Can a Strong June Salvage H World Group’s Second Quarter Malaise?

Chinese hotelier is enjoying rising room rates and occupancies at its over 8,000 hotels, but that’s unlikely to offset a disastrous April and May

Key Takeaways

  • H World Group’s average occupancy and revpar are recovering after steep declines in April and May due to pandemic restrictions, but still lag 2019 levels
  • Investors are watching whether the company’s loss will narrow in the second quarter on the back of improving hotel performance metrics

By Andrew Curran

Ahead of soon-to-be-released second-quarter results, hotelier H World Group Ltd. (HTHT.US; 1179.HK) is reporting some solid operational metrics for June. Still, a strong performance that month may not be enough to pull the company into the black for the quarter, following a disastrous period in April and May when its hometown of Shanghai was completely locked down to curb one of China’s worst Covid outbreaks to date.

H World, formerly known as Huazhu, has 8,176 hotels with 773,898 rooms across 17 countries – a lot of rooms by anyone’s count. Like other hotel owners and operators, Covid-19 hit H World hard, forcing it to slash room rates as occupancy levels plunged.

As that happened, H World posted a net loss of 630 million yuan ($93 million) in this year’s first quarter. Average occupancy across all of its China hotels in that quarter was 59.2%, and average nightly revenue per available room (revpar), one of the most widely-watched industry metrics, was just 132 yuan for its hotels in China, which make up the big majority of its business.

But H World’s performance has steadily improved since then despite getting off to a rocky start in April and May. In the second quarter of 2022, the company recorded an average occupancy of 64.6% and an average nightly revpar of 141 yuan for its Chinese hotels, according to its preliminary results announcement released last week. But these quarterly numbers don’t tell the whole story.

Critically, revpar for H World’s China hotels had recovered to 86% in June of pre-pandemic levels from June 2019. The company has operations in 17 countries following its purchase of Germany’s Deutsche Hospitality for 700 million euros ($711 million), but most of its revenues still come from its older legacy business within China.

The Deutsche Hospitality arm only accounts for 24,956 rooms across 125 hotels in the H World portfolio. That’s too bad for the company because June 2022 revpar across these 125 hotels was only 1% below June 2019 levels, reflecting a sharper rebound from Covid-19 outside China.

Once China began lifting its lockdowns and eased domestic travel restrictions, led by an official end to the Shanghai lockdown on June 1, H World began recording strong improvements at home as travel resumed. However, despite finishing the second quarter on a relatively high note, H World has remained cautious rather than optimistic in its comments.

When announcing its first-quarter results in late May at the height of the Shanghai lockdown, H World declined to give any annual revenue and operating outlook, saying the external business environment was too unpredictable.

At the time the company did say it expected its second-quarter revenue to decline 2% to 6% compared to the second quarter of 2021. While that may look relatively good against the backdrop of so many travel restrictions in China at that time, H World also noted the revenue decline would have been much greater excluding its hotels outside China from the German acquisition.

Lingering lockdown hangover

Last week’s data release took a deep dive into the performance of H World’s various hotel segments rather than looking at bigger-picture financial numbers. Not surprisingly, H World did say its Chinese hotels were still experiencing a lingering hangover from the lockdowns, while its European operations also faced their own challenges.

“Against the background of surging inflation in Europe and the resulting substantial increase in costs as well as uncertainties about the future development of Covid-19 and energy supplies, (H World’s European operation) has been focusing on cash flow improvement measures,” the company said in a statement to the Hong Kong Stock Exchange. “As a consequence, (the European operation) will continue to focus on efficiency improvements, re-negotiation of lease contracts, and personnel cost optimization. “

That tells you that while occupancy and room rates at the company’s European hotels may be solid, increasing operating costs are eroding the profits. In other words, H World is telling investors they shouldn’t count on those better-recovering European hotels to bail out the slower-to-recover Chinese operations.

Nonetheless, investors have been relatively forgiving of the company. H World shares haven’t climbed since it released its update on July 20. But they haven’t fallen much either, staying stable at around the HK$32 mark through their Thursday close in Hong Kong. That puts them not too far from the higher end of their 12 month range of HK$40.96 to HK$17.52, including a low point just four months ago as lockdowns in China’s largest cities were getting underway.

The Chinese Government’s “zero-Covid” strategy is exacerbating the country’s economic downturn, resulting in losses for H World that are depleting its cash reserves. And as Covid-19 has proven, hotels are one industry particularly susceptible to external shocks. Whatever happens, people still need to eat food, heat their homes, and maintain their health. But travel is always much more optional, making H World’s product a discretionary rather than necessary spend.

Despite the challenges, investors have bet China’s hotel and travel companies will enjoy a significant windfall once the country reopens, which is propping up the share price of companies like H World.

Some analysts think that, given H World’s growth potential, the stock remains undervalued. The company added 183 hotels to its portfolio in the second quarter and has a whopping 2,199 hotels in the pipeline. Its revenues are expected to grow by almost 50% over the next two or three years.

While you could focus on the potential downsides of being a major player in the Chinese hotel market, there’s also a lot to like about H World. The company’s roughly 20 hotel brands appeal to every price point, and H World’s sheer number of hotels means it has a massive presence in the world’s most populous country.

H World’s tie-up with French hotel giant Accor (ACC.PA) also brings a little international luster to the company. H World has the master franchise to operate the Mercure, Ibis, and Ibis Styles brands in China and operates 372 hotels under that agreement, including 219 Ibis branded hotels.

While international travelers may not be familiar with many of H World’s local hotel brands, they know the Accor brands. When China reopens to international travel, that familiarity will benefit H World’s bottom line.

But while the future offers opportunity, H World must deal with the present. Analysts predict a loss for the second quarter, but the size of that loss will be critical. Demonstrating a clear trend towards an eventual return to profitability will be well received. If positive hotel performance figures for June can ease concerns and the Covid-19 situation in China remains stable, H World may be able to show it is on track to return to better times in the not-too-distant future.

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