Description

H World (formerly named Huazhu) was founded in 2005 and listed on NASDAQ in 2010, .  It is the leading chain hotel operator and second largest hotel group in China. H World operates in a wide range of hotel segments with domestic brands including Hanting, JI, Crystal Orange and overseas brands including Intercity Hotel and Steigenberger. By business segment, 2/3 of the revenues come from leased and owned hotels while 1/3 comes from franchised  hotels.  Company has ~25 brands with a little <9,000 hotels across the network covering various end-segments, from economy all to way to upscale and luxury.  Company was started by Qi Ji, a serial entrepreneur in the hospitality segment with H World being his third enterprise (the first two were Ctrip – the largest OTA in China and Home Inns).  Qi Ji holds a 30% stake while co-founder holds 8% of the shares, and is the second largest shareholder. 

From an industry perspective, our research shows that H World’s brand and operating model has been an advantage in what has been a challenging market for the industry.  Given effect of Covid + China’s economy shutting down, the hospitality sector saw decreased supply during 2020-2022 – for example, by the end of 2021, the number of hotel rooms in China was down ~25% compared with 2019.  As hotels shut down, hotel chain operators increased market share from ~35% pre-Covid to ~37% post-Covid.   For comparison purposes, hotel chain penetration in Europe is ~37% while in the US it’s 75%.  Given the fragmented industry of the market in China, we expect hotel chain operation to take share from independent hotels and grow to levels between Europe and US.  As the economy has reopened, there is a large demand/supply imbalance and we believe the market is entering into a period of upcycle with HTHT leading in share gain. 

A key part of our bullish thesis is HTHT’s business model transformation from one that is leased and owned to a franchise model, thus improving the quality and cashflow characteristics of the business. The company has taken a concerted effort to shift its focus to franchise models with expansion within this segment and closure of low quality leased and owned (L&O) hotels.  The proportion of franchised hotels has gone from 82% in 2017 to 93% in 2022. Historically in China, and for the most part for hotels globally, operators usually like to start with the L&O model as they can control the quality of the product and build the brand. And in China specifically, most operators historically preferred to buy and own the land as real estate prices in China have always been on the uptrend. All of this obviously changed post-Covid with property market going through an unprecedented downturn.  As such, H World has accelerated its business model transition with an increased focus on growing its franchisee model.   The shift towards franchised models has improved the business operating metrics, lowering operating costs as well as capital tied up to capex – as such future growth results in business transforming to an asset light, high margin and strong FCF business. We are projecting the operating margins to reach ~27% which is significantly above the margins achieved in the pre-Covid period. 

In addition, one area of differentiation relative to competitors is the operational capabilities it has developed related to central reservation system, central procurement and maintaining standardized quality service standards across its brands.  For example, HTHT launched six regional management companies to improve and localize its operations – by decentralizing some of the operational functions (while maintaining centralized standards), it allows HTHT to gain market share in lower tier cities as well as less penetrated areas such as Southern and Central China.  This execution excellence leads HTHT to cut payback period of its hotels to 4-5 years vs. 5-6 for its competitors.  As can be seen below, optimized chain portfolio, streamlined operations and brand recognition has led to higher growth and better revenue profile relative to its largest comps (Beijing Touring and Jinjian). 

Another unique advantage HTHT has over its competitors is that it has developed a comprehensive loyalty rewards program.  Its estimated that its network has over 200mn members. The loyalty program provides a few competitive advantages. The main one is that HTHT owns the customers directly via rewards program and serves as a distribution platform for targeted marketing campaigns, enabling the company to maintain a high percentage of direct sales. >70% of room nights were sold to H Rewards members and almost 90% of room nights were sold through its own sales channels. By comparison, peers source ~30% of their customers via OTAs which cut a portion of the economics. 

We think HTHT offers compelling value today.  Stock trades at a 15x 2025 P/E and 9x 2025 EV/EBITDA for a business that we expect to grows mid-teens. As a comparison, Marriott trades at 23x 2025 P/E and 16x EV/EBITDA for a business that grows high single digits on the top-line/low double digits bottom line.  Clearly there is some discount for the China risk but given where we are in the cycle and the operating performance of the company, we feel the discount is unjustified resulting in an attractive risk reward today.

Catalyst

Cycle re-acceleration, increased mix towards franchise model, tier 3 penetratio driving higher growth