Asset-light Model And Lower-Tier Expansion Will Secure A Bright Future

Key Takeaways

• Expansion into lower-tier cities and asset-light transformation aim to boost revenue, market share, and sustainable cash flow.
  
• Growth in high-margin segments and strategic cost-cutting enhance profitability through brand recognition and restructuring.
  
• The shift from leased hotels to a franchise model and restructuring costs risks short-term revenue loss and affects profitability, impacting financial stability.

Catalysts

Develops leased and owned, manachised, and franchised hotels in the People’s Republic of China.

• Continued expansion into lower-tier cities is expected to capture more growth opportunities in the mass market, potentially driving revenue growth and increasing overall market share.
  
• Transformation towards an asset-light model is designed to provide more stable and sustainable development while generating stronger cash flow and supporting margin expansion.
  
• Strong growth in the upper-mid segment, with brands like Intercity and Crystal Orange gaining momentum, is expected to enhance brand recognition and increase revenue in higher-margin segments.
  
• Continued focus on product upgrades and brand positioning is aimed at improving customer satisfaction and driving repeat business, which should support revenue growth and potentially improve net margins.
  
• Strategic cost-cutting and restructuring activities, especially in the Legacy-DH business, are expected to improve profitability by reducing overhead costs and enhancing earnings stability.

H World Group Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming H World Group's revenue will grow by 6.4% annually over the next 3 years.
• Analysts assume that profit margins will increase from 12.8% today to 18.7% in 3 years time.
• Analysts expect earnings to reach CN¥5.4 billion (and earnings per share of CN¥17.17) by about April 2028, up from CN¥3.0 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting CN¥6.1 billion in earnings, and the most bearish expecting CN¥4.7 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 24.0x on those 2028 earnings, down from 27.7x today. This future PE is greater than the current PE for the US Hospitality industry at 23.2x.
• Analysts expect the number of shares outstanding to decline by 1.86% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.95%, as per the Simply Wall St company report.

H World Group Future Earnings Per Share Growth

Risks

• The temporary supply-demand imbalance in the hotel industry, due to supply increases in some regions, has led to pressure on Average Daily Rate (ADR), impacting potential revenue.
  
• The decline in Revenue Per Available Room (RevPAR) by 3% in 2024 despite an increased room count suggests a challenge in maintaining pricing power and revenue levels.
  
• The restructuring of Legacy-DH, including hotel exits and restructuring costs, may reduce revenue due to the transition from leased hotels to a franchise model, impacting earnings in the short-term.
  
• Legacy-DH's impairment loss and one-off restructuring costs in 2024 widened operating losses, affecting overall earnings and posing a risk to future profitability.
  
• Despite high shareholder returns and asset-light transitions, the reliance on cash dividends over share buybacks potentially reduces flexibility in capital allocation, impacting long-term financial stability and earnings.

Valuation

• The analysts have a consensus price target of $45.183 for H World Group based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $56.9, and the most bearish reporting a price target of just $35.04.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be CN¥28.8 billion, earnings will come to CN¥5.4 billion, and it would be trading on a PE ratio of 24.0x, assuming you use a discount rate of 10.0%.
• Given the current share price of $37.1, the analyst price target of $45.18 is 17.9% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.