Soko Fitness: Five Reasons to Be Optimistic

Mar.10.10 | About: SOKO Fitness (SOKF)

In line with our theme to identify bargains based on a set of criteria, we have come across Soko Fitness (OTC:SOKF), a leading operator of fitness clubs and spas in Northeast China.

Data Ended 3/8/2010

  • Price = $4.15
  • Trailing EPS = $0.52
  • Fully-Taxed Trailing non- GAAP EPS = $0.39 a
  • P/E based on Fully-Taxed Trailing EPS = 10.64

Reasons for Optimism

  1. SOKF currently meets 8 out of 10 Bargain Requirements

    Requirement Comments
    Yes Recent 52-week High (generally within 3 months) Reached high of $4.45 on 1/15/2010
    Yes 30% EPS Growth Rate 2nd Qtr. 2010 EPS increased 70.0%
    Yes 10% Revenue Growth 2nd Qtr. revenue increased 40.0%.
    Yes Strong Cash Flow/Balance Sheet As of 2nd Qtr. 2010
    YES Positive Cash Flow

    $7.75M

    YES Debt to Equity Ratio less than 20% 11.09%
    NO Current Ratio is at least 2:1 0.86:1
    No Return on Equity is at least 15% >15.0%
    No Minimum Pre-tax Operating Margins of 8% 42.8% as of 2nd Qtr. 2010
    Yes Preferably Under 50 Million Shares 18.2 M shares as of 2nd Qtr.
    Yes High Insider Ownership (generally greater than 15%) 53.3% as of 2009 10K
    Yes Limited Institutional Ownership (generally less than 20%) TBD
    Yes P/E Divided by Growth Rate (PEG Ratio) is Less Than 1. 0.15
    Click to enlarge
  2. Half of Soko's clubs are new or within the first year of operations which could lead to an acceleration of EPS growth.
  3. The company has selectively penetrated and expanded its target markets. Historically, Soko has operated in smaller cities that attract less competition. It has recently embarked on a plan to enter larger cities where it intends to compete using a proven business model that boasts an 81% member retention rate helping to drive practicable recurring revenue streams.
  4. Management seems very cognizant about increasing shareholder value and intends to use equity mainly as a means to pursue acquisitions that would be immediately accretive to EPS. We actually believe an equity raise to complete some acquisitions would not be such a bad idea. It would help alleviate the short-term drain on operations from the facilities it constructs from scratch. Generally, a brand new fitness center can take up to 18 months before it contributes to the bottom line. Right now, the company can internally fund its current expansion plans to add 7 to 9 beauty and fitness centers by the end of 2010. (The company currently has 6 fitness centers. Management has also shown that they are opportunistic by entering high growth and margin markets that have tough barriers to entry, such as the non-surgical medical beauty salon market.
  5. Soko has been more proactive on the investor relations front.

Potential Valuation Scenarios if the company can achieve its EPS growth goals

Short-Term Potential value based on fully taxed adjusted trailing EPS

P/E 20 * $0.39 = $7.80
P/E 25 * $0.39 = $9.75

a All EPS numbers have been adjusted by the GeoTeam to reflect a Chinese tax rate of 25%.

Disclosure: Long SOKF