May 15, 2014
Executives
Ida You - IR Qi Ji - Founder, Executive Chairman and CEO Yunhang Xie - COO Jenny Zhang - CFO and Chief Strategy Officer
Analysts
Lin He - Morgan Stanley Ella Ji - Oppenheimer Jamie Zhou - Macquarie Justin Kwok - Goldman Sachs Tian Hou - TH Capital Yaoxin Huang - CICC
Operator
Ladies and gentlemen, thank you for standing by and welcome to the China Lodging Group 2014 Q1 earnings conference call. (Operator Instructions).
I must advise you that this conference is being recorded today, Wednesday, May 14, 2014. I'd now like to hand the conference over to your host today, Ms.
Ida Yu, Senior Manager of Investor Relations. Please go ahead.
Ida You
Thank you, Desmond. Good morning, everyone.
Thanks to all of you for dialing in and welcome to our first-quarter 2014 earnings conference call. Joining us today is Mr.
Ji Qi, our Founder, Executive Chairman and CEO; Mr. Xie Yunhang, our COO; Ms.
Jenny Zhang, our CFO and CSO; and Ms. Bonnie Bao, our Director of Strategy and Capital Markets.
Following their prepared remarks, management will be available to answer your questions. I'd like you to be aware of a few upcoming China Lodging investor events.
We will participate in Morgan Stanley Hong Kong Summit on May 15 to 16; Deutsche Bank dbAccess Asia Conference in Singapore on May 19 to 20. In the week of June 2, we will conduct a non-deal roadshow in the United States.
During that period, we will participate in Goldman Sachs Global Lodging, Gaming, Restaurant and Leisure Conference in New York and Bank of America Merrill Lynch CalGEMs Conference in California. Before we continue, please note that the discussion today will include forward-looking statements made under the Safe Harbor provisions of the United States Private Securities Litigation Reform Act of 1995.
Forward-looking statements involve inherent risks and uncertainties. As such, our results may be materially different from the views expressed today.
A number of potential risks and uncertainties are outlined in our public filings with the SEC. China Lodging Group does not undertake any obligation to update any forward-looking statements except as required under applicable law.
On the call today, we will also mention adjusted financial measures during the discussion of our performance. Reconciliations of those measures to comparable GAAP information can be found in the earnings release that was distributed earlier today.
As a reminder, this conference call is being recorded. The webcast of this conference call, as well as supplementary slide presentation, is available on the Investor Relations section of China Lodging Group's website at ir.huazhu.com.
Now, I would like to turn the call over to Mr. Ji.
Qi Ji, please.
Qi Ji
Good morning, everyone. Thank you for joining us today.
At the end of first quarter 2014, we had more than 164,000 rooms in operation. Thanks to our market brand strategy, we start to see encouraging initial marketing success of our midscale hotels, which recorded a 14% increase in same hotel RevPAR during the first quarter.
Over the years, our fast and sustainable growth is mainly driven by our focus on visitor experience and continued innovation. We need to innovate more and adapt to be prepared for the future.
We can see page 3. Actually, we are alone in the product upgrade plan for 2014, probably one of those companies much more interested in looking forward than looking back.
Our focus is on delivering products that generate value for money stay experience, and to maintain our status as one of China's most innovating hotel groups. New products include the all-in-one bathroom model and new high quality bedding.
The new bathroom model is designed for smart use of space and the improvement on operational efficiency. The new bedding is to guarantee our guests a sounder sleep that makes a big difference for frequent travelers.
Not only has the hotel industry kept up with the time, but it's learning to embrace technology as a key component to succeed. Technology is a part of our daily lives, and this is especially true for the hotel industry as well.
Most of hotels have websites, online booking system and a technology based management system, etc. On this front, our continuous innovation on technology upgrade provides convenience and a secure hotel experience to guests, as we can see on page 4.
Our guests can complete their check-in within 30 seconds. They can open the door with their own smartphones.
In their rooms, guests have access to the free Wi-Fi and innovation sockets with USB, which makes them free of worry. With all this innovation mentioned above, as a result, we can see on page 5 our hotels are able to attract more new members for our brand and thus maintain a high occupancy rate.
In addition, our enhanced membership engagement is generating robust and quality growth of membership base, and improved frequent stay ratio. From 2012 to 2013, Hua Zhu Club members increased by 79% and the frequent stay ratio improved 3 percentage points.
These upgrades that offer comfortable convenience and a secure hotel experience enable Hua Zhu hotels to continue to lead the industry. With that, I will turn the call over to Yunhang, our COO, who will walk you through our Q1 operating highlights.
Yunhang, please.
Yunhang Xie
(Interpreted). Now, let me walk you through our operational highlights for Q1 2014.
In Q1, as shown on page 7, we opened 10 net new leased hotels and 109 net new manachised hotels. At the end of Q1, we had 1,530 hotels in operation, among which 38% were leased hotels, 62% were manachised hotels and the remaining were franchised Starway Hotels.
In addition, we continue to benefit from vendor and owner preference for our brand, as evidenced by 55 leased hotels and 357 manachised hotels contracted or under development at the end of Q1. Our hotel opening schedule is very well on track, so we are confident to achieve the full-year target of hotel openings set earlier this year.
As shown on page 8, in Q1, our Group blended occupancy was 86%, a decrease of 1 percentage point from a year ago, mainly attributed to a soft macro economy and the rising security concerns since March. The blended ADR was RMB171, a decrease of 1% year over year, mainly attributable to the city mix shifting towards lower-tier cities, partially offset by an increase of 0.3% in the same hotel ADR.
As a result, in Q1, the blended RevPAR was RMB146, a decrease of 2% year over year. Page 9 provides a detailed view of the growth trend of our same hotel RevPAR for the hotels in operation for at least 18 months.
In Q1 2014, our same hotel RevPAR decreased by 1%, with 0.3% increase in ADR and 1 percentage point decrease in occupancy. The slight increase in same hotel ADR was driven by price increase to enhance yield.
The decrease in same hotel occupancy rate was mainly due to a soft macro economy and the rising security concerns since March. In the first quarter, China's GDP growth was 7.4%, lower than 7.7% in the same period a year ago.
With that, I will turn the call over to Jenny, our CFO and CSO, who will walk you through our Q1 financial result. Jenny, please.
Jenny Zhang
Thanks, Yunhang, and hello, everyone. In Q1 2014, as shown on page 11, our net revenues increased 19.3% year over year, in line with our guidance.
Leased hotels revenue grew 19.2% and the manachised and franchised hotels revenue grew 21.1% year over year. Our manachised and franchised hotels revenue reached 12.6% of our total revenue in Q1 this year.
Page 12 shows the adjusted quarterly operating margin, which decreased by 1.7 percentage points in Q1 of 2014 when compared with a year ago. The hotel operating costs as a percentage of net revenues increased by 3.9% year over year, mainly attributable to the soft RevPAR and the increased number of hotels in the ramping up stage.
We added 25 new JI hotels in the past four quarters. Typically, a new JI hotel incurs a significant amount of rental and depreciation costs before its revenue ramps up to a stable level.
Our pre-opening expenses as a percentage of net revenues were a 1.6 percentage point decrease due to our enlarged revenue base. Benefiting from economies of scale and cost saving efforts, adjusted general and administrative expenses as a percentage of net revenues decreased by 1.1%.
However, we saw a 0.3% year-over-year increase in the percentage of adjusted selling and marketing expenses, primarily as a result of higher portion of reservation made through third parties. In addition, other operating income as a percentage of net revenues decreased by 0.2% in Q1 of 2014 when compared with Q1 of 2013, due to the decreases in government grants and a gain from government zoning.
Last but not least, move on to cash position as shown on page 13. Our cash balance closed at RMB479 million at the end of Q1.
We had a total credit facility of RMB898 million from ICBC and China Merchant Bank. For the first quarter, our operating cash flow totaled RMB130 million, an 83% increase from a year ago.
Our investing cash flow totaled RMB362 million, a 4% increase from a year ago. In January 2014, the Company borrowed RMB300 million from Ctrip.com under a one-year entrusted loan contract.
Entering the second and third quarters, we expect to have a net cash inflow with more cash generated from operations and less spending on CapEx. We believe that our cash balance, our operating cash flow and our available credit facility will be sufficient to fund our rapid expansion plan in the near future.
Finally, as shown on page 14, we reaffirm our full-year hotel opening target of 420 to 450 new hotels. On the sales side, we expect to achieve net revenues in the range of RMB1.21 billion to RMB1.24 billion in the second quarter of 2014, representing a 17% to a 20% year-over-year growth.
With that, let's open the floor for questions.
Operator
Thank you (Operator Instructions). Your first question comes from the line of Lin He from Morgan Stanley.
Please ask your question.
Lin He - Morgan Stanley
Good morning, everyone. Thanks for taking my question.
A couple of questions. First question is regarding page 9, the same store RevPAR ADR trend.
So, Q1, the 0.3% same store ADR growth is actually the lowest in past three to four years. I understand that there is a lot of things happened in Q1.
Can management please talk about, firstly, where are the areas you see particular weakness, and secondly, more recently, what is the recent trend we are seeing? Do we see this trend continue, or we see some trend of stabilization?
And given the recent cases of the security incident happened in Guangzhou railway station, are we worried that this trend may start to impact our tier 1 city hotels as well? And then, the next two questions I want to ask Mr.
Ji. Firstly is regarding Starway and the second is regarding the product innovation.
[Foreign Language].
Qi Ji
[Foreign Language].
Lin He - Morgan Stanley
Xie Xie.
Jenny Zhang
Actually, Lin raised quite a few questions. The first part is on the ADR and we'll leave that for Xie to answer later, and then the second and third question is for Mr.
Ji to answer. The first part is on Starway deal.
Lin asked what is the contribution of this deal, and when you look back, how do you think about the return on investment. And Mr.
Ji's answer is that Starway started as a brand by Ctrip, and Ctrip's initial intention was to form an alliance among economy and midscale hotels so they'd have a closer collaboration with Ctrip's booking system. And when we bought the brand, clearly, it is not yet a fully established brand.
It is more of a collection of hotels. And to make it a meaningful brand, we need to reclassify the product and make sure we have certain consistency among the different hotels, so the first step we did was to get rid of a lot of the prototype hotels.
That process is largely finished. We still have a few more to work on.
And our intention is to make Starway a second brand in midscale segment, as a brother branch to our JI hotels. I think the awareness of this brand across the different parts of China is a valuable asset, so the acquisition at least lasts one to two years of time.
We do believe this is a very profitable deal for us. We just need more time to ramp up the portfolio again, after the reorganizing of the portfolio in the past one to two years.
We believe in the near future we will show very positive financial results from this brand. The second question was relating to the product upgrades, especially the independent modulized bathroom.
Lin asked what's the expectation of this upgrade, from the customer experience as well as the financial perspective. Mr.
Ji answered, among the different players in the economy hotel segment; everyone has been working on the upgrade. And we also have invested more than one year to do the R&D work on the new version of our Hanting Hotel.
And the current version, which is almost ready for rolling out, is believed to be a milestone not only for Hanting but also for the economy hotel segment as a whole. Our expectation is for each room the investment will have a moderate increase, less than 10% in terms of CapEx.
However, it will provide a significantly better customer experience. We believe, as the product proves itself, we will be able to charge a higher ADR and achieve a higher RevPAR with the new product.
With the new generation, who have become a lot more demanding of quality and also less price sensitive, we believe raising the Hanting brand price by RMB5 to RMB10 will be very acceptable with this improved quality. And let me go back to the third question Lin raised at the beginning.
[Foreign Language].
Qi Ji
[Foreign Language].
Jenny Zhang
So, Mr. Ji answered that it is a fact that we have shown a relatively soft ADR increase in the first quarter this year.
Part of that is attributable to the soft macro economy, and the other part would be attributable to the change of distribution of our hotels by city tiers. And the rising security concern has an impact mainly on tier 3 cities, as well as our hotels in the western part of China.
So far, we haven't seen any obvious impact on our tier 1 cities.
Lin He - Morgan Stanley
[Foreign Language].
Operator
Thank you for your question. Your next question comes from the line of Ella Ji from Oppenheimer.
Please ask your question.
Ella Ji - Oppenheimer
Thank you for taking my questions. First question is a follow up with, as you are talking about investments for your rooms and that is going to lead to a less than 10% CapEx increase, what is your thoughts about ADR increase going forward when the economy rebounds?
And when do you think we are going to see some ADR increase? Do you expect to see the ADR increase to rebound to the 2% to 3% level in the rest of this year?
That is my first question.
Jenny Zhang
Okay. Let me answer that on behalf of Mr.
Ji. Our CapEx increase we expect for the new model is expected to be less than 10%.
If you translate that into a per room cost, that would be less than RMB2 per room on depreciation and amortization. And the ADR increase, we are expecting RMB5 to RMB10, which will translate into a 3% to 5% ADR increase for the new model.
We believe the return on investment is actually lucrative for the new model. Of course, this expectation is yet to be proved, after we start to roll it out in the second half of the year.
Ella Ji - Oppenheimer
Okay. Thank you.
And then my second question is relating to your margin's performance. One of your peers just recently lowered their full-year hotel opening target, given the softness of the macro environment, but you reaffirmed your target.
Can management talk about your thoughts behind that, and how do you expect the full-year margin performance to be as a result? Thank you.
Jenny Zhang
First of all, in regard to the opening target, we have already built a very strong pipeline, so we are confident that we will open those hotels. And your question seems to imply that you are expecting a scale back of new openings in response to the soft macro economy.
But when you look into the detail or the breakdown of our pipeline, you will see actually the new opening on leased hotels is very moderate, 60 to 70 new leased hotels. The significant majority is still franchised and management hotels.
So we don't think the current opening target is too aggressive from the financial perspective. At the same time, we believe the economic softness has provided us a lot of consolidation opportunities for ourselves, as well as for our franchisees.
And that's, I think, a lucrative opportunity coming with the soft market. We have, in turn, applied a very strict validation process to our new leased hotels.
And as to the full-year margin, I think there are a few points I want to share with the analysts and investors. First of all, our new leased hotels have a significant proportion of JI hotels, and the new leased JI hotels in nature have a fairly high rental as well as depreciation cost as a percentage of revenue.
And that will be very significant, especially during the ramping up stage, so that has an impact on our overall hotel cost as a percentage of revenue. As we mentioned a quarter ago, that we view 2013 as an investment year, that's exactly what we mean, that we are confident about the prospect of the midscale segment and we are willing to invest into it.
So that strategy has not changed. So that may put some pressure on our overall margin, but we believe part of that will be offset by the decrease of pre-opening expenses as a percentage of revenue, as well as SG&A as a percentage of revenue
Ella Ji - Oppenheimer
Thank you very much, Jenny.
Jenny Zhang
You're welcome.
Operator
Thank you for your question. The next question comes from the line of Jamie Zhou from Macquarie.
Please ask your question.
Jamie Zhou - Macquarie
Hi. Thank you for taking my questions.
My first question is a follow up to what management said earlier about reaffirming the full-year hotel opening target. As I recall, the Company has a history of investing during downturns and reaping the advantage of when other competitors are scaling back.
Can you share with us; are you seeing advantages in sourcing new properties for the leased hotels? And vice versa, has the weak macro environment become more difficult for some of our franchisees?
And in addition, you mentioned there's consolidation opportunities. Are we looking at acquisition targets?
Are they coming closer to a more reasonable valuation? That's my first question.
Jenny Zhang
Jamie, I'm not sure I captured the last part of the question. Could you repeat that?
Jamie Zhou - Macquarie
Yes. Are you looking at acquisition targets?
Jenny Zhang
I see. Okay.
Let me forward the first part of the question to Mr. Ji, and I will answer the second part.
[Foreign Language].
Qi Ji
[Foreign Language].
Jenny Zhang
Okay. Let me translate.
Regarding the first part of the question, when we sign new leased hotels, we haven't seen a significant change in the rental price. We have answered this question many times before.
In China, the rental price is quite sticky. It doesn't fluctuate significantly across the market.
However, what we have seen is a lot of properties are now empty for lease, especially the large-size properties, like shopping malls, used to be shopping facilities by those large electronics retailers, like Suning and Gome. And also, there are a lot of properties used to be four-star hotels, and now it's ready for lease.
So, as more of those properties come to the market, we're finding plenty of opportunities for JI hotels to capture those opportunities. And we are still (technical difficulty) a certain percentage of our new openings as leased hotels.
Philosophically, we believe that being able to open new leased hotels is a demonstration of our operational as well (technical difficulty) capability. And in the long run, they also can mean meaningful return from their own investment.
So we believe that model is still worth working on, going forward. And the second part of the question, relating to the operational environment for franchisees, clearly the general softness of macro economy has a negative impact on the franchisee hotels' profitability.
We have seen their profit from hotels decrease from the prior year. However, we haven't seen any significant crash in the business, so I think it's still quite bearable for those franchisees.
In certain areas, especially areas impacted by the security concerns, we have seen a significant drop in tourists. For example, when Mr.
Jin went to Lijiang last week, clearly the tourists had decreased significantly. But we believe that those security issues is a short-term impact.
In general, we believe the recent difficulties will not change the big picture of the long-term growth of China's tourism and the travel industry. And your third part of the question was relating to the acquisitions.
So far, we haven't entered into any significant deals. And we are negotiating some small-size deals, as we did in the past, and clearly the price has come down somewhat and we are able to buy some of those assets at a very reasonable price.
Jamie Zhou - Macquarie
Okay. Thank you.
That's very helpful. I'll jump back into the queue for my further question.
Jenny Zhang
Thank you.
Operator
The next question comes from the line of Justin Kwok from Goldman Sachs. Please go ahead.
Justin Kwok - Goldman Sachs
Thanks. Good morning.
Thanks for taking my questions. I have a question for Mr.
Ji and then some financial questions for Jenny. For Mr.
Ji, I just have a question on the industry competition. We have seen in some of the overseas market, where some new websites like airbnb, where people are now using the forces of the Internet to put together some of the very fragmented lodging facilities or even guest house together just for some hotel purposes.
Are you seeing that as a threat to the industry in China as well, because that's also where -- an arena where you guys are trying to grab your market share? That's my first question.
Qi Ji
[Foreign Language].
Jenny Zhang
Let me translate. Of course, airbnb and the Chinese version called Tujia is very hot in the capital market.
However, from the business perspective, we still see a lot of obstacles for them to really build up and form a threat to the hotel industry. So far, we haven't seen them being of much impact on our existing business.
We are not totally sure how this will evolve. All we're reading is that China is a very different market.
The airbnb model may work better in US and Europe, where there is a higher level of trust among the citizens. In China, I think the attractiveness of staying at someone's home still has a lot of issues around trust, security and quality guarantee.
Among the leisure travel as well as business travel, I think it's particularly difficult for a business traveler to really use this type of room for a trip that they can actually get reimbursement from their company. We believe, in general, professional hotel managers like us will be in a significantly better position to provide trustworthy lodging products to the general market.
Justin Kwok - Goldman Sachs
Thanks for the sharing. My next two questions are more related to the financial side.
The first one is you mentioned about the next generation of your product for the Express, and it was 10% higher in CapEx. I just wonder if you'd mind to remind us on now the overall CapEx guidance for the Company for this year and next year.
And will you be putting in extra money for the revitalization of your existing Express, to bring them up to the new standard, for this purpose? And my second question is about one of the loan.
When I look at your PowerPoint page 13, I'm not sure if I missed that earlier on. There is a entrustment loan from Ctrip.
Do you mind to walk me through what is the details on that, and the rationale, and some of the terms on why you would be doing that? Thanks.
Jenny Zhang
Sure. First, on the CapEx, we expect to roll out the new model in the second half of this year.
We will apply it throughout our new hotels, manachised sites as well as leased hotels. And for the existing hotels, some of them are coming to a re-renovation stage, and during those re-renovation we are going to apply the new model too, but we do not plan to upgrade.
So the upgrade of the existing hotels is going to be gradual, over the next few years, when those hotels are ready for a re-renovation. So we don't expect any significant jump on the CapEx, in that aspect.
And in regard to the loan, we entered into an agreement with Ctrip last year that they will provide us an operating loan with a favorable interest rate. And as you know, typically, in the first quarter of each year, we will have a significant outflow of cash to pay for our CapEx spending in the past 12 months.
That's the typical pattern in a Chinese business. And we also expect a relatively low operating cash inflow for the first quarter.
Therefore, we decided that we need to withdraw [indiscernible] loans to ensure that we have sufficient cash for the need of CapEx spending, payment. And among the loans we have, this one has the most favorable rate, so this is the first loan we chose to draw down.
And as to the details of the loan, we had a very detailed disclosure in our 20-F released like one or two weeks ago.
Justin Kwok - Goldman Sachs
Okay. That's helpful.
Thank you.
Jenny Zhang
You're welcome.
Operator
Thank you for your question, the next question comes from the line of Tian Hou from TH Capital, please ask your question.
Tian Hou - TH Capital
Good morning, management. I have two questions.
One is related to your new disclosure regarding the midscale leased hotels. And one of the reasons for your RevPAR to be soft was due to the ramping period of this group of hotels.
So you are planning to have 20% of the full-year open target to be in the midscale hotels, and I wonder what's the trend of the hotel operating cost. So, because those -- in the midscale hotels, your cost as a percentage of revenue actually gone up in Q1 versus a year ago.
So, if 20% of the hotels are from this group, I wonder what is the margin trend, at least the costs as a percent of revenue trend would be on a full-year basis. That's the first question.
The second would be you mentioned about the investment in the Suzhou Kangdu property, so I'm not quite get it. So what's the relationship between the -- so what is the synergy between the Hanting business and this property investment?
That's the two questions. Thank you.
Jenny Zhang
Tian, your line has some issues, so your voice is really somewhat broken. Could you maybe put the questions in Chinese or in some simpler language, so I can make sure I got it?
Tian Hou - TH Capital
Okay. [Foreign Language].
Jenny Zhang
I see. Let me address your question on the margin trend first.
I think the one single factor that impacts the margin the most is the RevPAR trend. As everyone knows, we are facing some general inflation on the cost side, and so we typically will need like a 3% same hotel RevPAR appreciation to maintain our leased hotel margin.
And so the decrease of margin in Q1 I think is significantly -- is mainly attributable to the same hotel RevPAR decrease of 1%. And relative to that, the increased number of ramping up midscale hotels is secondary.
Nevertheless, as we mentioned earlier, about 20% of our new openings is going be leased hotels, and out of that about 20 of those new leased hotels are going to be JI hotels. (Technical difficulty) expect that to have some impact on our business, on the margin.
But as I said earlier, it's actually secondary to the general RevPAR trend. And the second (technical difficulty) were asking about the real estate investment we disclosed last quarter.
The Company has already formed a joint venture with our Mr. Ji as a third party to invest in the property in Suzhou, and the Company holds less than 20% of the share in that investment.
And in return, the Company will gain the management contract of the hotel, which will be (technical difficulty) in that property. Does that address your question?
Tian Hou - TH Capital
Yes. Okay.
Thank you so much.
Operator
Yaoxin Huang, CICC.
Yaoxin Huang - CICC
Thank you for taking my question. I have a question goes to Mr.
Ji. [Foreign Language].
Qi Ji
[Foreign Language].
Jenny Zhang
Okay. Let me translate.
The question is relating to the (technical difficulty) contribution to the JI hotels, and also an observation on [indiscernible] actually in the market, which seems to have a trend (technical difficulty) on the different OTAs. So the question is will that trend add pressure on our business?
So Mr. Ji's answer is that, typically, among hotels of different pricing points, the economy hotels have the lowest percentage of business coming from the OTA.
As the pricing point moves up, midscale hotels who will have higher, and when it goes to upscale the OTA contribution will become even higher. And we believe that's normal.
When we acquired Starway, at the time, Starway's hotels had like close to 20% to 30% of the business coming from OTA. And currently, JI hotels have about 10% of business coming from OTA, slightly higher than our Hanting brand.
For the moment, we believe (technical difficulty) OTAs are actually helping us to accumulate customers, especially in our midscale and upscale brands. Going forward, as our brands get stronger, the network expands, and the further strengthening of our central reservation system, the OTA contribution in our midscale and upscale hotels will gradually come down.
So we actually see OTA as a helping hand in our business development, instead of a threat. With our own mass or scale, we can have a conversation with the OTA on even ground, and we are actually one of the very few hotel groups who have that kind of status in China.
As to the consolidation in the OTA market, our own business perspective, we of course (don't) [ph] prefer to see that, but we also don't think those changes are going to have any significant impact on our business.
Yaoxin Huang - CICC
Thank you. Thank you, Jenny and Mr.
Ji.
Jenny Zhang
Thank you. As the time comes, once again, thanks to everyone for making time from your busy schedule to join our call today.
We look forward to talking to you in the next quarter earnings call. Goodbye, Huang.
Operator
Thank you. Ladies and gentlemen, that does conclude our conference for today.
You may now disconnect the line.