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Edited Transcript of HCITY*.MX earnings conference call or presentation 18-Jul-19 3:00pm GMT

Q2 2019 Hoteles City Express SAB de CV Earnings Call

CUAJIMALPA DE MOREL Jul 24, 2019 (Thomson StreetEvents) -- Edited Transcript of Hoteles City Express SAB de CV earnings conference call or presentation Thursday, July 18, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Luis Eduardo Barrios Sánchez

Hoteles City Express, S.A.B. de C.V. - Chairman and CEO

* Paul Smith Márquez

Hoteles City Express, S.A.B. de C.V. - CFO

* Santiago Mayoral

Hoteles City Express, S.A.B. de C.V. - Head of Corporate Finances

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Conference Call Participants

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* Alan Macias

BofA Merrill Lynch, Research Division - Analyst

* Andrea Lara Cid Antúnez

Signum Research - Stock Analyst

* Armando Rodriguez

Signum Research - Stock Market Analysis Manager

* Fernando Froylan Mendez Solther

JP Morgan Chase & Co, Research Division - Analyst

* Leticia Loza Lopéz

Citigroup Inc, Research Division - Analyst

* Monique Skruzny; CEO and Founding Partner; InspIR Group

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Presentation

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Operator [1]

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Good day, and welcome to the Hoteles City Express Second Quarter 2019 Earnings Conference Call. (Operator Instructions) Please note, your event is being recorded. I would now like to turn the conference over to Monique Skruzny of InspIR Group Investor Relations. Please go ahead.

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Monique Skruzny; CEO and Founding Partner; InspIR Group, [2]

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Thank you, and good morning, everyone. Hoteles City Express' second quarter 2019 results were released yesterday after the market closed.

The company's earnings release can be found on Hoteles City Express website at www.cityexpress.com.

During this call, management's comments may include forward-looking statements, and we ask that you please refer to the legal disclaimer in the quarterly report for guidance on this matter.

Joining us on today's call are Mr. Luis Barrios, CEO of Hoteles City Express; Mr. Paul Smith, CFO; Mr. Santiago Parra, Corporate Finance Director; Mr. Santiago Mayoral, Investor Relations Vice President; and Mr. Hector Vazquez, the company's new Investor Relations Deputy Director. Mr. Barrios will begin with some opening remarks, followed by Mr. Smith who will discuss the company's financial results. We will then open the call for your questions.

Now it's my pleasure to turn the call over to Mr. Barrios.

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Luis Eduardo Barrios Sánchez, Hoteles City Express, S.A.B. de C.V. - Chairman and CEO [3]

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Thank you, Monique. Hi. Good morning to everyone, and thanks for joining us to review and discuss Hoteles City Express second quarter results for 2019.

As we communicated during the first quarter earnings call, our performance began to improve in the second half of February following the challenging market conditions that emerged at the start of the year. As the market continue to recover, we delivered solid performance in the second quarter with occupancy practically in line with last year's level, ADR growing above inflation and RevPAR posting a healthy 3% increase chain-wide.

We continue to see a healthy absorption of our newest inventory coupled with significant strength derived from established hotels portfolio, which registered a RevPAR growth of approximately 300 basis points above inflation, significantly higher than industry's average. We expect market conditions to remain favorable for us for the remainder of 2019.

Now that the transition period of the new presidency is complete and government activities are normalizing, in light of the improved business environment and our second quarter results, we remain confident in our ability to achieve our RevPAR growth targets for 2019. Once the negative trends for the first quarter have been reverted, we continue to see room for RevPAR increases.

As a reminder, over the last 6 years, including the first quarter figures, chain-wide RevPAR has grown at a compounded annual rate of 8% whilst inflation has grown less than 6%, and the Mexican peso to U.S. dollar pricing has grown by 7.4%.

In addition to being diversified in terms of the industries and market segments we serve, Hoteles City operates in select but diverse region. This includes the Northeast, Northwest, Southeast and Gulf corridors while -- where business conditions improved during the second quarter and where market regional trends continue to be positive.

In fact, year-to-date, our RevPAR is above last year's across all 4 regions. The economies of these regions are being driven mostly by exports to the U.S.

Mexico has become the leading trading partner for the U.S., and a healthy trade balance has been established following the renegotiation of USMCA. Specific factors of the economy that are benefiting include the maquiladora industry, oil and gas exploration as well as commerce, services and tourism. The robust cross-border dynamic has strengthened our hotels across the regions. While some specific cities like the Bajío region present softer dynamics, we remain confident in the potential of the center region's economy.

Turning to our performance. These solid operating trends in these last 3 months resulted in another quarter of double-digit sales growth. Contributing to the top line growth is our ability to optimize our average daily rate using a technology platform to implement differentiated pricing, capture of 80% of our reservations through our own distribution channel as well as counting on the best commercial team in LatAm, a sales force of more than 175 key executives both at the hotel and central office levels.

Regarding profitability, as anticipated at the end of the first quarter, our adjusted EBITDA reverted the negative trend it presented at the beginning of the year, registering a margin practically in line with last year's metrics. Even though we continue to see margin pressures stemming from higher energy costs, we expect to begin mitigating these in the beginning of the fourth quarter when our new power purchase agreement should be fully in place.

The effective expansion of our innovative operating, distribution and marketing platform is also expected to continue improving Hoteles City's profitability and should result in greater operating leverage longer term. We remain disciplined with our investments, focusing on markets that demonstrate clear and sustainable growth trends and where there is a healthy balance of supply and demand.

In addition to tapping current and future demand in these markets, we're investing to further diversify our portfolio. We continue to see market potential for incremental returns on our portfolio based on the new locations we're targeting. Even though financing costs are being impacted by higher interest rates for the real estate industry in general, the profitability and risk/return metrics for our projects continue demonstrating a very attractive difference between our cost of capital and internal rate of return, therefore, generating incremental value for our shareholders with every new opening.

We still expect to open 13 more hotels this year and the beginning of 2020. Most of these will be under City Express Plus brand, a brand designed for deeper metropolitan markets that offer above return -- average returns and helps spread our risk even more. That said, we're ready to execute our cash preservation mechanisms if needed.

Both geographic and product diversification combined with strength of strict investment discipline, differentiated products, flexible operating models and strategies focused on commercial agility, we believe position us to deliver greater shareholder value in the years ahead.

Before I turn the call over to Paul to discuss our financial performance, I would like to introduce Héctor Vázquez, our new Investor Relations Deputy Director. After being with our company for more than 6 years, Santiago Mayoral is leaving Hoteles City to advance his academic studies and contribute even more to our company's success in the future. Héctor, together with the rest of the team, will be more than happy to take all your questions and comments on the Investor Relations from now on. Santiago, we would like to serve you a very good and happy 2 years -- the next months coming and have a lot of success in your MBA studies -- degree.

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Santiago Mayoral, Hoteles City Express, S.A.B. de C.V. - Head of Corporate Finances [4]

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Thank you.

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Luis Eduardo Barrios Sánchez, Hoteles City Express, S.A.B. de C.V. - Chairman and CEO [5]

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Paul, please go ahead.

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Paul Smith Márquez, Hoteles City Express, S.A.B. de C.V. - CFO [6]

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Thank you, Luis, and good day to everyone on the call. Our remarks are based on Hoteles City Express second quarter 2019 financial results, which were prepared under IFRS.

During the second quarter, we added 2 hotels to our portfolio, which has 13 more properties than last year's comparable quarter. Out of the 152 properties now in operation, 109 of them or 72% of its total portfolio are established hotels. The number of installed rooms increased nearly by 11% to 1.6 million. This partly accounted for the 99 basis point year-over-year decline in consolidated occupancy.

Sequentially, occupancy rose 510 basis points as the market continues to recover from earlier in the year. As Luis highlighted, Hoteles City Express ADR increased 4.4%, a rate above inflation and a strong contributor to our 2.6% growth in RevPAR and a 13.6% increase in consolidated sales, which totaled approximately MXN 805 million.

Also driving sales was the increase in installed room nights related to the 9.4% increase in new hotels since last year's quarter. In addition to capturing 80% of reservations via Hoteles City Express reservation system, our price management system helped drive our ADR higher.

Hoteles City Express administration sales increased nearly 14% to MXN 53.8 million. Total cost increased 16.7% mainly due to the increase in installed room nights and the higher energy cost that Luis discussed. We have also been investing in our brand promise with improved guest security and better amenities geared towards the guest profile of our relaunched Plus brand hotels. We anticipate this cost will be absorbed once our new signatory continue to ramp up.

Our sales and admin expenses increased 16.8% in the second quarter. With the rise in operating cost, our adjusted EBITDA margins contracted 160 basis points to 31.7% but increased 9.1% in absolute terms.

As a reminder, we report under IFRS 16, which became effective at the beginning of this year. Accordingly, we report EBITDA and adjusted EBITDA in a way that proportionately recognizes as a cost/benefit the effect of capitalizing leases as well as the corresponding increase in depreciation expense as applicable. These effects are consolidated in operating costs and expense lines of our Hotel Operations and in depreciation expenses, respectively.

Net financial expenses increased twofold year-over-year to MXN 113 million due to the disbursement of bank financing lines over the last 12 months for the construction of hotels, coupled with higher interest rates. Our net debt, which includes the effect of a fully funded pipeline of 35 hotels that will begin operations from now until 2020, increased 13.4%. We expect this metric to decline as we ramp up new hotels.

To date, 70% of our debt is hedged at 7.5% plus a spread of 1.2% on average, and we have the flexibility to adjust our hedges according to interest rate changes and at no additional cost.

As another reminder regarding IFRS 16, our net financing costs this year recognize a proportional effect of capitalizing leases as an incremental cost in interest paid, an effect that is recorded in the interest paid line of our income statement. The increase in the second quarter financing costs mostly led to the 67% decrease in our net income, which totaled MXN 22.7 million. Also impacting our net income was a noncash net foreign exchange loss of MXN 8.9 million related to the valuation of equity interest in our subsidiaries in Chile and Colombia.

At the end of the second quarter, Hoteles City Express cash position totaled MXN 1.6 billion, an increase of 49% compared to our year-end 2018 position. With total debt at MXN 5.2 billion, our net debt-to-EBITDA ratio was 3.7x, slightly above our target of 3.5x but in line with a margin of 0.3x outside the target that we announced on last quarter's call.

Again, because our funding needs up to 2020 have been met, we can expect the ratio to fall below the leverage target by year-end. As a percentage of assets, our debt was 34% at the end of the period. Under our 2019 development plan, which is a target of 17 new properties, we invested approximately MXN 308.1 million during the second quarter. Year-to-date, 4 hotels have been completed.

To conclude my remarks, although we're confident in the markets on which our development pipeline is focused, we remain committed to our investment discipline and strict criteria that require every new project to generate incremental value based on the attractive spreads between our cost of capital and expected returns. As an example of this, our established hotel portfolio has historically yielded an ROE of more than 35%. Our main focus is to generate value to our shareholders who, thus far, have witnessed as the company triple its size over the last 6 years. And if needed, we are ready to prioritize cash preservation and distribution over development.

Thank you for your attention. Operator, please proceed with the Q&A session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Alan Macias of Bank of America.

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Alan Macias, BofA Merrill Lynch, Research Division - Analyst [2]

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Just 2 questions, if I may. The first one is on the cost side. We saw the increase, and thank you for the explanation of the electricity costs, but have you seen any pressure from labor increases? Also, is your current administrative or management platform adequate for the size you have? Any further investment you need to make?

And the second question is if you can remind us of your 2019 adjusted EBITDA target.

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Paul Smith Márquez, Hoteles City Express, S.A.B. de C.V. - CFO [3]

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Alan, this is Paul Smith. Thank you very, very much for your questions. On the first question, on the cost side, no, we haven't seen any pressure from labor costs. We typically pay significantly higher than the minimum wages. So an increase in that base did not have any effect, actually. Labor only impacted to the amount of inflation to our second quarter numbers, and we shouldn't expect anything different going forward. As I said, we have sufficient space between our median compensation and that of the minimum wage. So no issues there.

The main impact was basically electricity. Bear in mind that during the second quarter, the cost per kilowatt is basically 30% higher than last year. And even though this was budgeted, it's obviously significantly higher than last year's.

On the second part on the cost side, the platform per se is ready to operate up to 220 hotels. We shouldn't expect any significant investments to be made there to be able to operate at that level. Bear in mind that we continuously update our apps and so on and so forth, but that's a recurring expense. It shouldn't be something that impacts significantly the SG&A of our opco going forward.

And then on the last question...

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Santiago Mayoral, Hoteles City Express, S.A.B. de C.V. - Head of Corporate Finances [4]

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Alan, this is Santiago Mayoral together with Héctor. On the last question, we don't provide guidance on [EBITDA]. However, we can tell you that is going to be in line with -- in line or higher than last year's.

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Operator [5]

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Our next question comes from Armando Rodriguez of Signum Research.

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Armando Rodriguez, Signum Research - Stock Market Analysis Manager [6]

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My first question's related to the OTA expenses (inaudible). What should you expect this quarter and further quarters would be my first question. And my second question is related to your previous...

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Luis Eduardo Barrios Sánchez, Hoteles City Express, S.A.B. de C.V. - Chairman and CEO [7]

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Armando, I'm sorry. Could you be nearer the phone? I'm having a little bit of trouble hearing your questions.

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Operator [8]

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We have Andrea Lara of Signum Research.

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Andrea Lara Cid Antúnez, Signum Research - Stock Analyst [9]

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I have 2 questions. The first one is if you could give us a little color about the progress in the FSTAY portfolio? And my second question is how are you expecting the sargassum tide to affect the net results.

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Luis Eduardo Barrios Sánchez, Hoteles City Express, S.A.B. de C.V. - Chairman and CEO [10]

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I'm sorry, Lara. I couldn't understand the 2 questions. Would you mind repeating them, please?

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Andrea Lara Cid Antúnez, Signum Research - Stock Analyst [11]

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Sure. One question is if you could give us a little more color about the progress in the FSTAY Portfolio. My second question is how are you expecting the sargassum tide to affect your net results.

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Luis Eduardo Barrios Sánchez, Hoteles City Express, S.A.B. de C.V. - Chairman and CEO [12]

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Sargassum, yes, got it. So on the first question, Andrea, the FSTAY Portfolio continues to grow. Basically, as we mentioned, every time we stabilize a property, that is every time that every -- that from the opening date a property meets its 36-month criteria or it reaches an ROIC level of 12% or above, it's added to that portfolio. We committed strategically to the execution of that vehicle as soon as there's a market opportunity to launch it. So we have kept on adding properties to that vehicle. As a matter of fact, we have done a second round of recycling of assets in that portfolio. So we basically increased the leverage on the FSTAY by basically adding more assets and debt to those means.

On the second part of the question, which is basically sargassum, no, we have not been impacted by it. Actually, one of our strongest regions in this quarter is basically the Southeast region, which has been behaving better than the average portfolio for the last 2 consecutive quarters. Bear in mind that we are not necessarily geared towards the beach-going, leisure traveler. We're more focused on supplying the best quality stay for the businesses surrounding that industry. And some of these players basically take advantage of the season to continue doing maintenance and so on and so forth, and we take advantage of that.

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Operator [13]

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Our next question comes from Armando Rodriguez of Signum Research.

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Armando Rodriguez, Signum Research - Stock Market Analysis Manager [14]

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Well, I'm sorry for my previous communication. Well, my first question is about the OTA expenses. What we should expect on this matter through this quarter and the following quarters? And my second question is related to the Fibra STAY project. I understand you're waiting for maybe lower rates, and I don't know if, for example, long-term bond's current levels should improve this project. That's my -- both questions.

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Paul Smith Márquez, Hoteles City Express, S.A.B. de C.V. - CFO [15]

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Thank you very much, Armando, for your questions. This is Paul Smith again. On the first part of the question, OTA expenses don't vary that much for us, and they are not that important. Bear in mind that more than 80% of our reservations come through our own channels. So we don't have to pay commission for those reservations. This is significantly better than the industry average that typically rely a little bit more on the OTAs. For us, it's not necessarily a relevant item on our expense base.

On the second part of the question, you're absolutely right. The market is gearing towards a reduced rate on the M10 bond. So that part of the equation is working for us. The other part of the equation that needs to work is an opening in the equity markets. So we're looking forward to that evolution. And as I mentioned previously on the last question, we are ready to execute that vehicle as soon as both things align themselves.

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Operator [16]

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(Operator Instructions) Our next question comes from Froylan Mendez of JPMorgan.

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Fernando Froylan Mendez Solther, JP Morgan Chase & Co, Research Division - Analyst [17]

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I have 2 questions. Why not selling specific assets to fund your growth plans considering that the conditions to actually spin off the Fibra STAY are quite volatile? And in that sense, do you believe you can get lower cap rates on specific stand-alone properties than what you could get spinning out the whole portfolio?

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Paul Smith Márquez, Hoteles City Express, S.A.B. de C.V. - CFO [18]

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Thank you, Froylan. This is Paul Smith. Thank you very much for your question. Well, we typically find that it's better for us to have a continuous recycling mechanism rather than an opportunistic approach. What I want to generate is a vehicle whereby I can very steadily, very consistently and very strategically become asset-light. It's not necessarily a focus of opportunistic pick-and-choose strategies. We still have significant leverage left in the recycling asset vehicle.

So bear in mind that we believe that this is so much more efficient also considering that you would have a tax leakage impact on the opportunistic sale of an asset-by-asset strategy. If you look at that long term and you factor in with our overall strategic goals, you will see that the approaches we're following is better at creating a shareholder value.

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Operator [19]

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(Operator Instructions) This concludes our -- we do have an additional question that just came in. Our next question comes from Leticia Loza of Citi.

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Leticia Loza Lopéz, Citigroup Inc, Research Division - Analyst [20]

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And I just have one question. I remember that you mentioned in other calls we had that some of your new hotels were taking a bit longer to stabilize due to (inaudible) environment. I just wanted to ask you how you were seeing all this situation if this quarter was much easier? And how much in average will these new assets take to stabilize compared to the others?

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Paul Smith Márquez, Hoteles City Express, S.A.B. de C.V. - CFO [21]

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Leticia, this is Paul Smith, and thank you very much for both questions. No, I actually mentioned during that call that -- what I basically said, and let me restate it, is that we added 10% more capacity over the fourth quarter, but that doesn't mean that those hotels are actually maturing slower. As a matter of fact, the portfolio that we have recently opened instead of maturing at the 36-month historical time line, they have been maturing or reaching EBITDA levels of around 40% at the 24-month time line, so actually 12 months before the average.

One of the reasons why we have been diversifying to more denser markets is precisely because of this. There's lesser risk investing with a Plus brand in major metropolitan markets because they have a wider net of demand, and this product is very attractive for these markets. So as a result, what you find is that we will mature faster.

And then on the second part of the question, no, what we're seeing basically is that absent mobility issues that we basically faced in the first quarter where people could not move from one place or the other given the uncertainty of finding gasoline to return to their bases, we have seen a pickup in occupancy and in economic activity. And we have actually tracked this vis-a-vis the industry, and we find that it's better in our case and the rest of the industry. So at least in our case, we showcase better results than that of the industry. And you can also compare for that matter our stabilized portfolio, which is more comparable to the portfolios of other public issuers.

When you look at that performance, what you see is that far from 300 basis points above inflation, our RevPAR keeps on growing despite market conditions. So I guess that's a testament to showcase the strength of our portfolio.

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Operator [22]

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This concludes our question-and-answer session. I would now like to turn the conference back over to Mr. Barrios for any closing remarks.

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Luis Eduardo Barrios Sánchez, Hoteles City Express, S.A.B. de C.V. - Chairman and CEO [23]

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Thank you, again, for participating in our earnings call. Before we end the call, I am pleased to report that Hoteles City Express was included in the Mexican Bolsa Sustainable IPC Index for a third year in a row. We are the only hotel chain to be part of this index. Hoteles City inclusion reflects the 3 strategic pillars of our sustainability model: creating value, protecting the environment and making positive contributions to society. As always, our Financial and Investor Relations teams are available to answer any other questions you might have about our financials and operating results. Thank you, and have a good day.

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Operator [24]

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