The hotel operator is facing headwinds from the latest Covid-19 flare-up, whose impact is likely to affect its first quarter results

Key takeaways:

  • Huazhu Group is predicting greater uncertainties for its hotels in the first quarter as a result of the recent Covid resurgence and resulting travel restrictions
  • The company has pivoted to focus on quality over quantity growth, in an unexpected shift for some analysts

By Lau Ming

With recent Covid-19 fare-ups sweeping China and the new omicron variant spreading fast, local governments throughout the country have been tightening pandemic controls, further dimming prospects for the tourism industry. That reality was on display in the preliminary full-year results from hotel operator Huazhu Group Ltd. (HTHT.US, 1179.HK) last Thursday, which also suggest the disruptions are affecting its first quarter prospects as well.

But rather than wait and hope for things to improve after the pandemic, the company has been busy consolidating its business and adjusting corporate strategies on the belief that spring could be just around the corner once the current wave subsides.

China’s tourism sector rebounded strongly in the first half of last year, but then slumped again when the delta variant emerged and started to spread in China in July. Things got so bad that Chinese tourists only made 515 million trips during the “Golden Week” holiday from Oct. 1-7, representing 70.1% of the average level in normal times and 1.5% lower than 2020 in the first year of the pandemic. Tourist revenue during the holiday was even weaker, down to only 60% of pre-pandemic levels.

As delta eased, the even more infectious omicron variant came and further delayed the industry’s recovery.

Huazhu’s business performance has been as volatile as the pandemic. As the tourism industry recovered in the first half of last year, the company’s revenue per available room (revpar) in China, which reflects average prices and occupancy rates, grew by 56.7% and 65.5% year-on-year in the first two quarters, respectively. Revpar for the second quarter was even higher than pre-pandemic levels, at 102.2% of the same quarter of 2019.

But things quickly went south from there. The company met new headwinds in the third and fourth quarters as the pandemic situation intensified, with revpar falling by 1.1% and 12.25% year-on-year, respectively, equating to 82.2% and 85.6% of the level during the same period in 2019.

In its latest update the company said many factors are adding new uncertainties to its efforts to pull revpar from the doldrums, including growing new cases in places like Xi’an, Tianjin and Henan and tighter travel restrictions in Beijing and surrounding areas in the lead-up to the Beijing Winter Olympics.

Despite those concerns, investors remain bullish on the company. Its Hong Kong-listed stock rose by 5% last Friday after release of the update, and were up another 2% Monday to HK$29.65. But they are still 40% lower than their 52-week high of HK$49.30 from last February.

Changing Strategies

In fact, Huazhu, whose major stakeholders include French hotel giant Accor (AC.PA), has been quite resilient in the face of all the pandemic uncertainties. Its revpar in China tumbled to just 54% of 2019’s level when the delta variant spread rapidly last August, but shot up to 90% of the 2019 level as the situation came under control in September and October. So, it stands to reason that Huazhu is likely to recoup the lost ground and revive its momentum once this latest wave fades.

The company has also been very proactive in its response. It shifted strategies in the third quarter by turning its focus from fast to higher-quality growth. Besides focusing on its hotel count, it has also been paying more attention to customer satisfaction and the profitability of franchisees.

The erratic twists and turns of the pandemic over the past two years have accelerated consolidation for China’s overcrowded hotel industry, improving the market’s supply structure. Operators like Huazhu with technological and financial edges have been able to seize the opportunity to expand faster through M&A.

Despite a decline in China’s overall hotel count last year, the number of rooms in almost all chains except for the luxury category was up, pointing to strength in hotel chains’ business models, according to the “2021 accommodation consumption report” jointly released by the Elong Hotel Technology and Tongcheng Research Institute.

While the pandemic has put a major damper on tourism over the last two years, its future easing could lead to explosive demand. The rebound should also receive a boost as tourists demand better service and sanitation standards, which observers believe will most benefit branded hotels and mid- to high-end properties.

Huazhu’s latest report showed it added 1,037 hotels in China last year, including 361 in the fourth quarter. It added 410 budget hotels for the year, raising its count by 9.4%, while its mid- to high-end hotel count rose 27.2% for the year 627 properties. That shows the company is clearly betting on the relatively more profitable upscale segment.

The company has been moving up the value chain and eyeing that part of the market for several years now, including its purchase of Deutsche Hospitality, Germany’s largest hotel group, in 2019. A smooth rollout of the company’s plans to open more luxury and designer hotels in China could continue to improve Huazhu’s offerings at the high-end of the market.

Outlook downgraded

The pandemic has made investors cautious about the company’s prospects. Daiwa Securities believes the spread of the omicron variant worldwide has diminished the company’s profit prospects. It was also surprised to see Huazhu becoming more conservative in its expansion, probably after management underestimated the pandemic’s global impact. Despite its overall optimism toward the company over the long-term, it recently downgraded Huazhu from “buy” to “outperform” and lowered its target price from HK$50 to HK$38.

Chinese investment bank CICC downgraded its 2022 profit forecast for Huazhu by 13.2%, and expressed concerns over uncertainty about its recovery in the first quarter. Goldman Sachs believes declines in the company’s share price over the last six months reflect the market’s pessimism over its revpar over the next few quarters, and continues to rate the company a “buy” based on its relatively low valuation.

CICC’s latest price-to-earnings (P/E) ratio projection for Huazhu is 34.8 times, in between two other major Chinese hotel brands, Jin Jiang International (2006.HK; 600754.SH) and BTG Hotels Group at 45.2 times and 22.8 times, respectively. That could show investors believe Huazhu is somewhere in the middle of the pack with no apparent edge, and it’s fair to say the market is largely neutral on the company.

The global tourism industry still has a long way to go to fully recover. But with more experience accumulated during the pandemic and new Covid drugs coming into the market, the outlook for China’s hotel industry shouldn’t be overly pessimistic.

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