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GreenTree Hospitality Group Ltd. (NYSE:GHG)
Q3 2018 Earnings Conference Call
Nov. 19, 2018, 8:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Hello, ladies and gentlemen. Thank you for standing by for GreenTree's Third Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. After management's prepared remarks, there will be a question and answer session. As a reminder, today's conference call is being recorded. I would now like to turn the meeting over to your host for today's call, Mr. Rene Vanguestaine of Christiensen, the company's investor relations firm. Please proceed, Rene.

Rene Vanguestaine -- Investor Relations

Thank you, Anita. Hello, everyone, and thank you for joining us today. GreenTree's earnings release was distributed earlier today and is available on our website -- IR website at ir.998.com, as well as on PRNewswire services. As a reminder, we also posted a PowerPoint presentation that accompanies our comments today to the same IR website.

On the call today from GreenTree are Mr. Alex Xu, Chairman and Chief Executive Officer; Ms. Selina Yang, VP of Operations, Ms. Jasmine Geffner, Chief Financial Officer, and Mr. Nicky Zheng, IR Manager. Mr. Xu will present the company's Q3 2018 performance overview, followed by Ms. Yang, who will discuss business operations and company highlights, and Ms. Geffner will then discuss financials and guidance. They will be available to answer your questions during the Q&A session that will follow.

Before we begin, I'd like to remind you that this conference call contains forward-looking statements within the meaning of Section 21(e) of the Securities Exchange Act of 1934, as amended, and as defined in the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements can be identified by terminology such as "may," "will," "expect," "anticipate," "aims," "future," "intends," "plans," "believes," "estimates," "continue," "target," "is or are likely to," "going forward," "confident," "outlook," and similar statements.

Any statements that are not historical facts, including statements about the company and its industry, are forward-looking statements. Such statements are based upon management's current expectations and current market and operating conditions and relate to events that involve known and unknown risks, uncertainties, and other factors, all of which are difficult to predict and many of which are beyond the company's control, which may cause the company's actual results, performance, or achievements to differ materially from those in the forward-looking statements. You should not place undue reliance on these forward-looking statements.

Further information regarding these and other risks, uncertainties or factors is included in the company's filings with the U.S. Securities and Exchange Commission. All information provided, including the forward-looking statements made in this conference call, are current as of today's date. The company does not undertake any obligation to update any forward-looking statement as a result of new information, future events, or otherwise, except as required under applicable law. It is now my pleasure to introduce our Chairman and Chief Executive Officer, Mr. Alex Xu. Mr. Xu, please go ahead.

Alex S. Xu -- Chairman and Chief Executive Officer

Thank you, Rene, and thanks, everyone, for joining our earnings call today. I'm pleased to report our 2018 third-quarter results. During this quarter, we remain committed to a steady and stable growth strategy as we explore the growing consumption trend in the second- and third-tier cities and expand our geographical coverage across China. Now, we're covering 278 cities at the end of September 2018.

We now operate 2,558 hotels across nine different brands, from economy, mid-scale, to mid-to-upscale limited services segment of the markets. During the third quarter, we opened 146 new hotels and continue to grow our pipeline. We are on track to open more new hotels in the remaining part of the year. We also started to explore ways to grow our service apartment business recently. Finally, we continue to explore appropriate value-enhancing acquisition opportunities to help strengthen our hotel platform and increase long-term shareholder value.

In the third quarter of 2018, our total revenue grew 21.6% year-over-year to reach RMB256.8 million. Gross profit increased 19.5% to RMB180.7 million. Non-GAAP adjusted EBITDA rose 24.2% to RMB156.5 million. Net income increased 36.3% to RMB152.4 million, and the non-GAAP core net income rose 30.3% year over year to RMB125.3 million.

While gross margin changed slightly from 71.7% to 70.4%, adjusted EBITDA margin improved from 59.6% to 60.9%. Net margin improved from 52.9% to 53.3%, and the core net margin improved from 45.5% to 48.8% compared to a year ago. These results were driven by continued growth in our hotel network and improved operating performance at our existing hotels.

During the quarter, we opened 146 new hotels, with half of these new opened hotels in our mid-scale brands, around 35.6% in economy brands, and around 14.4% in the mid-to-upscale brands. Our pipeline of new hotels increased from 306 at the end of last year to 504 at September 30, 2018. Approximately a quarter of our pipeline is in the mid-to-upscale hotels, including GME, GYA and VX, which were launched late last year. We opened six under these new three brands in the third quarter of 2018. We continue to spread our geographic footprint further across China. We now cover 278 cities, up from 263 cities at the end of last year.

In terms of our operating performance, we saw steady progress across the board. Average daily room rate, or ADR, for the quarter increased by 4.4% year over year to RMB167. Occupancy rate had a slight decrease of 0.2% to 87.2%, which was related to accelerating new hotel openings in the first nine months of 2018 and the third quarter of 2018. And, revenue per available room increased 4.3% year over year to RMB146.

One of the biggest drivers of both our steady incremental improvement in operating performance and our high overall profitability is, again, our loyalty program. We now have 26 million individual loyal members and over 1.02 million corporate members. Out of the 26 million members, over 20 million of them have joined our premium paid membership program. Our strong brand and direct relationship with so many valued customers allowed us to continue to sell direct, instead of relying on online travel agencies, which is more expensive to our hotels. In the most recent quarter, we sold approximately 94.9% of our room nights through our direct sales channels.

M&A is one of our key growth strategies in the near future. We are actively searching for appropriate M&A targets and the focus on brand and geographic areas that are complementary to our existing hotel portfolio. We believe the right acquisitions as well as smooth integration will help accelerate our planned long-term expansion.

In conclusion, we are pleased with our performance so far this year. Although there is more hard work to be done in the coming years, we are confident in our business model, strategic positioning, and the long-term growth strategies, and will continue to invest in our people, brand, system, and technology in order to better serve our customers and franchisees and to ensure a long-term healthy development of our hotel network.

Lastly, in the last quarter of 2018, we noticed there were some market headwinds. We have already implemented franchisee support programs, including reduction of central reservation fees from RMB10-20 RMB for reservation to approximately RMB8 per room night to ensure that every franchisee will continue to do well during the quarter and next year. With that, I'll pass the call over to Selina, who will discuss our business operations and the company's highlights.

Selina Yiping Yang -- Vice President, Operations

Thank you, Alex. If you are following along on our slides, I will skip the overview on Slide 5 and go straight to Slide 6. Once again, the franchised-and-managed model remains our primary strategic focus. In fact, 98.8% of our hotels fall under this category, and as you can see on the chart on the right, F&M hotels have been expanding, increasing their contribution to our overall revenues. In the third quarter, the percentage reached almost 70%.

Let's turn to Slide 7. Another critical area of our business is our loyalty program. Our program differs considerably from most hotel businesses in the West. We have a paid program to which people sign up to enjoy a variety of premium perks and advantages. More importantly, we found that this program has allowed us to foster closer relationships with our guests. Members can book directly with us, which has helped us and our franchisees to reduce sales and marketing fees and expenses, and our GreenTree members are very sticky customers.

Overall, we now have about 26 million members in our loyalty program, along with 1,010,000 corporate members, up from approximately 24,930,000 as of June 30, 2018 and approximately 21,820,000 as of December 31, 2017. Around 94.9% of room nights were sold through our own direct channels, which includes our individual loyal members and corporate members.

Moving on to Slide 8, you can see our RevPAR chart here. The third quarter is generally one of the high seasons during the year. In the two charts at the bottom of the page, you can see that on a year-over-year basis, RevPAR for L&O increased by 4.8% to RMB152 and RevPAR for F&M hotels increased by 4.3% to RMB145 for the third quarter of 2018. Both segments showed healthy growth over the third quarter and first nine months of last year, mainly due to higher ADR.

On Slide 9, you can see that we've worked very hard this past quarter to further boost our pipeline of new hotels. During the third quarter, our pipeline grew to 504, while we opened 136 hotels. In particular, we're trying to boost the growth and, at the same time, to diversify our portfolio by adding more hotels at the higher-end and economy segments of the market.

Currently, 82.8% of our hotels -- really, the core of our business -- serve the middle end of the limited services market. This ratio continued to trend down this year from 86.6% at the end of 2017. In line with this strategy, during this quarter, we added 15 new GreenTree Easterns, two GME, one GYA, and three VX hotels, which primarily serve business and leisure travelers in the business to mid-to-upscale segment of the market. So, the number of hotels in this segment increased to 3.2% of the total portfolio.

Meanwhile, the number of hotels in the economy segment grew to 14%, with the addition of 52 economy hotels across our Vatica and Shell brands in the third quarter of 2018. We continued to roll out our three new brands at the mid-to-upscale end of the market as part of our strategy to strengthen our portfolio.

On Slide 10, you can see these brands, which we have named, GME, GYA, and VX. We are charging around the same price points for all three hotels, but the decorum and positioning of each will be quite different, as we cater to the tastes of different segments of the market. Now, we have 36 GME, 21 GYA, and 24 VX hotels in the pipeline as of September 30, 2018.

On Slide 11, we added four L&O hotels in this quarter -- two under GreenTree Eastern brand, one under GreenTree Inn, and one under a new brand in the mid-scale segment called Wumian. These hotels are in strategic locations in eastern and southern China. We believe that we can further improve the performance of these hotels under our direct management. With that, I will pass the call over to Jasmine, who will review our financials.

Jasmine Xin Yue Geffner -- Chief Financial Officer

Thank you, Selina. We delivered another solid quarter of operating and financial results. Moving on to Slide 13, we now have a total of 2,558 hotels with 209,463 rooms. On a year-over-year basis, we increased our hotel numbers by 20.7%. During the quarter, we opened 146 new hotels. By comparison, we opened 109 hotels in Q3 2017 and 425 for the full year 2017. So, as you can see, we substantially accelerated our hotel openings in Q3 2018 and the first nine months of 2018. Of the 146 hotels opened in Q3, 73 were in the mid-scale segment, 21 in the business to mid-to-upscale segment, and 52 in the economy segment. Of this, we opened 10 hotels in Tier 1 cities, 28 in Tier 2 cities, and the remaining 108 in smaller cities in China.

During the quarter, we only closed 22 hotels, so, net-net, we added 124 hotels to our portfolio. We closed five hotels due to their non-compliance with our brand and operating standards and closed two hotels due to hotel upgrades. We also closed 15 hotels due to property-related issues including rezoning, returning of government-owned properties, expiry of leases, and so on.

On Slide 14, you can see some of our key operating metrics. During the quarter, we continued to see improvement in our operating performance across the board. The key numbers looked at here are the orange bars representing the performance of our F&M Hotels. These hotels make up the biggest part of our business. The performance of our L&O hotels skewed a bit higher because we added four L&O hotels, renovated six L&O hotels this quarter, and converted one L&O to F&M hotel after the second quarter of 2017.

In terms of our F&M hotels, our ADR improved by 4.4% to RMB166 in the third quarter of this year. RevPAR increased by 4.3% to 145 RMB, while the occupancy rate for our F&M hotels had a slight decrease of 0.2% to 87.5%, which was due to the acceleration of new hotel openings in the quarter.

On Slide 15, you can see that total revenues grew 21.6% year over -year to reach RMB256.8 million. The year-over-year increase was primarily attributable to four factors: First, the increase of 123 F&M hotels in our network, second, the addition of four L&O hotels in this quarter, third, improved RevPAR for both F&M and L&O hotels, and fourth, growth in our loyal membership. This was partially offset by the renovation of six L&O hotels in the third quarter of 2018 and the conversion of one L&O to F&M hotel after the second quarter of 2017.

Total revenues from F&M hotels for the third quarter rose 20.3% to RMB179.7 million. Meanwhile, revenue from L&O hotels rose 19.7% to RMB57.4 million. During the first nine months of 2018, total revenues rose by 21.7% to RMB695.1 million. Total revenues for F&M hotels for the first nine months of 2018 were RMB489.1 million, up by 23.5% year over year. Total revenues from L&O hotels in the same period were RMB151.3 million, increased by 10.6% year over year.

Moving over to the expense side of the P&L, please look at the three graphs on the right-hand side of Slide 16. Hotel operating costs for the third quarter of 2018 were RMB76.1 million. The year-over-year increase of 27.2% was mainly attributable to three factors: First, the increased in number of general managers in our hotel network, second, other costs associated with the expansion of F&M hotels, third, higher operating costs for the four newly added L&O hotels.

Selling and marketing expenses for the third quarter of 2018 were RMB11.3 million. The year-over-year increase of 10.1% in the third quarter of 2018 was mainly attributable to model room construction, exhibition, and other advertising and promotion expenses related to our three new mid-to-upscale brands, increased personnel compensation and other costs, i.e., travel expenses of business development personnel as a result of the increased opening of hotels.

General and administrative expenses for the third quarter of 2018 were RMB24.2 million. The year-over-year increase of 13.6% in the third quarter of 2018 was primarily attributable to increased share-based compensation expenses. Overall, total operating costs and expenses grew 22% year over year to RMB111.7 million. It grew 18.2% year over year to RMB311.1 million in the first nine months of 2018.

Slide 17 shows that during the third quarter of 2018, gross margin decreased slightly by 1.3% to 70.4%, while we were able to improve adjusted EBITDA margin by 1.3% to 50.9%, net margin by 6.4% to 59.3%, and core net profit margin by 3.3% to 48.8%. Overall, gross profit grew 19.5% year over year to RMB180.7 million, adjusted EBITDA increased 24.2% year over year to RMB156.5 million, net income increased 36.3% to RMB152.4 million, and finally, core net income increased 30.3% to RMB125.3 million. Basic and diluted earnings per ADS improved by 23% to RMB1.50, equivalent to $0.22 USD, while basic and diluted core net income per ADS improved by 17.1% to RMB1.23 in the third quarter of 2018. On Slide 18, we show consistent growth and healthy margins during the first nine months of 2018 as well.

Moving on to Slide 19, our IPO has bolstered our balance sheet further, which was already strong, given our ability to consistently generate strong cash flow from operations. During the third quarter of 2018, operating cash inflow was RMB202.9 million. Cash and equivalents balance increased to almost RMB2 billion. This provides us with more resources to consider and evaluate additional capital investments and potential acquisitions. Lastly, in terms of guidance, we reaffirm a 20-25% year-over-year growth in total revenues for the full year 2018. This concludes our prepared remarks. Operator, we are now ready to begin the Q&A session. Thank you.

Questions and Answers:

Operator

Thank you. We will now begin the question and answer session. To ask a question, you may press *1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press *2. At this time, we will pause momentarily to assemble our roster. The first question today comes from Justin Kwok of Goldman Sachs. Please go ahead.

Justin Kwok -- Goldman Sachs -- Executive Director

Hi. Thanks for taking my questions. Perhaps I have two questions -- one on the franchisee support program and the other one on the service apartment on the strategic side. The first one -- I heard Alex mentioning that they have initiated the franchisee support program in the quarter, which will lower the membership transfer fee or booking fee for the franchisees. I just want to get a sense on the backdrop of this. Is that more related to competition or is it more related to some of the franchisees expressing their concerns on the operating environment? What other measures are there in the support program, and would you be able to give some color or quantify a bit on the impact to your revenue or to your profit on that side? That's the first question.

The second question would be on the service apartment. I read in your press release that you're also exploring the service apartment segment. Can I check what exactly is this, what are your plans, and whether you can give some color on the progress on that? Thank you.

Alex S. Xu -- Chairman and Chief Executive Officer

Okay, Justin. This is Alex. Thank you so much for the true important questions. With regard to the franchisee support program, the company always initiates those programs practically. We rarely wait for the franchisee to ask for help because by then, we think it's too late. We think that we have heard some concerns over the uncertainty of the economy for the first quarter and for next year due to a little bit of slowdown in the struggling economy, and also the trade conflict. So, we sense that some franchisees may be worried about their continued profitability.

We want to make sure -- even with the current environment -- our franchisees can continue to generate the same amount or even higher profitability for the individual hotels. So, as a result, we developed this incentive program. We think that the incentive program, coupled with increased membership drive, will improve -- at least, help -- our franchisees during the first quarter, next quarter, and next year as well. In our network, we have not experienced any major or noticeable slowdowns in consumer demand.

However, by reading the industry reports, we noticed there are some long-distance travelers, such as leisure and business travelers -- there may be a reduction of that, and there may be a reduction of the higher-end travels, but our strategy has always been focusing on providing -- delivering the hardcore demand for our everyday business travelers, and that the value-priced hotel chain is especially important during any kind of economic change time for the small to medium-sized business travelers. So, that's the reason for GreenTree to initiate the support programs.

During the downturn or during some downturns in certain geographic areas with the economic changes, we always have a franchisee support program. For instance, we may reduce some of the usage fees for the franchisees. From 5%, maybe will give before in 2009, 2008 -- the financial crisis -- or during certain small, regional economic change times, we'll provide the support. So, on balance, we don't think there will be a major impact on the company for the earnings because we always think that with healthy franchisees, we can support their profitability again and they will support the growth of the hotel network. So, that's the franchisee support program. We may implement further franchisee support programs depending on how the economy -- how the hotel market goes.

With regard to the service apartment, many people do not know that GreenTree started GreenTree Apartments almost 10 years ago during 2007-2008. We are kind of experiencing the business model for running a service apartment. However, we did not find a viable business model to grow that service apartment business, primarily because the rental fees -- the rental market and the price for rentals were not very high at that time, but 10 years later, right now, we see the rental market has a stronger demand, and we think that it's time for us to revisit GreenTree service apartments for a little bit shorter and mid-term stay.

So, we think that in the future, we'll complement our business, but our focus is still going to be our hotel business. We just started that department at a small scale, and we will pick up where we left 10 years ago. As you know, in the last 10 years, the service apartment has gone through a lot of changes, and many people tried different kinds of business models, but we have observed that most of them are not very successful. We think there is a way, and that there may be some ways we can work better, just like our hotel network. Justin, I hope I answered your questions.

Justin Kwok -- Goldman Sachs -- Executive Director

Yup. Thank you very much.

Operator

The next question comes from Billy Ng with Bank of America Merrill Lynch. Please go ahead.

Billy Ng -- Bank of America Merrill Lynch -- Analyst

Hi, good evening. I also have two questions. One is to follow up on Justin's question regarding the franchisee support program. Alex, since you mentioned that we have done that before in the last few cycles, can you describe how easy it is to roll back when things are improving again, whether some of those measures can be rolled back, and if that's the case, how easy was that? Also, I know you mentioned a little bit that it's not going to impact the profitability or the financials that much from our perspective, but roughly speaking, without those programs for those target franchisees, let's say if we are getting 4-5% of the top line, with those programs, how much can that be? Can we still get a similar cut of the revenue, or will it be slightly lower? That's question No. 1.

Question No. 2 is in terms of our -- I know it's still a bit early, but in terms of next year, the number of targets opening -- roughly speaking, because we saw some of your competitors increase their pipeline and most likely will have more openings than this year, but some competitors are probably already seeing a piece of the openings this year and will have a smaller number of openings next year. What do you think in our case and GreenTree's? Do you feel that we can open more hotels than this year, or will we more likely become a little bit more conservative given the macro uncertainty?

Alex S. Xu -- Chairman and Chief Executive Officer

Thanks, Billy. Again, because this is related to our strategy and operations, I'll pick up those questions even though I think Selina and Jasmine are well aware of what we are doing. First, regarding the incentive program and whether it can be rolled back once we implement it, we have experienced that when the market improves, we can easily roll those back because, according to the contracts, we have specific terms governing those kinds of policies in terms of reservations per room and reservation fees. So, we can apply the contract.

In the spirit of the corporation, we never really experienced any challenge rolling those programs. Our franchisees have been very thankful and appreciative to have a partner like GreenTree in the past, and our hearts and our support go with them. However, GreenTree is also the first mover to reduce a lot of reservation fees from RMB20 to RMB10 per room night already, primarily because 10 years ago, our support of franchisees with those reservations was coming from live telephone operators. With newer technology and improved system support, automation, and some simple AI, our reservation in terms of central support -- the costs have gradually decreased. So, with our reduction of the fees to the franchisees, so is our cost.

So, initially, we always designed that it wasn't additional income because we generate the income from 4.5-6% of royalty fees. We think we should -- the other support really should be a passthrough cost at most, so the reservation fees and the additional fees are from the franchisees, and we incur additional costs, so we have to continue to innovate to deploy the AI to improve our technology platform to reduce our central corporate office's expense in that end so the net result is not going to be having any major impact to the company's bottom line. So, that's the franchisee support program.

In terms of the second year -- next year's target openings, Billy, as we discussed with our analysts and our investors in the past, we have always had a three-year strategic plan, and we do not accelerate when the market is really hot and we do not decelerate when the market is cooling down. In the last two years, when the market is really hot, we actually are really reserved in terms of advising our franchisees not to bid up the rent and the lease expenses, and to be careful, but during the market correction, our program will be very effective to help our franchisees in terms of selecting the right site, selecting the right property with the right lease expenses.

So, our plan is 1,800 hotels for the next three years, so next year will be around 600, if not more. We believe we should be very comfortable to achieve that target. At the beginning of the year, we had 306 in the pipeline. Now, we have almost 200 more -- 504 in the pipeline. I think we'll continue to build the pipeline to ensure the next three years, we can easily achieve the target. So, that's regarding next year's plan, Billy.

Billy Ng -- Bank of America Merrill Lynch -- Analyst

Thanks so much.

Operator

The next question comes from Praveen Choudhary with Morgan Stanley. Please go ahead.

Praveen Choudhary -- Morgan Stanley -- Managing Director

Thank you. Thanks very much for taking my question. Hi, Alex. Congrats on a good number again. I have two questions. The first question is related to your cash flow statement. I see you have given loans to franchisees in this quarter, around RMB35 million, but then you have given loans to third parties. Would you explain what that is? That's RMB156 million. Including that loan to franchisees, around RMB200 million -- is that also to support your franchisees at this time when they're struggling? The related question is this time, around your PS growth rate of 20-30%, and yet, it seems like you are worried about downcycle and you're helping your franchisees. What other indications are you seeing based on your conversations with these franchisees that are making you either nervous or taking a proactive measure? Thank you.

Alex S. Xu -- Chairman and Chief Executive Officer

Okay, thanks, Praveen. I appreciate your continued support, as always. Regarding the detailed breakdown, I'll have Jasmine or Selina answer that, but I'll give you an overall picture of that. The support to our franchisees is coming from those franchisees -- typically, in the past, they may have had an easier time borrowing in the marketplace from their various financing programs, including from banks. In the last year, I think the PIP so-called finance market and the bank financing was tighter than before to some of our franchisees.

The result is that we saw some good opportunities. We do not want to discourage our franchisees not to do it, so we rolled out those franchisees, providing the loans to them to help them to speed out. But, those loans are typically provided to outstanding franchisees that already have successful hotels and operations. They have proven they have the experience and ability to run a good hotel, so we provide those kinds of loans to them.

Secondly, with rolling out the supporting programs, the market sometimes -- it's not the actual numbers that matter, it's the rumors and news that make people concerned and cautious. And so, during this time, we want to encourage our franchisees to do more in marketing and sales, and as a result, we also want to show our company will also participate in that to help them work together. And so, even during 2009-2010, we really did not experience a slowdown in terms of the corrections, for instance, for our priorities in our hotels, if I recall. That's the spirit we are working under. I think our franchisees are in the best position because the products and the price of our hotel properties are really meeting the demand for the small to medium-sized business travelers. So, for the detailed number breakdown, I'll leave that to Jasmine.

Jasmine Xin Yue Geffner -- Chief Financial Officer

Hi, Praveen, this is Jasmine. Regarding the loans to third parties, they're mostly to third parties that are related to our hotel business. For example, we made short-term loans to a company that's an operator of 168.com, which is our online e-commerce platform serving our members and hotel guests. Basically, our members and hotel guests can use the points they accrue by staying at our hotels to exchange for products on this online platform. So, we give them short-term loans to support their working capital needs. We do charge market interest rates of 4-6% on an ongoing basis.

Alex S. Xu -- Chairman and Chief Executive Officer

They're expected to pay it back.

Jasmine Xin Yue Geffner -- Chief Financial Officer

They're expected to pay it back before year-end.

Alex S. Xu -- Chairman and Chief Executive Officer

Great.

Praveen Choudhary -- Morgan Stanley -- Managing Director

Very helpful. Thank you, guys.

Operator

The next question comes from Ingrid Zhang with UBS. Please go ahead.

Ingrid Zhang -- UBS Investment Bank -- Associate Director

Hi, Alex and management. Thanks for taking my questions. First, congratulations on the great result. My question would be could you please provide a bit of color on the 2019 look, especially on the RevPAR trend? There are pricing market concerns about economy uncertainty, and some investors we talked to were really expecting RevPAR growth to decelerate to below 1%. Would you give us some more color on this? How do you expect the hotel industry RevPAR trend to be next year, and maybe on GHG specifically as well? Thank you.

Alex S. Xu -- Chairman and Chief Executive Officer

Okay. Even though my CFO told me we don't give out RevPAR guidance in the past, I still think that it's a valid question, and I appreciate you asking it. Our hotels are priced always reasonably, so we don't increase the price very rapidly or sharply during good times. We don't decrease them during bad times very much, either. So, in the long run, we think by the same segment, the hotel pricing should be more aligned with the CPI, but with improved product quality, it may be incrementally higher -- 3-5%. So, at this moment, we don't expect a decline or sharp deviation from that number, so if the market changes, maybe we should see a slight reduction, but we do not feel that we will be financially impacted. I wish I would also have 20/20 vision to tell for next year, but that's what we're budgeting and planning for: Along with the CPI.

Ingrid Zhang -- UBS Investment Bank -- Associate Director

Thank you.

Operator

Next question comes from Won Lin with 86 Research. Please go ahead.

Juan Lin -- 86Research -- Vice President

Hi, good evening, management. Thank you for taking my question. Congratulations on a strong set of results. So, I have two questions. My first question is on business expansion. You have these accelerating new hotel openings, especially in the mid/upscale hotel category. You also provided the pipeline for the upscale hotels. I wonder if you could break down your economy and mid-scale hotels. Also, in terms for Tier 1/Tier 2 versus Tier 3 cities, what is your future hotel opening plan in terms of geographic distribution of the different tiers of cities? Also, you mentioned that you are actively looking for M&A targets. I wondered if the M&A target is mainly to facilitate upward expansion or geographic expansion.

Second question is on operating efficiency. If I exclude the revenue mix factor, I see a pretty good improvement in operating efficiency. I wonder -- in addition to RevPAR improvement, what are the approaches or factors that have been driving the operating efficiency improvement? Thank you.

Alex S. Xu -- Chairman and Chief Executive Officer

All right. In terms of breakdown of the numbers, I'll leave that to Selina or Jasmine in terms of the economy hotel pipeline. I think they have the numbers over there. As for first-tier/second-tier/third-tier cities, I think our focus is going to be on organic growth, so, wherever there are good opportunities, we will go there. In the last quarter, I believe we had more in the second- and third-tier cities, but I will leave detailed numbers to Selina.

In terms of the margin, in the past, we have always tried to adopt technology to help our people do a better job. Last time, I think we discussed that there will still be a slight improvement with the margin business. We think we have not reached the optimum yet. The company has been also working really hard on the technology platform. I think that's the driver for our continued productivity increase. The second is our effective marketing program and our loyalty membership program, which is really standing out. Our membership program differs from a lot of others, and you don't see us taking a large number of members, but I believe our quality paid memberships help a great deal. And so, those factors are contributing to the improved profit margin.

In terms of M&A, we are looking for both complementary brand operators and complementary geographic operators. So, with the current market conditions, I think there will be more valuation opportunities than in the hot market. So, we are working really hard, and we think that -- but, even though we have urgency to grow, we also want to be disciplined while making sure we find the right match, the right team, the right philosophy, and a reasonable price with the right growth plan. So, we are applying very disciplined criteria for selecting our future acquisition partners. I'll leave the numbers to Jasmine or Selina.

Jasmine Xin Yue Geffner -- Chief Financial Officer

Okay. For our pipeline of new hotels, we see that about one-quarter of our pipeline -- 505 hotels -- is in the medium to upscale hotels, and about 23% are our economy hotels, including our Vatica and Shell brands.

Ax

So, the balance of business goes to the mid-scale. Twenty-three percent is in the budget category in Vatica and Shell.

Jasmine Xin Yue Geffner -- Chief Financial Officer

Yes, exactly.

Juan Lin -- 86Research -- Vice President

Thank you very much. That's very helpful.

Operator

The next question comes from Jisheng Liu with CLSA. Please go ahead.

Jisheng Liu -- CLSA Limited -- Analyst

Hi. Thank you, management, for taking my questions. Congrats again on the strong results. If I may, I have three questions. First, on the F&M hotel openings, I see on the press release that you have a temporary waiver on Shell hotel openings during the third quarter of 2018, so I'm wondering what's the reasoning behind that because, as Alex mentioned, you put some support to your hotel franchisees, but I would pretty much understand the temporary waiver for the initial franchise fee of Shell hotels as a push toward more accelerating hotel openings, so I'm just wondering if you have continuous plans in the future to put that kind of waiver, or if you would even more expand to other hotels such as Vatica. That's my first question.

The second one is on the L&O hotels. So, during the second quarter, I saw that you had one opening of L&O and three conversions from F&M, so, just wondering what's the rational behind that and what's your plan going into 2019. The third one is I guess you guys have also heard about a scandal last week across all the hotel industry in China where the cleaning staff are not doing their job very properly. Just wondering if you guys foresee any regulatory issues going into the industry and if you are going to input even more internal control procedures. Many thanks.

Alex S. Xu -- Chairman and Chief Executive Officer

Okay, thank you for three great questions. First of all, in terms of the Shell hotels, we did have a waiver or delayed payment of the initial application fees. I think those are conditional. We had a rollout of the program because the market -- a lot of new players coming into different areas offered different programs, and we wanted to give our franchisees a sense of comfort and confidence that, in the future, once they perform above the market and above and beyond what they have been operating, that those fees will be paid to us because our people worked really hard to help our franchisees in the beginning for the selection, doing the business analysis, and various other improvements. So, we incur work alike.

We're really different than most others in the budget segment. We do want to provide comprehensive, 360-degree support to our franchisees, so our cost structure is there. We are confident we will collect most of it. So, in the future, depending on the market, we want to continue to give our franchisees confidence that we can deliver a better performance. I think the program will show that. So, we enjoy very big support from them. I have personally talked to a few of our franchisees in that category, and they're more than pleased with the performance.

Secondly, with the three L&O conversions, those conversions -- we had a few criteria. First of all, the hotel was located in a strategic location, and for instance, the hotel that converted is located close to the location of the headquarters of two Fortune 500 companies, and the franchisee was to have the policy to do -- some of them were to do more hotels, and some of them were to acquire a million or invest with them. So, those Malay -- the Malay cases were, we think, strategically speaking and will have a longer-term lease in a strategic location, and those are going to be model hotels for new mid-to-upscale brands. So, that was our rationale for picking up the hotels. We're not picking up the hotel just because it has really good excellence in performance or returns.

Third, regarding the scandal, we were not surprised by that because we know the management of our room service is a tough job. We also understand that because of turnover, people from different hotels come in to do this work, so there is inconsistent behavior. We have thousands of people, and purely, we sometimes cannot guarantee that individuals will perform at their best. As a result, we think the training and management system -- the supervisory support system -- is very important, and we implemented an ethical working standard.

Our ethics code is printed in every single workroom, storage room, and housekeeping/maintenance room, so we have that ethical code to discourage that kind of behavior. We think it is up to each individual operator to do their own management, to do a good job to that end. We're also trying to find the right technology. In the past, we explored, for instance, placing types of video cameras that were wearable products. And so, I think that it is really a combination of constant education, training, supervision, and support, and with the right system, we can definitely do a better job. It's kind of sad to see what's happening in the five-star industry side, and hopefully, we all can do a better job.

In terms of regulation, we don't -- at least, we think the government is very smart. They recognize the kind of problem, and we just cannot probably rule out every single so-called bad behavior in the workplace, so we hope there will be some smart policy, but every policy coming out -- I think the government will be sensible and sensitive to the industry's condition and need. We don't think there will be a new regulation that will negatively impact the industry. I think the country will help the industry's continued healthy growth.

Jisheng Liu -- CLSA Limited -- Analyst

Thanks, Alex. Very helpful. Thank you very much.

Operator

Again, if you have a question, please press *1.

Alex S. Xu -- Chairman and Chief Executive Officer

By the way, I'm not reading those from prepared scripts. This is conversation. My English still needs to be improved. So, if you're a programmer, don't transcribe it the way it is. Correct it for me.

Operator

The next question comes from Bruce Mai with UBS. Please go ahead.

Bruce Mai -- UBS Investment Bank -- Analyst

Hi, management and Alex. Thanks for taking my questions. Actually, Selina has already answered one of my questions. Could you please provide any guidance on your closures in 2019? I also want to double-check -- Alex, before, you mentioned that in 2019, you would open around 600 hotels, right?

Alex S. Xu -- Chairman and Chief Executive Officer

That's right. In the next three years, we are opening 1,800, so, you do the math, but we do a three-year plan that averages 600 a year. That's opening. On closure, we have estimated right around 4% in the past. We think that next year, we'll not sharply deviate from them. We still have the lowest closure rate in the industry due to the profitability of our individual hotel owners. But sometimes, we can drag in and create new problems because when our franchisees are profitable, sometimes some of them have less incentive to operate, so we have to work really hard. This year, we'll roll out the incentive program for those upgrades. But, the closure is right around 4% plus or minus.

Bruce Mai -- UBS Investment Bank -- Analyst

Okay, thanks.

Alex S. Xu -- Chairman and Chief Executive Officer

Thanks, Bruce.

Operator

This concludes our question and answer session. I would like to turn the conference back over to Selina Yang for any closing remarks.

Selina Yiping Yang -- Vice President, Operations

Thank you, Anita. In closing, on behalf of the entire GreenTree management team, we'd like to thank you for your interest and participation in today's call. If you require any further information or have any interest in visiting us in China, please don't hesitate to contact us. This concludes the call. Thank you all.

Alex S. Xu -- Chairman and Chief Executive Officer

Thank you.

Operator

This conference has now concluded. Thank you for attending today's presentation. You may now disconnect

Duration: 70 minutes

Call participants:

Rene Vanguestaine -- Investor Relations

Alex S. Xu -- Chairman and Chief Executive Officer

Selina Yiping Yang -- Vice President, Operations

Jasmine Xin Yue Geffner -- Chief Financial Officer

Nicky Zheng -- Investor Relations Manager

Justin Kwok -- Goldman Sachs -- Executive Director

Billy Ng -- Bank of America Merrill Lynch -- Analyst

Praveen Choudhary -- Morgan Stanley -- Managing Director

Ingrid Zhang -- UBS Investment Bank -- Associate Director

Juan Lin -- 86Research -- Vice President

Jisheng Liu -- CLSA Limited -- Analyst

Bruce Mai -- UBS Investment Bank -- Analyst

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