in our apartment business.

Okay, that's fine.

So these are not disposals.

The RMB109 million, there's no tax on that, right? It's already after tax?

Yes, only these two, RMB56 million and RMB49 million.

No tax? Okay.

One last question. I think you've closed 49 hotels this quarter. I can't really get a lot from the previous quarters. I don't think -- sometimes you don't disclose. But it's the normal level very low? What I'm trying to get at is you probably don't have that many really bad hotels, right? So if we continue to close at such a high rate, then eventually you'll go back down to like a very low rate, right? Is that correct?

Now this, I would say that on the totality basis that we expect that there is a closure to be in a range of 150. So this quarter is a bit high, and then it's at, you know, you may either continue the closure in the Q3, then it may slow down after that. Once we clean up the hotels that are not meeting our standards, then there will be less rooms to close going forward.

Okay, that's great. But I think the number, like from last year had been much lower than 150, right?

Correct.

Okay, good. Thank you.

If you went back -- sorry, let me add just one word on that. If you went back two quarters on earnings release, you will notice that we have indicated that we are going to improve the quality of our portfolio, and then we are going to take more proactive actions to remove some of the lower quality properties from the portfolio. So what you have seen in the closure of Q2 is the successful execution of that strategy.

The next question comes from the line of Lin He from Morgan Stanley. Please ask your question.

Thanks for taking my questions, and congratulations on a very strong quarter. Two questions from me. One is -- the first one is for Qi dong . (Spoken in foreign language).

My second question from me is the impact of VAT reform. If I look at the business tax and the related surcharges and then I actually only account for around 2% of gross revenue this quarter. It's much lower than before. And also, I believe the margin uplift seems to be bigger than we discussed last time.

You also commented that it also has an additional impact on the expense side as well, for example, the rental expense you talk about. So it will be very helpful if you can give us a little more color on how to quantify the VAT impact going forward. Thank you.

The first question is for Mr. Qi. (Spoken in foreign language). This question for Mr. Qi Ji is about franchisee business. First, she wants an update with our discussions with the franchisees which has brought a lot of tension in Q2. That's number one.

The second is she wants to know Mr. Qi Ji's idea about franchised business in future in China.

(Interpreted). Okay, so yes I personally -- oh together with Jenny -- I personally met almost 10 franchisees who suffer the most from the business loss and I also [hang] out with the top 20 best performing franchisees to understand another side of the story. I even -- I assigned every district manager to meet 10 franchisees by themselves to really understand their needs. As you know, there are diversified needs but basically they want to cut franchisee as you can all imagine. And people trying to complain or all kinds of issues.

But I think the fundamental root cause is because their business is not performing as good as they expected, especially in the slowing down economy. And this problem mainly concentrates in tier three, four, five tier cities.

You know the macro economy is not something we can change. We don't have the magic stick. So what we can do is that really help our franchisees doing better than they used to be before and doing better than the competitors' franchisees.

So, as you know, we want to pick the franchisees who share the same value system with us, not just looking at the new opening store numbers. We care more about the franchisees behind them. And as our culture emphasized, we are a bunch of people who share the same mission and vision and accomplish great things all together and happily.

As a next step, we will form a franchisee committee which will channel back franchisees' feedback regularly to us.

And back to the big question about my view about hotel franchisee business, first of all, I think China Lodging is the best brand in the economy and the midscale segment. We are the top choice for our franchisees.

And second is that we think the branded chain penetration in economy and midscale market is still very low, so there are plenty room of growth and consolidation. So I'm very confident about the franchise business.

Third is that compared with other investment channels, which is quite limited in China nowadays, I think the franchisee business itself has a lot of merit and the return itself is quite handsome. So I think it's still quite an attractive business.

And fourthly, lastly but not least is that although we all -- we are prepared that the economy growth is slowing down and this phenomena is going to continue for a while. But we think in such a market circumstance, those companies who have very strong brands and very strong IT or other operating systems support can really stand out among other hotel companies. So I'm very confident in our franchisee business and ourselves.

Thank you.

Hi [Helene]. Hello, Helene. It's Teo. In response to the questions relating to the VAT reforms, number one is that this line will disappear going forward because the portion of the revenue that is collected from our customers will be directly paid to the tax authorities. And this amount will be reduced by the VAT debt on the invoices that we receive from our vendors such as our lease landlords, such as utilities, such as consumables and even from the purchases of capital expenditures that we spend.

So effectively is that our net -- our revenue line will only show to -- our total revenue line will be similar to our net revenue line going forward. And similarly is that our operating cost -- hotel operating costs -- will be reduced by the portion of the VAT that we can use to deduct against the VAT debt we receive from our customer and payable to the tax authorities. Does that answer your questions?

So we can move to the next question. The next question comes from the line of [JG Lee] from Brean Capital. Please ask your question.

Hi. This is [J Lee] from Brean Capital. First, congratulations on your good strong quarter and I would like to raise my question on behalf of Fawne.

This question is regarding the guidance for the third quarter. You expect the net revenue to grow 10% to 12% in the third quarter. But normally speaking, the third quarter is the peak season for leisure and travel. I just wonder why HanTing, China Lodging that you guide a little bit lower? Thanks.

(Spoken in a foreign language)

Hi. Hi. Teo here. Okay, in response to your question, at the beginning of the year we guided in the range of -- to grow net revenue by approximately 12% to 15%. This is in the light of the considered -- the comparison to the trend in the year 2015. Back in the year -- in Q1 2015 the Q1 revenue was pretty low. It was impacted by the downturn that was start of -- back in 2014. So the Q1 in 2015 is very low.

So in Q1 2016 it's that it was reflected as the higher growth compared to what we have expected because the trend in 2016 was actually a recovery from what has happened back in 2015. So -- but in Q2 we said we continue to guide in the range of 12% to 15% and it is similar to what I have explained earlier because like last year in 2015, Q2 it was also in the recovery stage. But going forward, in Q3 in 2015 the net revenue has grown more healthily. So the -- so we expect that the growth in 2016 compared to the 2015 will be more moderate. This is one.

And number two is that as we mentioned is that we are also cleaning up our portfolios by actually removing hotels that are not meeting our quality standards. So that will actually impact our revenue growth for the second half of 2016.

But having said that is that we are still pretty confident in terms of meeting our revenue growth for the entire 2016. And we also expect that the -- we will continue to record a margin expansion because by removing those hotels with a lack of qualities it actually helps us improve our profitability.

Okay. Thank you.

Thank you, there are no questions. I would like to hand over the call to the speakers. Thank you.

Thank you all for your time today. Our management is looking forward to talking to you next quarter. Thank you. Bye.

Thank you.

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

Portions of this transcript that are marked (interpreted) were spoken by an interpreter present on the live call. The interpreter was provided by the Company sponsoring this Event.