Thomas Barwick
Elevator Pitch
I have a Hold rating for H World Group Limited (NASDAQ:HTHT) [1179:HK]. The focus of my earlier March 22, 2024 article was the company’s full-year 2023 results review.
With this latest update, I assess H World’s near-term financial prospects and long-term growth potential. HTHT’s Q2 2024 top line performance is expected to be lackluster considering the company’s guidance and industry data. On the flip side, H World still has the potential to deliver meaningful revenue growth and margin expansion for the long run, taking into account the venture into new Chinese cities and the shift to a capital-light model for its overseas operations. Given that there is a divergence between HTHT’s short-term and long-term outlook, I have chosen to leave my existing Hold rating for H World unchanged.
Second Quarter Guidance Was Disappointing
H World outlined the company’s outlook for the second quarter of 2024, when it issued its Q1 2024 earnings press release last month. Specifically, HTHT has guided for a Q2 top line expansion of between +7% YoY and +11% YoY in RMB terms. As a comparison, the company delivered a much better revenue growth of +18% YoY in Q1 2024.
Furthermore, HTHT disclosed expectations of a “flattish to slightly negative” RevPAR (Revenue Per Available Room) growth rate for its Mainland Chinese hotel operations in Q2 2024 at its first quarter analyst call. Notably, H World’s China business, referred to as Legacy-Huazhu segment in company’s disclosures, registered a relatively superior +3% YoY RevPAR increase for the first quarter of this year. Also, H World’s domestic RevPAR outlook implies that the achievement of the company’s overall +7%-11% top line expansion for Q2 2024 will be largely reliant on new hotels rather than organic growth.
The overall Mainland Chinese hotel industry didn’t perform well during the Labor Day holiday in the first week of May this year. This could explain why H World has a dim view of its expected performance for Q2 2024.
A May 12, 2024 South China Morning Post news article cited data from Chinese stockbroker Caitong Securities indicating that Mainland China’s hotel industry saw its RevPAR and occupancy rate decrease by -5% and -430 basis points, respectively for the 2024 Labor Day holiday (vis-a-vis the same holiday period in 2023).
Another report published by travel industry research firm Smith Travel Research or STR on May 22, 2024 noted that the Chinese hotel sector’s Labor Day holiday ADR (Average Daily Rate) was -12% lower as compared to last year. This late-May STR research report attributed the weak performance of the Chinese hotel industry to factors like “increased market supply” and “outbound travel diversion.”
Separately, HTHT’s profitability might also be under pressure in the second quarter, as the company’s selling and marketing or S&M expenses could remain elevated.
H World’s S&M costs rose by +33% YoY to RMB260 million in the most recent quarter. This also means that the company’s S&M costs-to-revenue ratio went up from 4.4% in Q1 2023 to 4.9% for Q1 2024. At its latest quarterly analyst briefing, HTHT emphasized that the higher S&M expenses were driven by “new markets” and “new brands.” As mentioned earlier, H World’s Q2 2024 revenue is expected to be heavily dependent on new hotel openings, which is likely to translate into an increase in S&M costs.
But Long-Term Growth Story Is Intact
There are concerns regarding HTHT’s near-term prospects as detailed in the previous section. But the outlook for H World in the long run is still favorable.
Based on consensus data obtained from S&P Capital IQ, the sell-side analysts forecast that H World’s revenue and normalized operating profit will expand by CAGRs of +10% and +18% for the FY 2023-2027 time period, respectively. HTHT’s normalized operating margin is projected to improve from 21.5% for FY 2023 to 28.3% in FY 2027 as per the consensus estimates.
HTHT’s expansion into lower-tier (i.e., Tier 3 and below) Chinese cities for the domestic business (Legacy-Huazhu segment), and the shift to a capital-light model for the overseas business (Legacy-DH segment) are the key long-term drivers for the company.
In its Q1 2024 results presentation slides, H World shared details of the progress the company had made in penetrating new cities in Mainland China, especially lower-tier ones. The proportion of HTHT’s Chinese hotels, which are currently up and running, in lower-tier cities rose from 39% in Q1 2023 to 40% for Q1 2024. Also, more than half, or 54% to be specific, of the company’s Mainland China hotels in the pipeline are located in lower-tier Chinese cities.
Considering both its existing hotels and planned new hotels, HTHT has a presence in 1,290 cities in Mainland China as of March 31, 2024, which is up +14% from a year ago. Looking forward, H World’s goal is to have hotels in 2,000 Chinese cities in the long run, and the company has clearly made good headway in getting closer to its long-term target.
On the other hand, H World’s profitability for the company as a whole has the potential to improve in a meaningful way when its overseas business (Legacy-DH segment) pivots successfully to a capital-light operating model.
HTHT has the intention to have its overseas hotel business gradually move away from leased and owned hotels towards franchised hotels. At the company’s Q1 2024 earnings call, H World stressed that “the asset-light strategy” and transition into a “hotel brand and management company” for the Legacy-DH segment or overseas hotel business is a “long-term target.” The company also indicated at the most recent quarterly results briefing that “the progress (of the pivot towards a capital-light model for Legacy-DH) is still within our expectation” and mentioned that it will continue to update the market on related developments.
It is reasonable to think that HTHT’s overall operating profitability will improve as its overseas business or the Legacy-DH segment grows its proportion of franchised hotels over time.
Concluding Thoughts
A Hold rating for H World is maintained after considering the company’s lackluster short-term outlook and its good long-term growth prospects. Also, HTHT’s valuations are comparable to that of its peers, which supports a Neutral view. H World currently trades at 14.4 times consensus next twelve months’ EV/EBITDA according to S&P Capital IQ data. As a comparison, the consensus forward EV/EBITDA multiples for Hyatt Hotels (H) and Marriott International (MAR) are 14.3 times and 15.4 times (source: S&P Capital IQ), respectively.
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