Domestic liquor and travel continue to slow down, but Huazhu Group is accelerating its store openings?

Before the US stock market opened on August 20, 2024 Beijing time, Huazhu Group (1179.HK/HTHT.O) released its financial report for the second quarter of 2024. In summary, Huazhu's various financial indicators this time were generally slightly better than expected, but performance continues to point towards a weakening trend in the hotel and travel demand. Specifically:

1. In terms of underlying operating data, in the second quarter, the average room revenue of Huazhu hotels was 296 yuan/night, a year-on-year decrease of 2.4%. It can be seen that the vitality of the hotel and travel supply and demand has indeed been gradually declining in recent quarters. Looking at price and volume drivers, the average room rate this quarter decreased by about 3% compared to last year. The occupancy rate was 82.6%, about 0.8 percentage points higher than the same period last year. It can be seen that this year's demand for hotel and travel is still growing (occupancy rate is increasing), but the decline in prices due to more rational consumption choices (possibly downgrading) and a more balanced supply and demand is the main reason for the decrease in RevPAR.

In contrast, European hotel and travel demand has experienced a significant boost due to the European Cup and the upcoming Olympics in the third quarter, leading to a noticeable surge. The average room revenue (RevPAR) reached 115% of the level in the same period in 2019, setting a new high since the epidemic. However, due to its limited scale, its impact on the overall group is not significant.

2. Despite the slight decline in supply and demand vitality in recent quarters, Huazhu's pace of opening new hotels is accelerating. In this quarter, a total of 469 net new hotels were opened, an increase of 46 compared to the previous quarter. The number of hotels awaiting opening is close to 3,300, an increase of more than 120 from the previous quarter. The company also announced that the target for the number of new hotels opened in 2024 has been raised from 1,800 to 2,200, clearly demonstrating Huazhu's intention to accelerate hotel openings. While the counter-cyclical opening strategy may logically help the company's market share, it may also put pressure on profitability in the short term.

3. Although the average RevPAR in China this quarter is slightly lower year-on-year, with the rapid growth in the number of stores, the total revenue of all hotels in the Huazhu Group increased by 15% year-on-year this quarter, a more accurate reflection of the real operating conditions.

On the revenue side, this quarter, the overall revenue growth of Huazhu Group continued to slow to 11%, exceeding market expectations by 110 million. However, due to different revenue calibers, the importance of self-operated business revenue from the reduced number of stores was overly magnified.

For Huazhu's direct-operated business, with a net decrease in the number of hotels, revenue growth was only 2%. However, the revenue of the franchise business still maintained a year-on-year growth rate of 26%, although it also slowed down on a quarter-on-quarter basis but still impressive. Moreover, the monetization rate in the franchise business is higher than the 18% revenue growth, indicating that Huazhu's monetization rate in the franchise business has also improved.

4. As the franchise business recognizes net income on a revenue basis, the cost side mainly reflects the costs of self-operated business, which are relatively rigid. This quarter, Huazhu's overall hotel operating costs increased by 200 million year-on-year and 100 million quarter-on-quarter, while revenue increased by nearly 620 million year-on-year. Among them, the slightly increasing self-operated revenue and costs roughly offset each other year-on-year, while the incremental revenue from the franchise business largely translated into incremental gross profit Therefore, the gross profit increased by more than 300 million year-on-year. The gross profit margin increased by 1.6 percentage points year-on-year, reflecting the company's gradual light asset and platform transformation.

5. However, expenses in this quarter still showed relatively high growth. Among them, selling expenses increased by 21% year-on-year (about 55 million), which to some extent reflects the need for more promotion due to the growth in the number of stores and the potential increase in customer acquisition difficulty. Additionally, administrative expenses increased by 28% (about 120 million), with a more significant increase. It was explained that the growth in administrative expenses was mainly due to the company starting to expand its total number of employees and increasing equity incentive expenses.

Due to the expense growth, compared to the 1.6 percentage point increase in gross profit margin year-on-year, the year-on-year growth rate of operating profit narrowed to 0.6 percentage points, reaching 25.6% for this quarter, which is still better than the lower market expectation of 25%.

The company is more concerned about the adjusted EBITDA indicator, which was 20.2 billion for the quarter, slightly exceeding expectations by 0.9 billion. Looking at the segments, Huazhu's domestic EBITDA increased by 15% year-on-year. Overseas EBITDA increased from 110 million to 130 million, which, although a good growth, is still relatively small in scale.

Dolphin Research Viewpoint:

Firstly, from Huazhu's performance, it can indeed be seen that the domestic hotel and travel demand is in a state of steady decline, but the slowdown is generally within market expectations, and the actual performance of various key indicators is slightly better than expected. This verifies that the trend of subdued demand has not brought incremental bad news.

Looking ahead to the third quarter, the company's guidance indicates that total revenue will increase by 2%-5% year-on-year, a further significant decline from the over 10% growth in this quarter. Although it is highly likely still affected by self-operated business (not ruling out the possibility of negative year-on-year growth in self-operated revenue next quarter), and last summer was also the peak of travel demand after the unblocking, with a high base. Under the influence of these two factors, the slowdown in growth is reasonable, but it also indicates that the demand for domestic leisure travel this summer is not particularly hot.

In this regard, it can be seen that the favorable cycle benefiting from the recovery of travel demand after the unblocking has basically come to an end. However, after the industry beta dividend ends, Huazhu is still expanding its franchise stores, promoting market share improvement, while also lightening its business (the company itself does not need to bear high costs like leasing in self-operated business, and the risk of possible failure of individual hotel operations). In terms of valuation, after a significant pullback, the current market value corresponds to around 15 times the after-tax operating profit, and it remains to be seen whether the company can continue to maintain good profit growth while expanding its store network.

The following is a detailed interpretation:

I. The prosperity of the wine and travel industry remains stable, neither strengthening nor weakening

Before interpreting the financial data, let's first review the performance of Huazhu from a more fundamental operational data perspective this quarter.

1.1 Supply and demand tend to balance, RevPAR remains stable but slightly decreases

In the second quarter, the average revenue per available room (RevPAR) of Huazhu Hotels was 296 yuan/night, a year-on-year decrease of 2.4%. If we compare it to the data from the same period in 2019, this quarter's ADR is equivalent to 118% of 2019, lower than the 121% of the same period last year. It can be seen that the prosperity of supply and demand in the wine and travel industry has indeed been gradually declining in recent quarters.

From a price-volume perspective, although the average room rate (ADR) increased by 25% compared to the same period in 2019, it decreased by about 3% compared to last year. The occupancy rate this quarter was 82.6%, about 0.8 percentage points higher than the same period last year. Therefore, it can be seen that this year, the actual demand for wine and travel is still growing (occupancy rate is increasing), but the decline in prices due to more rational consumption choices (possibly downgrading) and a more balanced supply and demand is the main reason for the decrease in RevPAR.

1.2 European Cup & Olympics, surge in wine and travel demand under the dual events

In contrast, due to the driving effect of the European Cup and the upcoming Olympics in the third quarter, there has been a significant surge in wine and travel demand in Europe. The average revenue per available room (RevPAR) reached 115% of the level in 2019, setting a historical high since the epidemic. However, as it is influenced by special events, it cannot be considered as a subsequent norm.

Specifically, this quarter saw new highs in both occupancy rate and average room rate. Among them, the average room rate (ADR) reached 120% of 2019, significantly higher than the previous quarter. The occupancy rate increased by 1.2 percentage points compared to the same period last year, but it is still more than 2 percentage points lower than in 2019.

1.3 The pace of new openings continues to accelerate

Despite the slight decline in the supply and demand prosperity of the wine and travel industry in recent quarters, Huazhu's pace of opening new hotels continues to accelerate. A total of 469 new hotels were opened this quarter, an increase of 46 compared to the previous quarter. The number of hotels awaiting opening is close to 3,300, with more than 120 additional hotels compared to the previous quarter At the same time, the company has raised its target for opening 1,800 new hotels in 2024 to 2,200, reflecting the company's intention to accelerate store openings. Structurally, it is still the case that self-operated stores are closing on a net basis, while the number of franchised stores is increasing rapidly, with a 19% year-on-year increase in the number of franchised stores this quarter, gradually lightening the group's operations.

Compared to the countercyclical store opening strategy, although logically beneficial to the company's market share, it may also create pressure on profitability in the short term.

1.4 Despite store growth, revenue still performs well

In combination, although the average RevPAR in China this quarter is slightly lower year-on-year, under the rapid growth of stores, Huazhu Group's total revenue for all hotels this quarter still increased by 15% year-on-year. Moreover, compared to revenue, which weakens the importance of 3P category income due to different confirmation criteria, this revenue indicator more accurately reflects the true operating conditions.

II. Reducing Weight of Business, Franchise Business Drives Growth

1.1 Despite self-operated drag, franchise business still shows good growth

As the hotel and travel industry cools down, this quarter, Huazhu Group's overall business growth rate continued to slow to 11%, exceeding market expectations by 110 million. However, due to different revenue criteria, the importance of self-operated business revenue, which has reduced the number of stores, has been overly magnified.

Specifically, Huazhu's direct-operated business, due to a continued net decrease in the number of hotels, has seen its revenue growth rate drop significantly to 2%, almost approaching zero. Meanwhile, franchise business revenue still maintains a year-on-year growth rate of 26%, although it has also slowed down compared to the previous period. However, from an absolute perspective, a 26% growth rate is still impressive. Revenue growth is higher than the 18% growth in revenue, in other words, Huazhu's monetization rate in franchise business has also improved.

1.2 Self-hedging costs, franchise for profit

From the perspective of gross profit, since franchise business is accounted for in the financial report based on net income, the costs in the financial report mainly reflect the costs of self-operated business, which are relatively rigid. It can be seen that in the relatively peak season of 2Q, Huazhu's overall hotel operating costs increased by 2.1 billion compared to the previous quarter, while revenue increased by nearly 620 million year-on-year. Therefore, the gross profit increased by more than 300 million year-on-year. The gross profit margin increased by 1.6 percentage points year-on-year, reflecting the company's gradual platformization achievements, but the increase in margin seems to be lower than expected.

Specifically, the proportion of various cost expenditures in Huazhu's self-operated business remained relatively stable year-on-year. In other words, the slightly increased self-operated revenue and costs offset each other, and the incremental franchise business revenue largely converted into incremental gross profit.

III. Expenses continue to grow relatively high, profits are still acceptable

However, this quarter's expenses still showed relatively high growth. Among them, sales expenses increased by 21% year-on-year (about 55 million), reflecting to some extent the need for more promotion due to the increase in the number of stores, and the possible increase in customer acquisition difficulty. In addition, management expenses increased by 28% (about 120 million), with a more significant increase. According to the explanation, the increase in management expenses is mainly due to the company's expansion of the total number of employees and increased spending on equity incentives.

Due to the growth in expenses, compared to the 1.6 percentage point increase in gross profit margin year-on-year, the growth rate of operating profit narrowed to 0.6 percentage points year-on-year, reaching 25.6% this quarter. However, the market's expected operating profit margin is lower at 25% (i.e., flat year-on-year).

In terms of the adjusted EBITDA indicator that the company pays more attention to, the overall figure for this quarter is 20.2 billion, slightly exceeding expectations by 0.9 billion. Looking at the segments, Huazhu's domestic EBITDA increased by 15% year-on-year. Overseas EBITDA increased from 110 million to 130 million, which is a good growth, but the scale is still relatively small.

Dolphin Research on "Huazhu" Past Analysis:

Financial Report Reviews

March 20, 2024 Financial Report Review "Huazhu: Profits Fluctuating, Relying Too Much on Luck?" (Link)

November 24, 2023 Financial Report Review "Huazhu: False Alarm, Still a Top Player in the Industry" (Link)

April 25, 2023 Financial Report Review "Huazhu: Surging Room Rates, Significant Recovery in Business Climate" (Link)

March 28, 2023 Conference Call "Lean Growth is Key (Huazhu 22Q4 Conference Call Summary)" (Link)

March 28, 2023 Financial Report Review "Huazhu: Rise in Volume and Price, Ready to Take Off" (Link)

November 29, 2022 Conference Call "Cost Reduction and Efficiency Improvement, Upholding Business Growth (Huazhu 22Q3 Conference Call Summary)" (Link)

November 29, 2022 "Growing Against the Odds, Huazhu Striving for Growth" (Link)

In-depth Analysis

December 23, 2022 "Can Huazhu at $43 Continue to Soar to the Peak?" (Link)

December 14, 2022 "Surging by 75%, How Did Huazhu Cultivate Its Faith? (Part 1)" (Link)

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