HWORLD-S: Profits Fluctuate Wildly, Too Dependent on External Factors?

After the Hong Kong market closed on March 20, 2024 Beijing time, HWORLD-S (1179.HK/HTHT.O) released its financial report for the fourth quarter of 2023. In summary, due to the marginal decline in travel demand in the fourth quarter, the revenue scale contracted compared to the previous quarters, and the relatively fixed costs and expenses of hotel operations led to a significant decline in HWORLD-S's profit this quarter. Specifically:

1. HWORLD-S achieved a total operating income of 5.59 billion RMB in the fourth quarter, a 92% increase from the same period in 2019, lower than the growth rates of 93% and 106% in the previous two quarters compared to 2019. Among them, domestic direct-operated hotel revenue was 2.29 billion RMB, slightly lower than the previous quarter's 2.7 billion RMB. Meanwhile, franchise hotel revenue for this quarter was 2.3 billion RMB, showing a slight increase year-on-year, mainly due to an increase of approximately 240 franchise hotels.

2. In terms of operational data, the average revenue per room for H World during the fourth quarter was equivalent to 120% of the same period in 2019, a slight decrease from 129% in the third quarter. Looking at the breakdown of price and volume, the main reason for the decline in room revenue was a decrease in average room rate by about 12%, to 122% of the same period in 2019, significantly lower than 132% in the third quarter. The occupancy rate followed normal seasonal fluctuations and did not cause significant drag.

As for overseas business, the steady growth momentum continues, with average revenue per available room (RevPAR) reaching 109% of 2019, a slight increase from the previous quarter's 106%. Similarly, the growth is mainly driven by the increase in ADR.

It can be seen that after the peak of travel demand during the summer, the tight supply and demand situation in the fourth quarter eased, leading to a certain correction in the soaring hotel prices. The decrease in average room rate not only resulted in lower revenue but also laid the "root" for the lackluster profit this quarter.

3. Operating costs mainly related to self-operated hotel business decreased by about 400 million RMB compared to the revenue, while costs increased by about 400 million RMB, resulting in a decrease of approximately 1 billion RMB in the company's overall gross profit for the quarter. In particular, the company recognized impairment losses of about 360 million RMB this quarter, and specific reasons may be explained during the conference call.

Similarly, operating expenses and management expenses increased while revenue decreased. Sales expenses increased slightly from 290 million RMB in the previous quarter to 330 million RMB. Management expenses increased from 540 million RMB to 640 million RMB. Dolphin Research speculates that the decline in demand sentiment and occupancy rates in the fourth quarter may have prompted HWORLD-S to increase customer acquisition investment. Additionally, the continued growth in the number of hotels may have been a factor in the increase in management expenses.Due to the relatively rigid operating costs of the hotel business, profits can fluctuate greatly with changes in revenue scale. This quarter, there was a significant decrease in revenue scale compared to the previous quarter, but costs and expenses continued to grow due to the increasing number of stores and the difficulty in acquiring customers, resulting in a very noticeable decrease in profits.

Specifically, HWORLD-S's adjusted EBITDA for this quarter was 1.27 billion, nearly a 10 billion decrease from the previous quarter's 2.19 billion. Net profit also dropped significantly from 1.34 billion to 740 million.

In guidance, the company expects first-quarter revenue to increase by 12%-16% year-on-year, with the midpoint corresponding to 5.1 billion in revenue, roughly in line with market expectations of 5.15 billion. The guidance for full-year revenue growth is between 8%-12%. Dolphin Research believes that the 10% revenue growth center is based on a neutral and cautious expectation that this year's demand for hotel and travel will not have a significant "tipping point".

Dolphin Research's viewpoint:

However, based on HWORLD-S's performance this quarter, the domestic hotel and travel demand showed a certain degree of decline compared to the peak in the summer season during the fourth quarter. And since HWORLD-S has not delved too much into outbound travel business, there is currently insufficient outbound demand with greater room for recovery to offset the marginal weakening of domestic demand. Additionally, the heavy asset hotel operating model makes HWORLD-S unable to adjust costs and expenses flexibly like platform-based companies, resulting in significant fluctuations in profits with changes in economic conditions. Therefore, whether domestic hotel and travel demand can continue to experience several phased high economic periods next year (driving hotel prices higher during these periods) may lead to significant differences in HWORLD-S's performance, especially in profits. In comparison, the visibility of performance is not as high as Ctrip.

Below is a detailed analysis:

1. Operating data continues to rise across the board, with sustainability being key

Before interpreting this quarter's financial data, let's briefly review the previously released operating data to better understand HWORLD-S's performance this quarter.

1.1 Domestic RevPAR: Equivalent to 120% of 2019, with a slight decline in economic conditions

During the fourth quarter, H World's average single room income was 229 yuan/night, equivalent to 120% of the same period in 2019, showing a significant decline compared to 129% in the third quarterFrom the perspective of splitting factors driven by price and volume, in the fourth quarter, the main reason for the decline in average customer price by about 12% compared to the previous quarter, reaching 122% of the same period last year, significantly lower than the 132% in the previous quarter, is the main reason for the decline in room revenue.

As for the occupancy rate, it averaged 80.5% during the fourth quarter, although it also decreased by about 5 percentage points compared to the previous quarter. However, historically, this is considered a normal seasonal variation and not a bad signal.

Combining the two, after the peak demand for hotel and travel during the summer, the supply-demand tension in the fourth quarter has eased somewhat, with a noticeable pullback in previously high hotel prices. The decrease in average customer price is also the fundamental reason for the lackluster profit this quarter.

1.2 Continued Steady Recovery in Overseas Business

Compared to the slight decline in domestic hotel demand, the overseas business continues to maintain a steady growth pace, with the average revenue per available room (RevPAR) reaching 109% of the previous year, a slight increase from 106% in the previous quarter.

Specifically, this is mainly due to a significant increase in average daily rate (ADR) to 119% of the previous year. As for the occupancy rate, it also decreased by about 5 percentage points due to normal seasonal changes.

Looking at the company's domestic and overseas operations, a pattern can be observed: whether domestically or overseas, the growth in HWORLD-S's revenue per available room is mainly driven by price increases, while the occupancy rate shows a trend of decline. The trend reflected behind is worth considering.

1.3 Store Opening Pace Slows Down

In terms of store openings, the pace of opening stores in the fourth quarter has also slowed down compared to the previous quarter, which is consistent with the trend of demand. Management may have adjusted the pace in response to changes in demand.

Structurally, the number of self-operated stores decreased by one this quarter compared to the previous quarter, and the growth of stores is entirely driven by franchised storesThe above is a review of the previously announced operating data. Next, let's look at the newly released financial data performance.

II. Overall Performance: Still Stronger Than Expected

1.1 Similar to the operating data, the revenue growth trend has also slowed down:

HWORLD-S The overall operating income in the fourth quarter was 5.59 billion RMB, a 92% increase from the same period in 19, lower than the growth rates of 93% and 106% in the previous two quarters. As the previously announced RevPAR data also showed this trend, the decline in revenue growth is reasonable.

Looking ahead to the first quarter of 24, the company guides that total revenue will increase by 12%-16% year-on-year, with a corresponding 1Q revenue of around 5.1 billion RMB, broadly in line with the market's expectation of 5.15 billion RMB. The guidance for full-year 24 revenue growth is between 8%-12%. Although after passing through this year's rapid recovery period, the growth in 24 will return to normal, the 10% revenue growth center is based on a neutral and cautious expectation that this year's travel demand will not have a significant "tipping point" again.

By revenue type, HWORLD-S's domestic direct-operated hotel revenue was 2.29 billion RMB, slightly lower than the previous quarter's 2.7 billion RMB. The revenue from German hotels was 1.17 billion RMB, roughly stable compared to the previous quarter. Similarly, the demand for HWORLD-S's overseas travel in the 3rd and 4th quarters was roughly similar, but there was a slight decline domestically.

Unlike the decline in revenue growth for self-operated hotels, franchise hotel revenue this quarter was 2.3 billion RMB, with a slightly higher year-on-year growth rate. Combining with the operating data, this is mainly due to the significant increase in the number of franchise hotels, even though the revenue per room has decreased compared to the previous quarter, the revenue is still accelerating.

However, since the revenue calculation for self-operated and franchise hotels is different, even though the proportion of franchise hotels has exceeded 90%, the revenue proportion is still less than 1/3. In terms of actual hotel operations, HWORLD-S's overall hotel revenue in the fourth quarter was 20.4 billion RMB, and according to our estimation, the revenue of HWORLD-S's franchise hotels is close to 17 billion RMB, an increase of approximately 83% year-on-year.1.2 Slight Decline in Domestic Hotel and Travel Industry Prosperity, with Rising Costs

Due to the relatively fixed costs in the hotel industry, and the fact that most costs reflect those of self-operated hotels, the main cost component for franchise hotels is generally store management personnel. In other words, the relationship between costs and self-operated revenue should be the main focus. Specifically, in this quarter, while self-operated revenue decreased by approximately 400 million compared to the previous quarter, costs instead increased by about 400 million. This offsetting effect led to a decrease of approximately 1 billion in the company's overall gross profit for this quarter.

In terms of specific details, the proportions of various cost items to self-operated revenue mostly remained relatively stable compared to the previous quarter, except for the proportion of other costs which increased from 11% to 23%. In other words, the unexpected increase in costs mainly came from this part. According to the company's explanation, this quarter recognized impairment losses of approximately 360 million. The source of this impairment can be further understood by checking if there is any explanation during the conference call.

3. Operating Expenses Increased Contrary to the Cycle, Dragging Down Profits

Not only did the increase in costs lead to a significant decline in gross profit, but in the case of declining revenue, HWORLD-S also saw an increase in operating and management expenses contrary to the cycle. Sales expenses increased slightly from 2.9 billion in the previous quarter to 3.3 billion. Meanwhile, management expenses increased from 5.4 billion to 6.4 billion. Dolphin Research speculates that the slight decline in demand prosperity and occupancy rates in the fourth quarter may have prompted HWORLD-S to increase its marketing investment. Despite the decline in revenue, as the number of hotels continues to grow, this may also be a factor contributing to the continued growth in management expenses.

HWORLD-S' adjusted EBITDA for this quarter was 1.27 billion, a decrease of nearly 1 billion from the previous quarter's 2.19 billion. Net profit also decreased significantly from 1.34 billion to 740 million.

Due to the relatively fixed operating costs of the hotel business, profits can fluctuate greatly with changes in revenue scale. This quarter saw a significant decrease in profits due to the continued growth in store numbers and the increasing difficulty in acquiring customers, despite a considerable drop in revenue scale. This situation exemplifies the close relationship between revenue and profit**

Dolphin Research on "HWORLD-S" Past Studies:

Financial Report Reviews

November 24, 2023 Financial Report Review "HWORLD-S: False Alarm, HWORLD-S Still a Top Player in the Industry"

April 25, 2023 Financial Report Review "HWORLD-S: Housing Prices Soar, Business Confidence Rebounds Significantly"

March 28, 2023 Conference Call "Lean Growth is Key (HWORLD-S 22Q4 Conference Call Summary)"

March 28, 2023 Financial Report Review "HWORLD-S: Prices and Volume Rise Together, Ready to Take Off"

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

November 29, 2022 "Growing Against the Odds, HWORLD-S Striving for Growth Amidst the Pandemic"

March 24, 2022 Conference Call "HWORLD-S Fourth Quarter Conference Call Summary: Focusing on Lean Growth"

March 23, 2022 "HWORLD-S: Long Road to Recovery Amidst Recurring Pandemic Challenges"

In-depth Analysis

December 23, 2022 "Can HWORLD-S at $43 Reach the Peak Again?"

December 14, 2022 "Surging by 75%, How Did HWORLD-S Cultivate Its Faith? (Part 1)"

Risk Disclosure and Disclaimer for this Article: Dolphin Research Disclaimer and General Disclosure