Getting Short Life Time Fitness After The Run Up

| About: Life Time (LTM)


The fitness center operator is exploring spinning its real estate into a REIT.

Shares have spiked 22% over the last month, but we still have a bear thesis on the stock, noting that this type of overreaction has happened before.

We felt this type of plan could be on the table as it was revealed back in March that Life Time might be looking into such a deal.

But the company is simply exploring the option and we’re a long way from applying and approval.

Life Time Fitness (NYSE:LTM) shares are up 14% in just the last week. Investors are betting big on a REIT deal. This comes after the company posted a weak quarter that reaffirmed out bear thesis. This isn't the first overreaction we've seen in Life Time's stock this year.

In May, shares ran up from $48 to $56 (a cool 16%) in a matter of days, only to come back to reality a short time later. That came after hedge fund Marcato Capital took a 7% stake and Piper Jaffray tipped off the market that Life Time might be looking into a REIT formation. Piper Jaffray has gone as far as upping its price target from $44 to $61.

The weak 2Q revealed a number of key weaknesses that will persist going forward. We still believe there's a lot of churn in the industry and that Life Time lacks any sort of moat to promote a long-term sustainable business model. As we noted last year,

Life Time is very susceptible to the idea of "trading down," given its gyms are higher-end (aka pricier) than the average gym. As consumers opt to forego the gym entirely or choose a cheaper alternative, Life Time is likely to see top- and bottom-line weakness, which would not be the first time.

During 2Q, attrition (churn) was up 10 basis points to 8.3%. Its trailing twelve month attrition rate is 35.8%, higher than the 34.5% in 2Q 2013. Its second-quarter same-store sales were down 0.6%, with its 37-month mature store sales down 0.9%. Even its operating margin plunged to 17.6%, compared to 19.8% 2Q 2013.

Bottom line

The key news that has driven Life Time shares higher is simply "exploring" the potential use of a REIT. Recall that Iron Mountain had a two-year saga after announcing it was formally applying for conversion to a REIT. Shares of Iron Mountain are up less than 10% since announcing its plan to convert to a REIT back in the summer of 2012. It would be a similar, long, and winding road for Life Time Fitness.

In looking at the balance sheet, the company remains heavily leveraged with $1.13 billion in debt and only $16 million in cash. The declining revenues, increasing churn and mediocre valuation make the run up in Life Time shares more than unjustified.

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