H World Group Ltd (HTHT) 2017 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to China Lodging Group Third Quarter 2017 Earnings Conference Call. (Operator Instructions) I must advise you that this conference is being recorded today, Wednesday, November 29, 2017. I would now like to hand the conference over to your first speaker today, Ms. Ida Yu. Thank you. Please go ahead.

Thank you, [Richie]. Good morning, everyone. Thanks to all of you for dialing in, and welcome to our third 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 our strategy review and the Q3 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. 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 IR section of China Lodging Group's website at ir.huazhu.com, H-U-A-Z-H-U dot com.

Now I would like to turn the call over to Jenny. Jenny, please?

Good morning, everyone. [To briefly start] I'll outline our strategic focus for 2017. As we proceed towards the end of the year, today, I would like to give you a comprehensive review of how we have executed those strategies and the achievements due to those strategies.

On Page 3, our first strategy focus is to upgrade our economy hotels. We don't view HanTing as just one of the major hotel brands. Our ambition is to position it as the hotel of choice for Chinese people. As you can see, with the efforts from multiple fronts, the same hotel RevPAR for HanTing brand has accelerated to 9.8% in Q3, a historical high. The growth was mainly driven by the growing mix of our upgraded product, which is HanTing 2.0 and 2.5, our improved operational quality and the customer satisfaction level, the successful branding and sales efforts. We also attribute this phenomenal growth to strong domestic travel demand.

Page 4 shows the first HanTing Plus hotel performance in the first operational month. As you can see, we not only create HanTing 2.0 and 2.5, we continue to upgrade our products, leveraging the well-known HanTing brand for some more innovation. This brand, HanTing Plus, is positioned as an entry-level midscale brand. And this first completed hotel was opened at the beginning of October in Shanghai. The pictures show some (technical difficulty) will give you a flavor of this new product.

In addition to the new and refreshed layout of the lobby and rooms, HanTing Plus also provides more convenience to customers including Niiice Café, built check-in, checkout kiosks, a wider selection of pillows, 24 hours self-storage and laundry, and many other features. We are proud to report that this newly opened HanTing Plus hotel achieved a RevPAR of RMB 358 in the first operational month. Before the renovation, it was HanTing Hotel. The comparable RevPAR is up 40% year-over-year. As of now, we have 23 hotels in the pipeline for HanTing Plus. We see the franchisees are very enthusiastic about this new product introduced. We expect a lot of new HanTing Plus will be opened in the coming year.

Our efforts for economy hotel upgrades also extend to our Elan and Hi Inn brand. On Page 5 and Page 6 are pictures of the new Elan and the new Hi Inn products. Elan is our economy hotel brand designed for franchised and manachised hotels. This newly rolled out Elan 1.0 has a smart renovation concept designed for different property size and shapes.

Similarly, Hi Inn 4.4 -- 4.0, as shown on Page 4, is designed to optimize space utilization for the smaller properties, with a small lobby and a small room. Nevertheless, we try to put in all the necessary functionality into this very condensed space.

Moving on to our strategic focus of expansion in midscale segment. Page 7 demonstrates our well-covered brand portfolio in the midscale hotel segment. We structure our brands from 2 angles as we explained to you before: pricing and standardization level. We divide our hotels in midscale into 3 different levels: entry-level midscale, midscale, and upper midscale. And from a design perspective, we separate them from highly standardized hotels, hotels with standardized styles and hotels with standardized core elements. This portfolio avoids -- this portfolio positions each brand in a unique position to meet the different customer needs as well as property features.

As you can see, starting from the entry-level midscale, by leverage HanTing strong brand recognition, we launched HanTing Plus, as we just introduced. And we also have the new ibis product positioned as entry-level midscale in the market. With a very European design, we find this very well received by Chinese consumers.

At the midscale segment, we have JI Hotel, CitiGo, Orange Select, ibis Styles and Starway, which can well satisfy the different CapEx budgets and the different type of properties in the Chinese market.

Furthermore, we have 4 brands to cover upper midscale segment, which are HanTing, which are (technical difficulty) Crystal Orange, Mercure and Novotel. Each of these brands are also catered to different customer preferences.

As you can see, we have successfully repositioned Huazhu's hotel portfolio [provide] the chance of Chinese consumption upgrade.

On Page 8, our mid- and upscale hotels now have a significant portion of contribution to our revenue. In Q3 2017, the revenue contribution from mid- and upscale hotels increased by 13 percentage points to 41% of our significant larger hotel net revenue. This increase was driven by our rapid push into the mid- and upscale hotel segments and acquisition of Crystal Orange completed in Q2 this year.

From the room count perspective, you can see on Page 9, we also have a growing room count for midscale hotels. During the past 3 years, we have increased our room inventory in mid- and upscale segments from 11% in 2014 to 25% in Q3 2017, and approximately 66% of our rooms in the pipeline are mid- and upscale hotels. We expect for the new hotels we are going to open next year, 60% to 65% of the room counts are going to come from our midscale and upscale hotel brands.

Page 10, details and updates on Crystal Orange, our newly acquired brand. In Q3, Crystal Orange posted strong same-hotel RevPAR growth of 14.5%. In addition, we have completed the integration of operational and booking systems, loyalty program and back-office support for this newly acquired business. We are happy to see our centralized reservation system contribute to Crystal Orange's strong performance.

Our third strategy focus is to grow our same-hotel RevPAR. In addition to hotel upgrades, we also focused on transforming our relationship with members in our direct channels, which make a significant contribution to the same-hotel RevPAR growth. In August, we launched a marketing campaign to boost Orange's loyalty program and the Huazhu app.

Page 11 shows some of the pictures of the various campaign angles. We displayed the Huazhu Club logo in various hotel brands on high-speed trains traveling from Shanghai to Beijing. And this train will carry our logo for the next 6 months after the launch. And they joined -- the passengers can join Huazhu Club by scanning and downloading our app on the train. We also launched a new version of our app last quarter. In the new app, Hello Huazhu is one of the new features which bridges communication between our guests and our staff. In addition, we also optimized and customized the booking function and committed to the lowest price from Huazhu's direct online channels.

As you can see on Page 12, our fast-growing membership program contributes significantly to our sales achievement. Approximately 97 million customers joined our member program up to Q3 2017, and we're happy to report that our membership program reached the 100 million mark just last week.

On Page 13, with all the sales efforts as well as the quality improvement, our same-hotel RevPAR growth recorded 9.5% in Q3. This number is achieved without counting the Orange acquisition. So this is primarily our existing brand portfolio. So with the detailed view on Page 13, you can see the growth of our same-hotel RevPAR performance trending very well in the past 2 years.

In Q3, the 9.5% increase was driven by a 3% increase in same-hotel ADR and a 4.5 percentage point increase in occupancy. The midscale and upscale hotels maintained a high single-digit same-hotel RevPAR growth rate at 9.5%, as driven by 1.2% increase in ADR and 3.6% -- percentage point increase in occupancy rate.

Our economy hotels also performed very well, and the RevPAR growth rate accelerated to 9.4% in Q3, driven by a 4.3% increase in ADR and a 4.5 percentage point increase in occupancy rate.

As I just said, the Crystal Orange hotel RevPAR are not included in our reported same-hotel RevPAR statistics as you have seen on the chart. We are -- they will be included when they are included in the Huazhu system for at least 18 months. As mentioned in earlier page, Crystal Orange alone posted a same-hotel RevPAR growth of 14.5%.

Moving to Page 14 in Q3. Our blended RevPAR growth accelerated to 17.3%, driven by higher ADR, occupancy and mix upgrades. We expect the RevPAR growth trend will continue due to factors that I will further elaborate in the following pages.

As you may recall, in our last earnings call, we shared with you the price comparison among hotel room and other consumer products in China versus U.S. We found that ADRs for hotels in China are significantly underpriced. Today, let's take another angle. In Q3, our blended ADR grew from RMB 194 to RMB 218, which is a year-over-year increase of RMB 24. Such increase in ADR is less than the price of a Tall cup of Starbucks coffee latte in China. So we believe such price increase is properly affordable to the Chinese consumer, who is experienced [user of] big type of consumption upgrade. And I think this consumer buying power, we will continue to drive our ADR growth in the long run.

Turning to Page 16. The domestic travel market remains very strong. From 2011 to 2016, disposable income per capita grew at CAGR of 7%, while domestic travel expenditures grew at 14% CAGR. The strong demand for travel has been driven by consumption upgrades and a lifestyle change. The increasing adoption of the annual leave system and a higher frequency of short distance leisure travel are prevailing in China, especially for the young generation. We are not only facing a positive demand trend. On the supply side, we also see very favorable trends.

Turning to Page 17. We can see the net addition of branded hotels started to slow down in 2016, and we expect this moderate, slow trend will continue in 2017 and 2018. We think that such trend is reflective of the general trend in China Lodging market. The escalating rent and the funding costs, scarcity of private properties and a higher investment requirement prohibited sales [trend on cost] or post competitive challenges for many smaller and individual players from entering into the lodging market. While the demand for travel remains strong, the slowdown of supply will provide the perfect environment for ADR growth as well as occupancy growth.

With that, I would like to turn the call over to Teo, who will talk you through our operational and financial results in Q3.

Thank you, Jenny. Hi. Good morning, everyone. At the end of Q3 2017, our total number of hotels in operations has reached 3,656. The net opening of this quarter is 115, with 167 of gross openings and 52 closures. Including these 108 Crystal Orange hotels consolidated from the acquisition in Q2, we have achieved a total gross hotel openings of 528 or 387 net.

In the first 9 months this year, excluding the hotels consolidated from the Crystal Orange acquisition, we maintained our guidance of 500 organic gross hotel openings for this year.

Page 20 shows that our hotel pipeline remained robust, standing at 606 as at the end of Q3. And our hotel pipeline numbers continue to grow in Q4. Therefore, we are positive on the new openings of hotels in the future.

Turning to Page 21. In Q3, our blended RevPAR grew by 17.3%. This was driven by an increase in occupancy by 4.2 percentage points, an increase of ADR by 12.1% year-over-year, mainly due to the increasing mix of midscale and upgraded economy hotels as well as strong domestic travel demand.

Moving to the financial results on Page 22. Our net revenue grew by 33.8% year-over-year. This was at the high end of our quarterly guidance range. Breaking down the revenue of CNY 2.4 billion, you see CNY 1.86 billion contributed from our leased and owned hotels and CNY 507 million from manachised and franchised hotels. Net revenues from our leased and owned -- leased and operated hotels increased by 34% year-over-year, and net revenue from our manachised and franchised hotels were up 36% year-over-year.

As demonstrated on Page 23, our operating margin came in at 24.9% in Q3 2017. This is an increase of 5.1 percentage points from Q3 2016. The hotel operating costs and other operating costs as a percentage of net revenue decreased by 7 percentage points year-over-year. This was mainly due to our improved blended RevPAR, better operating efficiencies from scales and favorable VAT impact on fixed operating costs such as rental. The preopening expenses as a percentage of net revenues increased by 2 percentage points, while the SG&A expenses and other operating income as a percentage of net revenues remained flattish compared to the same period last year.

Turning to Page 24. The strong RevPAR growth and better operating efficiencies drive our profitability. In Q3, our EBITDA increased by 55% year-over-year to CNY 850 million, while our EBITDA margin expanded from 31% to 36%. Net income increased 60% year-over-year to CNY 470 million, while the net income margin expanded from 17% to 20%.

Moving on to the cash flow status on Page 25. In Q3 2017, our net cash from operation reached an auspicious number of CNY 888 million, while capital expenditure for maintenance and new developments totaled CNY 213 million. As a result, the free cash flow in Q3 was CNY 675 million. In Q3, we also made some investment in hotel and shared service offices totaling CNY 251 million. In October, we declared a CNY 300 million dividend payable to the shareholders in mid-December.

Page 26 provides a summary of our recent convertible bond issuance. We issued a USD 475 million, 5 years convertible bonds due in 2022. The coupon rate is 0.375%, with a [put] call arrangement to increase the conversion premium. The convertible bond is convertible to China Lodging's ADS at the price of USD 221 per ADS. We have used the proceeds to repay the USD 250 million revolving credit facility for the Crystal Orange acquisition. The remaining balance of the proceeds will be used to make some investment in related business overseas and fund other general corporate purposes. Financially, we expect this will lead to a saving in our interest expense.

Finally, our guidance on Page 27. We expect to achieve a net revenue growth rate of 29% to 32% year-over-year in the fourth quarter. For the full year, we expect a net revenue growth of 24% to 25%. We affirm -- we reaffirm gross openings of approximately 500 hotels in 2017, on top of the 138 hotels consolidated from Crystal Orange acquisition.

In 2018, we plan to accelerate the gross openings to 650 to 700 hotels, and we expect 60% to 65% of which are midscale and upscale hotels.

With that, let's open the floor for questions.

(Operator Instructions) Your first question comes from the line of Yaoxin Huang from CICC.

I have 2 questions, goes to Mr. [Jin] and Mr. [Jian] (foreign language) So I have 2 questions. First on OYO hotel investment. Second is around the [Luangong] IT platform development strategy.

Okay. Let me address those 2 questions, and Mr. [Jin] can add on that as needed. OYO is an interesting player in India. It actually has combined the business model of the hotel operator and OTA. But they face an interesting market which is the scarcity of supply of quality, reasonable price inventory. So that demand was very similar to what we faced 12, 15 years ago, when the economy hotel chain started in China. So we see that as a strategic opportunity. That's why we invested in OYO. Despite it's not a significant amount, we expect OYO to have a significant contribution to the travel industry in India. As of now, I think OYO is the largest economy hotel chain in the country. As to JI Hotel and our automatic check-in, (foreign language). This is a product we already rolled out in all the JI Hotels across the country, and we just started to roll it out to other brands in the Huazhu portfolio. Our target is to equip half of all of our hotels next year with this automatic check-in machine. [Luangong], which is IT service company funded and supported by Huazhu, not only provides services to Huazhu hotels, they also serve mainly the upscale hotels. They have customers such as [Conmat], MGM, and we provide comprehensive IT solution to upscale hotel operators of different scale. They supply products like PMS, CRM, also supply solutions like (foreign language) and in-house housekeeping tools. So far, the customer feedback has been very positive. We expect Luangong to accelerate their growth next year. I hope that addressed your question.

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

Perhaps 2 broader question and 1 question on the numbers. The first question that's, again, on the use of cash. Since you now have a -- well, for this quarter, a very auspicious CNY 8 million operating cash flow. Surely, you're going to continue the free cash flow trend. And at the same time, you also initiated another one-off special dividend during the quarter. So I just want to get a sense on, going forward, how you're going to plan to deploy this free cash flow. Would it be a more recurring redistribution of cash back to shareholders as dividend? Or are you going to deploy more in the new investment as like OYO or other [Luangong] kind of new initiative that you're doing? That's the first question.

Yes, thank you, Justin. We are going to reinvest most of the cash we generated from the business into new opportunities. That includes strengthening our own hotel portfolio. As Teo mentioned, we are considering not only expanding our business in China, we are also considering overseas opportunities. And then secondly, we also leverage our scale and our business know-how to create or support more new business. [Luangong] is one of those examples. Aside from those, we want to maintain a moderate dividend which will be approximately RMB 300 million a year. So that's the overall thinking of our cash deployments.

Great. That's very clear. The second thing that you -- in your slide, you also added the HanTing Plus as some of the new products that you're rolling out in the mid -- kind of entry-level midscale setting. Can you share a bit more on what kind of pricing differential you're going to see between HanTing Plus and other midscale product, you have like JI? And with these entry-level products rolling out, would it be more coming in from an upgrade of your existing HanTing pipeline or there's more coming in from a new opening from -- of that property premises?

That's a very good question. We are seeing, as the JI Hotel becomes more and more popular in the market, the pricing points of JI Hotel has increased significantly in the past 3 years. Now in Tier 1 city, the pricing point between JI Hotel and HanTing are somewhere around RMB 150 to RMB 200 right now. We see that as an opportunity to put 1 more product app, the existing HanTing and JI Hotel. So that's where we put the HanTing Plus. As you can see in the first HanTing Plus in Shanghai, that property wouldn't be ideal for JI Hotel because the room size is smaller and the lobby size is also kind of not as grand as you would want to see in a JI Hotel. Nevertheless, it has made very significant RevPAR improvement from the original HanTing Hotel. Currently from the feedback of franchisees, we see the growth fueled by both upgrading of the existing property, but more coming from the new hotel, built or converted from other brands or other independent hotels to this model. Because of its flexibility in the lobby size as well as the room size, I think it will be a very attractive offering for all the hotel owners currently running economy hotels.

Maybe my last question on some numbers is that you now rolled out the 2018 opening target on the growth side, 650 to 700 new additions. Can you also share what would be the run rate of the closure in 2018? So I think year-to-date, for the first 3 quarters, you've probably closed 150 hotels. Is this something more like happening in 2018? So is the stabilization of the franchise network mostly done in 2017? Or do you still see some happening in 2018?

Last year, we opened approximately 200 -- we closed about 200 hotels. And this year, we also expect to close a little bit more than 200 hotels. We will maintain that number into 2018. Currently, we are budgeting closure of 220 hotels next year. Those closures are attributable to 3 different types of reasons. One is, of course, the expiration of the lease for our leased hotel as well as the franchisees or some other reasons like rezoning that prohibit us from continuing the operation in the property. So that will contribute about 1/3 of the [2018] closures. And the rest are either coming from quality issues, compliance issues or there are some problems between the partners, the partners [within our 1] franchise hotels. So there are many different situations contribute to the other 2/3. But mainly, those are hotels we want to close because they are not willing to keep up to our quality standard. So we see those closures as generally healthy for the overall portfolio.

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

I have 2. The first one is, we noticed that's been -- the competition in midscale hotel segment has been increasing, and a lot more players are entering into this segment. So my question is, do management view this as an opportunity to HanTing or, in fact, to Huazhu -- to HanTing overall? And also, could management remind us what was our -- what is our core competency to keep us ahead of other players? This is first question. Second question is, I noticed that we no longer disclose the percentage of HanTing 2.0 upgrade. Was that because some of them are converting to HanTing Plus or some of them converting to other hotel as well? So what was the degree of willingness of these franchisees to convert to HanTing Plus? And also, what is the additional CapEx for them to upgrade to HanTing Plus?

First of all, in the midscale competition, Huazhu is very well positioned. As we discussed with our investors on a one-on-one basis, currently there are 7 brands has more than 100 hotels in the midscale segment. And out of the 7, Huazhu has 4 brands -- has 3 brands, which are JI Hotel, Orange as well as Starway. We also expect our HanTing Plus will quickly surpass the 100 mark in the next 18 to 24 months. So we have a very strong portfolio in the midscale segment. And we not only have more brands compared to competitors. We also have the best brands in our portfolio. JI Hotel has the highest GOP rate among all the midscale brands. And Orange has the highest RevPAR achievement among all the hotel brands. So we have 2 jewels in the midscale segment. So we believe we are very well positioned in this competition. That's also why we are confident approximately 2/3 of our new openings next year were coming from the midscale segment. And in response to your question about the HanTing portfolio, we have now taken a more adaptive approach to renovating the HanTing existing hotels. We have rolled out multiple solutions to fit the different CapEx budgets and the location and the remaining lease tenure for our franchise hotels. That has created a more kind of suitable solution for each hotel. We don't report -- we didn't report the percentage of HanTing 2.0 this quarter, does not mean we are stopping the effort there. Actually, the number continually is moving forward. We are targeting to have approximately 40% of our HanTing portfolio to be fully renovated to HanTing 2.0 or above product version. At the same time, I also want to point out even for many of the hotels who haven't done a major renovation, by improving the operation standards and consumer services, we are also achieving very significant same-hotel RevPAR growth. So the upgrade for HanTing should be viewed as a multiple front, not only at a major renovation level but also at an operational improvement level. We are pushing both.

(Operator Instructions) And we have a follow-up question from Yaoxin Huang from CICC.

I have 2 follow-on questions. First question is about the weight of hotel rooms in first-tier and second-tier cities. I noticed in the PPT that the weight of hotel in Tier 1 and Tier 2 cities stay the same at 77% this quarter, similar to last year and 2015. The thing is, do you expect that there are still large potential even in Tier 1 city to expand in the future? Or do we plan to increase the percentage in Tier 3 or lower tier cities? That's my first question. And the second question is about just financial data. I noticed that we have recorded in third quarter CNY 51,000 other income, net. So what is the other income, net? What does this item included?

Okay. I will address the first question, and we'll ask Teo to address the second question. On city mix, we expect our mix in the near term to maintain at a similar level, as you have seen historically. We see a lot of opportunities in Tier 1 and Tier 2 cities. And we clearly maintain a much higher percentage compared with our competitors. And that outcome of our market brand strategy, we try to create different solution to different properties so we can maximize the return of each property.

To address the question -- on the second question on the other income. If you recall, the [CNY 51 million] in the other income in Q3. And this is actually -- it comprises of 2 items. Number one is actually a reversal of losses from our previous investment in -- which turns into a gain of approximately CNY [40 million]. And now the remaining CNY 10 million is actually a gain from some short-term investments.

Your next question comes from the line of [Vincent Yao from Citi]. I'm sorry. I think [Vincent Yao's] line is having a problem. (Operator Instructions) I'll move on to the next questioner, Ms. -- or Tallan Zhou from Deutsche Bank. Tallan Zhou, your line is now open. Please check your phone if it's on mute.

I have 1 question. If we exclude Crystal Orange, what is the likely growth rate for EBITDA in the third quarter on a like-for-like basis?

Sorry. Can you repeat the question again?

So if we exclude -- excluding Crystal Orange, what is the likely growth rate for EBITDA in the third quarter?

Okay. Excluded the Crystal Orange, our EBITDA growth rate will be approximately 38%.

The next question comes from the line of [Vincent Yao from Citi].

I have a follow-up question on Crystal Orange. In general, can you describe a little bit more about the overall integration process of Crystal Orange? And also, what is the strategy for Crystal Orange going forward? Is the team more operating more independently or you have already a lot of collaboration internally for -- between the 2 teams?

Sorry. Can you repeat your questions again?

Just a follow-up question more on the strategy of -- integration and strategy for Crystal Orange. Overall, how is the integration process after the acquisition of Crystal Orange? Is the team of Crystal Orange more operating independently or you already have a lot of collaboration between the 2 teams? And also secondly, what is the overall strategy for Crystal Orange going forward?

Vincent, we have acquired Crystal Orange partly because they have a strong brand and a strong operational team. So we maintain the existing team to continue to brand those hotels. From that side, you can see the front-end is reasonably independent. At the same time, we have integrated the systems in the back office to achieve the -- to optimize the efficiency. For example, we have connected all the reservation systems, and we have also merged the loyalty program Orange had into the Huazhu Club program. We also have integrated HR, IT, finance, all the back-office functions. We also consolidate the call center. So because Huazhu has much more of the wealth in terms of technology and system and the automation in terms of all the backhand office work, so we see clearly efficiency gains through those efforts. At the same time, the consolidation of the loyalty program also enables Huazhu's 100 million members to use Orange hotel more. So that has a meaningful impact to the occupancy as well the RevPAR growth of Orange in the past few months. As you can see, before the acquisition, Orange didn't have a significant same-hotel RevPAR growth. But immediately after the acquisition, we have seen the double-digit single-hotel RevPAR growth starting from June and continue into Q3. So we have seen this acquisition integration work being quite successful.

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

Thank you, everyone, for your time being on the call today. And we look forward to talk to you in the next quarter. Thank you.

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