After the Hong Kong market closed on November 24, 2023, Huazhu Group (1179.HK/HTHT.O) released its third-quarter earnings report for 2023. The company's previous conservative guidance for the full year turned out to be a false alarm. Overall, both revenue and profit exceeded expectations, and the guidance for the fourth quarter was also positive. The key points are as follows:

In the third quarter, revenue reached 6.29 billion, an increase of nearly 14% MoM, reaching a new high in the peak summer season, and exceeding expectations by about 6%. Among them, domestic revenue increased by 18% MoM, while Deutsche Hospitality decreased by about 1% MoM, indicating that Europe started to recover earlier and is now beginning to decline. The domestic market has just passed its peak.

The better-than-expected revenue growth was driven by a further increase in RevPAR in the third quarter to 129% of the same period in 2019. In terms of price and volume, the average daily rate increased by about 6% MoM, reaching 141% of the same period in 2019, while the occupancy rate increased by about 4.1 percentage points MoM, but still remained at 98% of 2019. This indicates that the increase in prices is the main reason for the improvement in RevPAR.

In terms of self-operated and franchised formats, the net addition of hotels in the third quarter reached 407, nearly double the total in the first half of the year, indicating a significant acceleration in pace. However, the number of self-operated hotels decreased by 8 MoM, while the proportion of franchised hotels continued to rise.

In terms of individual store performance, the revenue of franchised hotels increased by 9.2% MoM, outperforming the 8.7% growth in revenue per store of self-operated hotels. The resonance between more franchised stores and better individual store performance has further pushed Huazhu towards a light-asset, high-operating leverage model.

Operating costs in the hotel business model are relatively rigid. In this quarter, revenue increased by nearly 760 million MoM, while operating costs only increased by 130 million. The increase in gross profit of 570 million is equivalent to a MoM increase of about 1/4. This shows that when revenue increases, Huazhu's profit elasticity accelerates significantly.

Although operating expenses are not as rigid as costs, both marketing and management expenses have increased in line with revenue, with the proportion of revenue remaining relatively stable. The operating profit margin has also increased by about 5%.

In the end, the net profit attributable to shareholders increased by about 30% MoM to 1.34 billion. The adjusted EBITDA, which reflects the cash profit of the hotel industry, reached 2.19 billion, significantly exceeding the market's expected 1.88 billion.

Dolphin Research's viewpoint:

Overall, due to the further increase in occupancy rates and average daily rates of Huazhu hotels during the peak summer season, the company's revenue in this quarter still exceeded expectations. With relatively inert costs and expenses, the company's profit growth elasticity is stronger than expected. Therefore, this quarter's performance is the best combination of beating both revenue and profit. At the same time, the midpoint of the revenue guidance for the 4Q travel and tourism outlook is 5.3 billion yuan. Although Huazhu's revenue is expected to decrease by about 15.7% compared to the previous quarter due to the cooling of domestic travel and tourism during the National Day holiday, the decline is higher than the seasonal decline in the past. However, compared to the market's more pessimistic expectation of 5.06 billion yuan, it is still nearly 5% higher.

The company's previous revenue growth guidance for the full year of 2023 was between 48% and 52%, implying a particularly pessimistic expectation for the second half of the year, especially the 4Q. With the latest guidance, the actual annual growth is expected to be around 55%, which is significantly better than the upper limit of the original guidance.

From a valuation perspective, assuming that Huazhu can achieve a profit growth rate of about 15% next year, the net profit for the whole year can reach about 5 billion yuan, with a PE multiple slightly lower than 17x (similar to Ctrip), which is not demanding (of course, it is not considered undervalued either). Therefore, as long as the travel and tourism market next year does not weaken rapidly and significantly, Dolphin Research believes that Huazhu at the current price is worth paying attention to.

The following is a detailed analysis:

1. Continued overall growth in operating data, sustainability is key

Before interpreting the financial data for this quarter, let's briefly review the earlier released operating data to better understand Huazhu's performance this quarter.

1.1 Domestic RevPAR: Recovered to 129% of pre-pandemic level, continued improvement in market conditions

With domestic travel reaching its peak during the summer vacation, Huazhu's domestic RevPAR has reached 129% of the pre-pandemic level, indicating a continued improvement in market conditions and reaching a new high. However, it is important to note that no matter how well the third quarter performed, it is already in the past, and the outlook for market conditions next year is the key factor affecting the company's trend.

In terms of price and volume, the average daily rate (ADR) in the third quarter increased by about 6% compared to the previous quarter, reaching a level of 141% of the same period in 2019. However, the occupancy rate increased by about 4.1 percentage points compared to the previous quarter, but it only recovered to 98% of the same period in 2019 (of course, considering that Huazhu's total number of hotels has increased by more than 75% from 2019 to 2023, there may be a dilution effect on the occupancy rate). However, in summary, the strong recovery of RevPAR is mainly driven by price increases.

1.2 Stable performance in overseas business

Compared to the peak in domestic market conditions in the third quarter, the recovery of overseas business has been relatively stable, with ADR remaining flat year-on-year and a slight decrease compared to the previous quarter. However, the occupancy rate has increased slightly from 67% to 69% (although the seasonal growth is lower than the same period in previous years), ultimately leading to a slight increase of EUR 1 in RevPAR to EUR 79 on a quarter-on-quarter basis. Growth rate is clearly slowing down.

1.3 Significant acceleration in store openings in the third quarter

In terms of domestic store openings, after a significant slowdown in the first half of the year, the net addition of hotels in the third quarter reached 407, which is only twice as high as the total in the first half of the year, indicating a significant acceleration in the pace of openings. Specifically, there were 545 new openings (2Q23: 374), with 139 closures in the third quarter, a significant decrease from the 216 closures in the second quarter. It is understood that the closures are mainly due to underperforming brands such as Yilai Hotels. With the acceleration in store openings and the reduction in closures, the net addition of stores has increased significantly.

In terms of structure, despite the increase in the total number of stores, the number of self-operated stores has decreased by 8 on a MoM basis, while the proportion of franchised stores has increased, indicating that Huazhu is moving towards a light-asset, high-leverage model.

The above is a review of the previously announced operating data. Next, let's look at the performance of the newly released financial data.

II. Overall performance: Still strong and exceeding expectations

1.1 Revenue recovery, hotels entering a stable operating state:

Let's first look at the overall revenue. In 3Q23, Huazhu Group's total revenue reached 6.29 billion yuan, an increase of nearly 14% MoM, even though the operating data had been announced earlier, it still exceeded expectations by nearly 300 million yuan (6.4%). Against the backdrop of further improvement in the domestic tourism market in the third quarter, Huazhu also achieved its highest revenue.

Looking ahead to the fourth quarter, the company expects total revenue to grow by 41%-45%, with the midpoint corresponding to a 4Q revenue of 5.3 billion yuan, higher than the expected 5.06 billion yuan. Although there is a 15.7% MoM decrease, which is higher than the seasonal changes in the past, it still shows that the demand for international travel and accommodation has started to decline after the National Day holiday. However, Huazhu's performance is still better than conservative expectations.

Looking at the revenue breakdown, Huazhu's revenue from self-operated hotels reached 3.88 billion yuan, an 8% increase MoM, which is lower than the overall revenue growth rate.

Among them, the revenue from Deutsche Hospitality remained at around 1.1 billion yuan, with the increase mainly coming from domestic operations. In addition, the revenue of franchise hotels this quarter reached 2.3 billion yuan, an increase of over 22% MoM, which was the main driving force behind the growth this quarter. Combined with other data, the growth in revenue of franchise hotels and the increase in the realization rate of franchisees by Huazhu both contributed to this.

Due to the rigid nature of costs in the hotel industry, and the fact that most of the costs are for self-operated hotels, there is a low correlation between the costs and revenue of franchise hotels. Basically, the absolute value of the changes in revenue will directly translate into profit. Therefore, it is sufficient to focus on the absolute value of operating costs. Specifically, this quarter's revenue increased by nearly 760 million yuan MoM, while operating costs only increased by 130 million yuan. This fully reflects Huazhu's profit elasticity. This quarter, gross profit increased by nearly 570 million yuan, equivalent to a MoM growth of about 1/4.

Looking specifically at the MoM changes in various cost items, rental fees, utilities, and labor costs increased by 50-70 million yuan, while other depreciation and consumable costs increased by no more than 20 million yuan.

Secondly, the proportion of franchise business has increased, and the performance of individual stores has also improved, which is a positive resonance. In terms of revenue, the increase in the franchise business this quarter was greater. However, due to the inconsistent revenue calculation methods for self-operated and franchise businesses, the revenue scale of the larger franchise business appears to be relatively lower. So, how did the hotel revenue, which reflects the actual operating conditions, perform?

This quarter, Huazhu's self-operated and franchise hotels achieved a total revenue of 23.5 billion yuan, a MoM increase of 15.8%, which is higher than the growth rate of the financial report revenue. Among them, the revenue of franchise hotels increased by 17% MoM, which is indeed higher than the 7% growth of self-operated hotels.

In addition, looking at the realization rate of franchise revenue/franchise hotel revenue determined by the company, it increased by 0.5 percentage points this quarter, further promoting the acceleration of franchise revenue. However, historically, it is normal for the realization rate of franchise business to slightly increase during the peak summer season in the third quarter. In fact, in the third quarter, Huazhu Group opened over 400 new hotels, while closing 8 self-operated hotels. From the perspective of hotel quantity, it is reasonable that the growth of franchise business is better than that of self-operated business.

In terms of individual store performance, the average revenue of self-operated hotels increased by 8.7% MoM to 5.6 million, while the average revenue of franchise hotels increased by 9.2% MoM. This indicates that not only the change in hotel quantity, but also the growth of individual franchise stores is better. Combining the previous analysis, as the proportion of franchise hotels increases, their individual performance also improves, creating a positive resonance.

Third, the profit elasticity is stronger than expected. Due to relatively rigid costs, Huazhu's gross profit margin increased by nearly 5% QoQ. Although operating expenses, such as marketing and management expenses, increased in line with revenue, their proportion to revenue remained basically unchanged. Therefore, the operating profit margin also increased by about 5%.

After considering the impact of other non-operating factors, Huazhu's net profit attributable to shareholders increased by about 30% QoQ to 1.34 billion. Taking into account the depreciation of assets in the hotel and travel business, the adjusted EBITDA, which reflects the company's actual cash profit, reached 2.19 billion, significantly exceeding the market's expectation of 1.88 billion. As the revenue scale continues to grow, Huazhu's profit elasticity is higher than expected.

The fundamental reason for the increase in profit margin is naturally because the ADR (average daily rate) and occupancy rate of Huazhu hotels continue to rise.