H World Group Ltd annual report, Q4 FY2020

Business context and reporting period

Huazhu Group Limited (now H World Group), a multi-brand hotel operator based primarily in China, filed this Form 20-F for the fiscal year ended December 31, 2020. It reports annual results, not standalone 2020 Q4 financial statements. The company operates leased and owned hotels and manachised and franchised hotels. It acquired Germany-based Deutsche Hospitality on January 2, 2020; its inclusion makes 2020 results less comparable with 2019.

Key financial and operating metrics

Unless noted otherwise, amounts are RMB millions. U.S. dollar equivalents are shown where relevant.

Revenue from leased and owned hotels was RMB6,908, down 10.5%; revenue from manachised and franchised hotels was RMB3,136, down 6.2%. Operating costs and expenses rose 29.1% to RMB11,925, or 116.9% of revenue. Hotel operating costs alone were 95.4% of revenue, versus 64.1% in 2019. Reported other operating income of RMB480 included subsidy and insurance income, mainly associated with Deutsche Hospitality and COVID-19. The company recorded RMB437 of goodwill impairment, RMB180 of long-lived asset impairment and RMB92 of investment impairment; its cash-flow reconciliation reports total impairment loss of RMB709.

At year-end, cash and cash equivalents were RMB7,026, short-term investments RMB3,903 and restricted cash RMB64. Current assets were RMB12,882 and current liabilities RMB10,529. Short- and long-term debt totaled RMB11,998, excluding lease liabilities. Operating lease liabilities were RMB30,454 and finance lease liabilities RMB2,528. The filing also reports RMB52,783 of operating lease obligations in its contractual-obligations table, which includes commitments not yet reflected in the 2020 balance sheet. Capital expenditures were RMB1,533.

Hotels in operation increased to 6,789, including 6,036 manachised and franchised hotels; a further 2,449 were under development. Legacy Huazhu’s annual RevPAR fell to RMB149 from RMB198 in 2019. At December 31, occupancy was approximately 71% at legacy Huazhu hotels and 34.8% at legacy Deutsche Hospitality hotels. In Q4, legacy Huazhu RevPAR was RMB186 versus RMB191 in Q4 2019; comparable same-hotel RevPAR was down 7.6% year over year.

Material changes versus the prior comparable period

• COVID-19 sharply reduced travel demand, hotel occupancy and RevPAR. Legacy Huazhu revenue fell 22.7% year over year; consolidation of Deutsche Hospitality partly offset that decline in group revenue.
• The company swung from 2019 net income of RMB1,769 to a 2020 net loss of RMB2,192, and adjusted EBITDA swung from RMB3,349 to a loss of RMB244.
• Operating cash flow fell from RMB3,293 to RMB609. Investing cash outflow increased substantially, principally reflecting RMB5,060 of acquisitions, net of cash acquired, including Deutsche Hospitality, as well as investment and property purchases.
• Hotel operating costs rose substantially, reflecting the acquisition and the lower revenue base. The group’s balance-sheet cash increased to RMB7,026, while restricted cash declined from RMB10,765 to RMB64.
• Year-end hotel count and network expansion continued despite the downturn; approximately 88.9% of operating hotels were manachised or franchised.

Outlook, commentary, risks and unusual items

• Management said business recovery in China had outperformed the industry since March 2020 and expected operating cash flow to improve as COVID-19’s effects diminished. The filing provides no specific revenue, earnings or RevPAR guidance, and stresses uncertainty about the pandemic’s duration and effects.
• Management stated that cash, operating cash flow and available credit were expected to meet working-capital and capital needs for at least 12 months. It cited RMB6.6 billion of unutilized credit facilities at year-end. Hotel closures and low occupancy could trigger defaults under banking arrangements; required waivers had been obtained, but future waivers are not assured. Certain covenant waivers restricted cash dividends through June 30, 2021.
• COVID-19 measures included cost reductions, rent negotiations, temporary franchise fee reductions, staff furloughs and support to franchisees seeking bank loans. Legacy Huazhu had 74 hotels under government requisition and 207 temporarily closed at year-end; Deutsche Hospitality had 18 temporarily closed. Franchisee distress, lease burdens and renewed closures remain risks.
• The Deutsche Hospitality acquisition added substantial European exposure and goodwill and intangible assets. Its 2020 revenue was RMB1,532 and net loss RMB1,345. The company recorded RMB437 of goodwill impairment for the business; the remaining valuation depends on forecasts and discount-rate assumptions.
• Liquidity and capital structure warrant attention: debt maturities, convertible notes, substantial lease obligations, foreign-currency exposure, and limits on transfers from PRC subsidiaries. The filing states RMB3,846 was unavailable for distribution from PRC subsidiaries as of year-end.
• The filing describes two short-seller reports received in September 2020. A special committee and advisers investigated; the company said allegations were untrue and without merit, subject to ongoing internal investigations. It also disclosed pending legal and administrative matters and RMB60 of accrued contingencies.
• Management and the auditor reported effective financial reporting controls for the assessed group, but Deutsche Hospitality was excluded from the first-year assessment. The audit report also highlights significant estimation judgment in goodwill and brand impairment testing.

Important facts for investors to verify

• Whether post-2020 travel recovery, occupancy and RevPAR support the company’s recovery assumptions, separately for legacy Huazhu and Deutsche Hospitality.
• How much of the 2020 loss and cost increase is recurring versus acquisition-related, pandemic-related, impairment, subsidy or insurance items; also reconcile reported impairment figures.
• Debt maturities, covenant compliance and waiver terms, availability of undrawn facilities, and the ability to service debt alongside operating and finance lease commitments.
• Deutsche Hospitality’s operating performance, integration progress, cash needs, and the sensitivity of goodwill and brand valuations to forecast and discount-rate changes.
• Franchisee financial health, hotel openings and closures, lease renewals, and the extent of property-title, licensing and regulatory compliance risks.
• Potential effects of PRC cash-transfer restrictions, currency movements, dividend limitations, and U.S. audit-inspection or listing developments.