Huazhu Group Ltd (NASDAQ: HTHT) is an under-the-radar leisure stock that operates a wide range of hotels, primarily in China. Although it’s not as recognisable as other leisure stocks, such as Hilton Hotels or Marriott International, it arguably has just as much potential for investors over the long term.
Founded in 2005, Huazhu Group Ltd has grown to over 4,600 hotels and over 460,000 rooms through a combination of organic expansion and expansion via M&A. In the first quarter of 2019, for example, the company averaged an opening of two new net hotels per day.
In 2017, the company also bought Crystal Orange Hotels, a chain with over 100 hotels in tier-1 and 2 cities in China, for RMB 3.35 billion (US$470 million). As a result of its growth, Huazhu stock has risen more than 10-fold from its stock price in early 2010.
Like other hotel companies, Huazhu operates under multiple brands. In fact, the company has 18 brands to more effectively target the upscale, midscale and economy class that encompass the majority of the working population of China. In terms of where it gets its revenues, Huazhu earned 56% of its sales from the mid and upscale segments for the second quarter, while the economy class made up the rest.
Secular growth, scale and technology
Huazhu has grown quickly for several reasons. First and foremost, it benefits from the development of China’s economy. China’s leisure sector is booming thanks to the increase in disposable income per capita in China, which increased at a compound an nual growth rate (CAGR) of 9.1% from 2013 to 2018.
As a result of increasing incomes, spending on leisure (per capita) rose at a CAGR of 9.7% from 2013-2018. More importantly, the domestic travel market has been strong with domestic travel expenditures having grown at an even more robust CAGR of 14% from 2013 to 2018. As more Chinese climb the income ladder, they naturally travel more and increasingly frequent Huazhu hotels.
Second, China’s lodging market is highly fragmented, with many independent hotels making up a large part of the market. The fragmentation offers an opportunity for Huazhu, which has greater economies of scale and resources, to grab market share and grow even quicker than the market. For FY19, Huazhu estimates that its net sales will grow 10-12%, a rate faster than the 2013-2018 growth in leisure spending mentioned above.
Great financial performance
In terms of valuation, Huazhu commands a premium to its peers. The stock trades at a forward price-to-earnings (PE) ratio of around 30 while Marriott and Hilton both trade at forward PE ratios of around 20 to 21.
There is good reason for this premium though. For the second quarter, Huazhu had 1,553 unopened hotels in its pipeline, or about a third of all the company’s hotels in operation. Once those hotels open and start generating cash flow, Huazhu’s valuation will likely be more in line with Hilton and Marriott (assuming their stock prices and financial performance remain the same).
The company is also expanding more in the midscale and upscale segments, both of which are potentially more margin-friendly and thus more lucractive. The company’s net revenues grew 13.4% year-on-year in the second quarter, with sales from mid and upscale hotels growing 27% year-on-year.
In addition, the company has a share buyback programme of up to US$750 million effective for five years. For comparison’s sake, Huazhu has a market capitalisation of around US$10.7 billion.
Huazhu Hotels’ operations and its stock price have both increased substantially due to China’s rapidly-growing middle class and solid track record of management execution. Although the Chinese economy is slowing (and Huazhu admittedly trades at a premium valuation), the company should continue to deliver the goods if these long-term trends continue.
HK MoneyClub (www.hkmoneyclub.com)