TRAVEL: Looming Downturn Wipes Shine Off China Lodging

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Bottom line: China Lodging’s revenue growth could slip into single digits by the end of the year and could start to contract in 2017, as China’s hotel industry corrects after years of strong growth.

China Lodging assists franchisees

Overbuilding and a slowing economy are taking a toll on one of China’s leading hotel operators, which has just revealed it is slashing some of the fees it charges to its franchising partners as they struggle for business. The revelations by China Lodging Group (Nasdaq: HTHT), also known as Huazhu, bode poorly for China’s broader hotel industry, which is suffering a hangover following explosive growth over the last 2 decades. Investors greeted the downbeat news by selling off China Lodging shares, which closed down 2.4 percent and have lost more than 12 percent of their value since the end of March.

Regular readers will know that I’m a big fan of China Lodging, and previously named it as one of my favorite Chinese stocks based on its strong management and good positioning to capitalize on booming demand from Chinese travelers. (previous post) But that said, the hotel industry is notoriously cyclical in every market around the world. And in China especially, the market has shown such strong growth over the last 2 decades that this kind of downturn was quite inevitable.

China Lodging founder and Chairman Ji Qi said in an interview that his company has been in conflict with many of its franchisees recently over some of the fees it charges. (Chinese article) Based on the article’s overtones, it appears that many of the franchisees are losing money or just barely profitable due to slowing business, and are simply looking for some ways to cut costs.

As a result of the difficult situation, China Lodging has decided to suspend the financial consulting oversight fees that it charges as of July 1, and will stop providing some related services as a result. At the same time, China Lodging is also rolling out a program of policies designed to assist some of the struggling hotels run by its franchisees.

The report in China Business Network (CBN) points out that rival operator Homeinns, which recently de-listed from the Nasdaq, is also facing backlash from its franchisees. Similar issues have occurred in the related airline ticket industry, with many of China’s carriers reportedly slashing their fees and withholding their most heavily discounted tickets from private travel agents and even large sites like Qunar (Nasdaq: QUNR).

Q2 Guidance Intact

China Lodging’s Ji doesn’t discuss how much revenue his company will lose as a result of the fee cancellation and other measures to assist its struggling partners. It’s probably quite deliberate that the changes take effect on July 1, which is the first day of the third quarter. That means the changes should have little or no impact on China Lodging’s previous guidance, which was for second-quarter revenue growth of 12-15 percent.

That rate already represents a slowdown from China Lodging’s first-quarter net revenue growth of nearly 19 percent. Thus this new assistance program for franchisees is likely to further cut into China Lodging’s revenue growth for the third quarter, which could slip to 10 percent or less. The company relies heavily on franchised hotels for its business, with 80 percent of its hotels either partly or completely falling into that category.

All that said, the bigger question is what this will mean for the larger industry and how long the downturn might last. I suspect that nearly everyone will suffer, from budget operators like Homeinns and hometown rival Jin Jiang (HKEx: 2006; Shanghai: 600754), all the way up to the big international high-end brands like Marriott (NYSE: MAR) and Intercontinental (London: IHG). I expect we could even see China Lodging and other China-based operators post a period of revenue contraction for a year or two from 2017-2018, but that the downturn shouldn’t last longer than that.

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