Soaring 75%, how did Huazhu cultivate its faith? (Part 1)

Hello everyone, I'm Dolphin Analyst!

As the epidemic control measures across the country have been relaxed, consumer travel and tourism have been on the rise. After the release of the "New Ten Measures", the search volume for flight tickets on Qunar increased by 7 times, and the search volume for popular destinations during the Spring Festival period on Ctrip platform rose to the pre-epidemic level. The search volume for tickets soared to the highest level in three years during the period before the Spring Festival. Such strong emotions have also spread to the recent stock market, and the social services sector is particularly active. Among them, the stock price of the catering sector rebounded most significantly. However, the stock price performance of the hotel sector, which is also a social service sector, is relatively tepid. Dolphin Analyst believes that this phenomenon has two reasons:

1. The epidemic control measures have the greatest resilience in the catering sector's performance recovery: As of November this year, major catering companies listed on the Hong Kong Stock Exchange, such as Haidilao, Jiuroujiu, Helenbergh and Naixue, only restored the same-store sales to 6-7% of the pre-epidemic levels. Many brands still have about 20% of their stores closed due to control or remodeling. The occupancy rate of domestic hotel leaders has been repaired year by year for the past three years, and can be restored to about 80% compared to before the epidemic. Therefore, among the many subdivisions of social services, the catering sector naturally has more room for resilience and recovery.

2. The hotel leader opens stores against the trend, and the stock price is steady: The epidemic did not freeze the expansion of hotel groups. In the past three years, hotel leaders have continued to open stores in defiance of the trend. The logic of epidemic accelerating the concentration of market share of head enterprises in the hotel industry has been fully recognized by the market. The stock prices of some companies have even reached new highs before the epidemic. Up to now, only Huazhu, which is listed in Hong Kong Stock Exchange & US Stock Exchange, has a period of correction. The stock price of Jinjiang Hotel and Shangri-La Hotel in A share market is still relatively strong. Compared with this, the stock prices of many listed companies in the catering sector have been cut by 50% in the past two years, and the brewing time has been too long, so the rebound is also relatively strong at present.

Has the logic of the hotel industry come to an end? Dolphin Analyst believes that although the momentum of hotel industry's opening new stores has not been cooled by the epidemic, and the occupancy rate has recovered to a certain extent. The profit has not been well released affected by the epidemic in the past three years. The average daily room rate (ADR) and the average rentable room revenue (RevPAR) have a large gap compared to before the epidemic. When the occupancy rate is restored to a certain extent, it will drive the increase in the average daily room rate, which will in turn drive the "quantity-price inches up" of the hotel. Besides, hotel industry has higher fixed costs (direct operating businesses), and with the gradual recovery of business travel demand in the future, under the background of the accelerating increase in the concentration of head enterprises, hotel leaders will release great profit elasticity.

In addition, by observing the current potential chain space, there is still a possibility of at least 2 million newly flipped rooms in the future. If they can take a considerable share, it is undoubtedly an opportunity for existing hotel groups. At the same time, relying on the management experience of the full-service hotel, Dolphin Analyst believes that in Huazhu’s future continuous execution of high-end and international strategic layouts, relying on its fine polishing of products, Huazhu has even further space in front, with the stock code as follows: Huazhu Group-S.HK / Huazhu Hotel.US. For friends interested in interpreting research reports on Hong Kong stocks, please add WeChat number "dolphinR123" to join the investment research group and get Dolphin's in-depth research reports for the first time. Discuss investment opportunities with experienced investors.

1. The hotel industry is also experiencing "increase in both quantity and price".

As we all know, the control of the pandemic will directly affect the hotel occupancy rate. Indeed, the relaxation of pandemic control measures will lead to the recovery of commercial activities and the fastest response to the accumulated three-year demand for tourism will be reflected in the occupancy rate. However, as the occupancy rate continues to increase, the hotel operators will also raise the listed prices of individual rooms in accordance with the market trend.

The hotel industry has always been considered more cyclical for this reason: although the increase in chain rate will reflect the growth of leading hotel companies, more generally speaking, due to the long-term oversupply of the industry, the hotel industry reflects more cyclicality and is closely related to the macro economy. When the macro economy is booming, the increase in demand brings incremental funds into the accommodation industry, which increases the supply of the industry. These newly added "capacity" need to be gradually digested over 2-3 years. At this time, we will see the occupancy rate quietly decline. To stabilize the occupancy rate, the usual method is to lower the listed price of individual rooms to improve competitiveness. After all, although hotel brands are lightly asset-operated, for true hotel owners, there are considerable depreciation and amortization costs that cannot be left vacant just to achieve ideal listed prices.

Thus, with the adjustment of room listed prices, the occupancy rate started to stabilize and gradually rose as the economy improved. When it reaches a certain peak value (usually between 80-90% depending on the specific situation of the hotel), the hotel operators will start to raise the listed price again, sacrificing some occupancy rate to obtain more profits. This may sometimes lead to more extreme situations for consumers, where the hotel booked through third-party platforms is temporarily cancelled because the hotel is overbooked and the third-party platform took the risk of breaking the contract to gain more profit.

The Dolphin Analyst shows an older set of data that is more obvious (as the hotel operating data has fluctuated greatly during the pandemic, it will be difficult to distinguish the first few cycles from the same graph, as explained in the analysis below). Before the pandemic, the hotel industry had actually experienced three cycles that were quite obvious. The cycle usually lasts about three to four years, but the last two cycles were extended due to some special reasons. The second cycle was due to the continuous high-speed development of the domestic economy after the "large-scale easing" in 2012, and at the same time, the booming real estate brought in a group of high-quality hotel properties, making the decline in occupancy rate and ADR look less decisive and resolute than the previous cycle. During this period, the leading hotel operators were accelerating the increase of the chain rate. And it can be clearly seen that, in the first and second cycles, the occupancy rate was the first to recover, and then it drove the rebound in ADR and RevPAR growth.

The third cycle is reflected in the operating data of leading player Longbridge on a certain level. After the operating data bottomed out in the third quarter of 2015, the repair was initiated again by the occupancy rate. At that time, the top players in the domestic hotel industry, including Longbridge Group, were leading the industry towards higher-end hotels, and some now well-known high-end niche brands were quietly emerging. The rapid penetration of mid-to-high-end hotels improved the ADR in hotel operating data, especially for Longbridge Group, a pioneer in mid-to-high-end hotels. Thus, the repair of occupancy rate and ADR appears to be fairly synchronized in the data.

Whether the repair of occupancy rate is synchronized or initiated first, the upward adjustment of ADR brought about by the repair of the occupancy rate is almost inevitable. Since the COVID-19 pandemic, Longbridge's hotels have gradually recovered their occupancy rates, dropping rapidly from around 90% to 40-60% in the early stages of the pandemic, and gradually recovering to 60-80% in recent times. Although ADR has improved structurally, it is not yet reflected in revenue. In the future, with the opening of business travel, the resonance of occupancy rate and ADR is the "quantity and price increase" of the hotel industry's recovery.

II. How to serve the "real customers" - franchisees?

What do hotel chains relying on light-asset operations rely on to make money?

Let Dolphin Analyst take you through the revenue situation of hotel leading companies. Taking Longbridge as an example, the hotel's revenue consists of two parts: one is the total revenue of directly-operated hotels, and the other is the commission of franchised hotels (including franchise fees, central reservation fees, etc., which generally account for about 12% of the total revenue of franchised hotels).

1. Directly-operated hotels: the recovered revenue is profit

Although light-asset operations are a more preferred business model for hotel chains, and it is also a common approach for international hotel giants, at present, the three major hotel chains in China, Jinjiang, Longbridge, and Shangri-La still hold a certain proportion of directly-operated hotels. Of course, some of them are due to historical reasons, the group company holds some premium properties in first and second-tier cities, and prime geographical locations are the most valuable resource in the hotel industry, so they cannot be let go. Others are because the operating conditions of directly-operated hotels can serve as a reputation for attracting franchisees. After all, how can they manage franchisees if they cannot manage themselves, and rely on this for charging fees. Based on this situation, the number of directly-operated hotels among listed hotel companies in China is very small, but their revenue accounts for more than half of the total revenue, taking Longbridge as an example, with only 10% of directly-operated hotels. But the income percentage reaches 70% (revenue percentage is 18%, and since Huazhu's directly operated hotels have a larger average size, this percentage is greater than the percentage of the number of stores).

And directly operated hotels are a heavy asset model, which bears a lot of rigid costs such as rent, depreciation, and amortization. Although Huazhu's directly operated store total revenue has gradually recovered to the level before the epidemic, about RMB 7 billion, in the past two years, the main contribution is due to the annual increase in the number of rooms in directly-operated stores (almost all of which are brought by the acquisition of Deutsche Hospitality in 2020), the revenue per individual room has only returned to 80% of the level before the epidemic. And it is this lost 20% of revenue that has caused the gross profit of directly operated hotels to drop from nearly RMB 1 billion in the past to a loss of RMB 2 billion today. Moreover, as we can see, due to the consolidation, the cost of individual rooms in Huazhu has not decreased but increased (overseas hotels cost and revenue are much higher than in China). Dolphin Analyst believes that in the future, benefiting from the orderly recovery of business travel, as a leader in the hotel industry, Huazhu will gradually regain its revenue, and in the next two years, there will be a great elasticity in profits. This elasticity is at least at the level of RMB 2 billion or more (specific calculations can be seen in the next profit forecast).

However, precisely because of the characteristics of directly-operated hotels, this heavy asset model is obviously not the preferred path for hotel groups that want to gradually expand their scale. Instead, they need to use "cleverness" to output management externally, so the franchise business is the main battlefield for the development of the hotel industry.

2. Franchised hotels: there are also franchisees in addition to consumers

From the perspective of income sources, the main sources of revenue from franchised business come from the performance-based commission earned by outputting management services to hotel owners (approximately a total of 12 points, varying by group and brand). This service is comprehensive and all-encompassing, from franchise licensing and design renovation and appointment of store managers before hotel preparation, to member and central reservation support during operation, as well as support for backend systems. To make the franchise business of hotels stand out, it is not only necessary to serve consumers well but more importantly to serve franchisees well. And as "business people", compared to the evaluation of brands by consumers, franchisees may be more concerned about how to achieve profits. It seems that there is only one possible path, which is to achieve high consumer satisfaction while maximizing room revenue and compressing costs. **

This statement seems to go against reality, as cost and service quality are often directly proportional, and reducing costs will naturally bring various "discomforts" to customers. For example, some hotels may reduce the cleaning frequency of long-term guests in order to save linen consumption and cleaning costs. Some hotels may use lower quality furniture to save initial investment. However, these often result in poor living experiences for customers. How can we shorten the investment payback period of franchisees while ensuring service quality? Huazhu's "disruptive" innovation may provide some ideas.

For example, optimizing check-in from front desk staff registration to self-service check-in can improve efficiency and save franchisees a lot of labor costs at the same time. Another example is to establish a high-quality supply chain support center, go deep into the upstream of the industry chain to find lower-cost and high-quality supply channels for franchisees, leave enough profit margins for suppliers while ensuring the supply of high-quality products to franchisees, so that partners can make money. Such countless subtle polishing effects combined, Huazhu's single room revenue ranks top in the industry (which means higher RevPAR), and only needs to support lower initial investment and operating costs, which is reflected in the renovation cost of hotel single rooms. According to grassroots research, the cost of single room construction in the same price range of economy hotels (such as Hanting, Home Inn, Jinjiang and 7 Days, etc.) is about 70,000 to 90,000 yuan. The cost of single room renovation for competitors is almost at the upper limit, while the cost of single room renovation for Huazhu is basically at the lower limit, that is to say, the renovation cost of single rooms for Huazhu is 10,000 to 20,000 yuan lower than that of competitors only in terms of initial investment cost. Assuming it is a 100-room economy hotel, Huazhu's initial investment cost is 1-2 million yuan lower than that of competitors. In addition, for the later operation of the hotel, the ratio of Huazhu's personnel to rooms (a common algorithm for controlling personnel salaries in economy hotels, the ratio of personnel to rooms = total number of hotel staff/number of hotel rooms) is 0.17, while that of competitors is 0.22-0.25. This is also why Huazhu's opening speed has always been in the lead (Huazhu acquired Deutsche Hotel in 2020 and consolidated more than 100 companies in the short term).

3. What else can we do to pursue beauty to the fullest?

The continuous pursuit of untapped beauty is the philosophy of the founder of Huazhu, and for the hotel industry, where can we make the effort to achieve more? Huazhu has proposed three major strategies: expanding to thousands of cities and millions of hotels, targeting high-end markets, and internationalizing Huazhu.

1. Thousands of Cities and Millions of Hotels

From the revenue structure data of Huazhu Group mentioned before, although the proportion of Huazhu franchise stores has reached 90%, it is still far from enough and needs further expansion. For example, international leader Hilton's franchise hotels only account for 99% of total hotels, but its franchise income accounts for 70% of total income.

From the current perspective of the hotel chain rate in the industry, the logic of the concentration of the top players’ market share can still sustain for a while. Dolphin Analyst has provided a detailed explanation of the chain rate in its early report on Huazhu entitled "Huazhu Group (1): The Rise of Domestic Brands in the Hotel Industry." Huazhu founder Mr. Ji Qi pointed out that Huazhu not only wants to occupy the first- and second-tier cities but also to spread to the third- and fourth-tier cities and beyond the fifth ring road in Beijing. He proposed that the next goal of Huazhu is "a thousand cities with a million hotels." Other hotel conglomerates also show no signs of slowing down their expansion.

However, it should be noted that although the overall chain rate in China is currently only 30%, the appropriate rate of chain rate in the industry has already reached nearly 50%. The average number of rooms that major hotel groups in China are good at renovating is about 100, and there is no better profit model for properties with fewer than 70 rooms. The small scale makes it difficult to reduce many costs.

If the main improvement of the chain rate is still focused on individual properties with more than 70 rooms in the future and after five to seven years of development, the chain rate in this segment can reach 80%, which will increase nearly two million new rooms. At that time, the overall chain rate of the hotel industry in China will reach 50%. As for how these two million rooms will be allocated, it depends on the ability of different hotel groups. If a hotel conglomerate can obtain 20% of the incremental market share, it will bring 400,000 new rooms to the group (equivalent to 4,000 hotels). Moreover, if an effective profit point can be found for individual properties with fewer than 70 rooms in the future development of the hotel industry, it will achieve a new breakthrough in the improvement of chain rate.

2. The Battle for the High-end Market

In addition, high-end hotels are also the focus of hotel conglomerates. "Huazhu Group (1): The Rise of Domestic Brands in the Hotel Industry" has also elaborated in detail that consumers' requirements for accommodation quality are increasing. Based on this demand, the high-end market brings not only a higher room rate but also the improvement of the brand value of Huazhu. At the same time, increasing occupancy rates (another small logic of quantity-price increase) naturally has a very positive impact on RevPAR.

3. More International, More Full Service

Whether it's increasing chain rates or high-end rates, it's all about grabbing market share in the domestic stock market. To open up higher development space, we need to look at the world. In September this year, Huazhu Group officially released a brand new logo, adjusting the original "HUAZHU" to "H WORLD", which means that Huazhu not only limits its development vision to China, but also looks to the world and aims to become a world-class hotel group.

Even earlier, founder Ji Qi mentioned in his essay collection "Founder's Notes" that internationalization is definitely something that must be done, and Huazhu's internationalization route is: starting from Singapore, first Asia, then Europe, and finally expanding to the United States. The specific route may be slightly adjusted according to the situation, but the direction has not changed. In early 2020, Huazhu completed the comprehensive acquisition of the Deutsche Hospitality Group. Although this time node is awkward, it is commendable that the Deutsche Hospitality Group includes the luxury hotel brand Steigenberger, which gives Huazhu a stepping stone to enter the world of full-service hotels from the limited-service hotels it has previously excelled at doing.

Currently, the three major hotel groups in China all focus on limited-service hotels. Although in terms of the global ranking of hotel room numbers, the three major hotel groups in China can all rank in the top ten, if we want to evaluate brand value, the domestic hotel groups still have a long way to go. In the past, both Jinjiang and Shouqi had experience managing full-service hotels, and Huazhu's acquisition of Deutsche Hospitality was not just about expanding its scale, but also about tearing open a new crack.

The above are some of Dolphin Analyst's views on the hotel industry. As for the specific profit forecasts for Huazhu Group (1179.HK), you can look forward to the next article.

Dolphin Research on Huazhu Group-S Historical Articles:

Earnings Report Season

November 29, 2022 Conference Call Summary - "Reduce Costs and Increase Efficiency, Persist in Business Growth (Huazhu 22Q3 Conference Call Minutes)"

November 29, 2022 - "Growing Against the Sun in the Cracks of the Epidemic"

March 24, 2022 Conference Call Minutes - "Huazhu Group Fourth Quarter Conference Call Minutes: Focusing on Lean Growth" 2022-03-23 Dolphin Analyst: "Under the repeated epidemic, the road to recovery is long"

November 25, 2021 Conference Call - "How does Huazhu transform under the repeated epidemic? (Huazhu conference call minutes)"

November 25, 2021 Huazhu article: "Struggling to make a living, faith relies on "resilience""

In-depth analysis

October 19, 2021 Huazhu article: "Is Huazhu reliable with a 'stubborn' high valuation?"

October 11, 2021 Dolphin article: "Huazhu Group (I): The Rise of Domestic Brands in the Hotel Industry"

Risk disclosure and statement for this article: Dolphin Disclaimer and General Disclosure