HTHT - H World: Capital Return And Growth Prospects Are Key Considerations

2024-01-04 07:57:53 ET

Summary

• HTHT has announced a new policy distributing 45% of its yearly earnings as dividends to shareholders, and the company is also contemplating share buybacks.
• However, H World is likely to witness a slower pace of growth in FY 2024, considering the high base for the prior year.
• A Hold rating for HTHT is warranted, taking into account the company's shareholder capital return approach and growth outlook.

Elevator Pitch

I rate H World Group Limited (HTHT) [1179:HK] shares as a Hold. My earlier October 19, 2023, write-up was focused on the preview of HTHT's financial results for the third quarter of last year.

I turn my attention to H World's capital return initiatives and the company's growth prospects in this latest article. These are the key things that investors have to consider in assessing HTHT as a potential investment candidate.

HTHT's new dividend policy and the potential for share repurchases are positives for the company in my opinion. On the other hand, the Mainland China hospitality sector's outlook and H World's financial prospects for 2024 are less favorable as compared to 2023. Taking into account these factors, I have a Neutral opinion of H World, which translates into a Hold rating for the stock.

Positive Changes Relating To Shareholder Capital Return

An ordinary dividend per ADS (American Depositary Share) of $0.62 and a special dividend per ADS of $0.31 will be distributed to H World's shareholders (who held the company's shares on December 21, 2023 ) on January 17 this year.

This marks a significant shift in HTHT's shareholder capital return stance, as H World hasn't declared any regular or ordinary dividends since the end of 2019 . More importantly, H World also outlined the company's new policy of paying out "an ordinary dividend every year up to 45% of its net income" as indicated in its 6-K filing . A "normal" dividend payout ratio is typically around 20%-30%, so HTHT's new dividend policy appears to be pretty generous.

At its most recent Q3 2023 results call , H World shared that the company's "business is going to be more asset-light" and noted that it hopes to manage its "cash and net profit" well going forward. The company's proportion of manachised (managed hotels) & franchised hotels as a percentage of its total hotels increased from 32% as of end-Q3 2022 to 36% as of September 30, 2023, which validates the management's view that the business is becoming "more asset-light." HTHT's management commentary suggests that it expects to generate a higher level of free cash flow as it becomes less capital intensive, with the intention to allocate excess capital in a more efficient and effective manner.

HTHT also indicated at the company's latest third quarter earnings briefing that it doesn't rule out "the possibility to do some share buybacks at an appropriate time."

In my October 2023 update, I had cautioned that "the absence of a formal (dividend) policy" could "deter income-focused investors from initiating a new position in HTHT's shares." This is no longer an issue that limits H World's potential upside, taking into account the company's recent actions and comments regarding shareholder capital return.

But 2024 Is Unlikely To Be A Repeat Of 2023

2023 was a great year for H World, but it will be tough for HTHT to deliver a similar level of growth in 2024.

Last year, the Chinese hospitality industry and the company benefited from China's decision to pivot away from the COVID-zero policy towards the end of 2022 . HTHT's actual quarterly normalized net profit in local currency or RMB terms for Q1 2023, Q2 2023, and Q3 2023 beat the market's consensus forecasts by +76%, +26%, and +12%, respectively as per S&P Capital IQ data. Top line for H World surged by +61% YoY to RMB16.3 billion in the first nine months of 2023.

Based on consensus data sourced from S&P Capital IQ , the sell-side analysts currently see H World registering a +8% increase in revenue and +9% growth in normalized net income for full-year FY 2024. These are decent but unexciting growth rates.

According to Mainland Chinese broker CMB International's December 18, 2023 China market research report titled "A Silver Lining Ahead", "a mild increase in RevPAR" for the China hotel industry is expected for 2024 due to the "cannibalization from the normalization of overseas travel, and the increase in hotel supply."

Separately, a December 13, 2023, South China Morning Post commentary piece quoted a dean at China's Institute for Theme Park Studies sharing his forecast that "China's domestic tourism will recover, at most, to a similar level as 2019" (prior to the COVID-19 pandemic) in 2024. It is important to note that tourism revenue in China had already recovered to about 91% of pre-COVID levels last year, so any further growth in domestic tourism in 2024 should be pretty limited. In other words, domestic "revenge travel" following the end of China's COVID-zero policy in end-2022 has already materialized to a large extent last year.

A normalized level of earnings growth for HTHT in 2024 and beyond means that the stock's current valuations are reasonably fair. H World is now valued by the market at a consensus forward next twelve months' EV/EBITDA multiple of 14.4 times (source: S&P Capital IQ ). In comparison, the company's consensus FY 2023-2026 EBITDA CAGR estimate is +15.1%. A rule of thumb is that a stock is deemed to be trading at a fair valuation when its earnings multiple is equal or close to its expected earnings growth rate.

Closing Thoughts

I continue to assign a Hold rating to H World, considering both the positives and negatives associated with the stock. It is encouraging that HTHT has adopted a new dividend policy and the company is considering the possibility of engaging in share buybacks for the future. On the flip side, H World's financial results for FY 2024 are likely to be reasonably modest, especially compared with the company's massive outperformance in FY 2023.

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