Planet Fitness' Valuation Is A Dealbreaker

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About: Planet Fitness, Inc. (PLNT)
by: Freyr Capital
Summary

Planet Fitness is a leading fitness club franchisor/operator.

It is well-positioned to capitalize on secular trends of growing mind and wallet share devoted to fitness and the strong U.S. consumer.

Its differentiating asset light business model is characterized by attractive financials.

Despite our positive take on the value proposition and market potential for Planet Fitness, we're deterred by valuation.

We're neutral on Planet Fitness.

Investment Thesis

Planet Fitness (PLNT) is a leading fitness club franchisor/operator. It is well-positioned to capitalize on secular trends of growing mind and wallet share devoted to fitness and the strong U.S. consumer. Its differentiating asset light business model is characterized by attractive financials. Despite our positive take on the value proposition and market potential for Planet Fitness, we're deterred by valuation. We're neutral.

Fitness is a Secular Growth Trend

From the rise of Whole Foods to meatless meat alternatives, from the rise of Crossfit to the cyclist commuter, the trend of health is one of the strongest in the recent decades. Longer life expectancy and growing wealth has started a craze of attempting to live longer and longer in developed markets. This has manifested itself in two ways: more exercise and wholesome nutrition. Today we focus on the former. The mind and wallet share devoted to exercise is unprecedented.

The rise of social media has pushed people to gyms. People are growingly more conscious about their look. They want to be fit for the looks as well as for health. People want to be seen going to the gym, exercising. We call this rising tide "gym culture."

The combination of growing health awareness and popularity of gym culture has boosted the fitness industry. The number of fitness/health club members grew with a CAGR of 4% from the year 2000 to 2017. The trend is expected to continue with some experts forecasting a growth rate greater than 10% CAGR out to 2023.

It's a Good Time to Invest in the Consumer

The U.S. consumer appears to be the last bastion of strength in the softening global macro picture. All central banks on the move to lift a weakening global economy. Consumer data, however, is still strong. With robust retail sales data and a low unemployment, experts say that the U.S. consumer is keeping the economy from tanking and that it will get boosted by further monetary easing. Discretionary spending by consumers should increase.

Planet Fitness Is Well-Positioned To Capture These Trends

Planet Fitness sits at the crossroads of the two trends. It is one of the largest and fastest growing franchisors and operators of fitness centers in the U.S. The company has 12.5 mn members and 1,742 stores. It operates in a capital light model with a franchising ratio of 96%.

The company has a unique business model with three major revenue streams. In addition to operating the 76 company owned stores, Planet fitness takes a percentage of membership fees. The company is periodically raising this amount, the current royalty fee stands at 7%. Planet Fitness is continuously franchising new stores and is growing the segment. Company-owned stores make 24% of total revenues and franchised stores make 39%.

Planet Fitness also makes revenues off of selling equipment to franchisees. The company makes it mandatory to use equipment with its logo and can offer competitive pricing and stronger warranty terms thanks to scale and enhanced service levels, and a seamless order process. In addition to selling equipment to new gyms, the company makes it mandatory for franchisees to upgrade equipment every 7 to 15 years. Equipment revenues represented 37% of total in FY18.

Marginwise franchising is by far the most profitable with a remarkable 84% EBITDA margin and a 54% EBITDA contribution. Company-owned stores have 41% EBITDA margin and 22% EBITDA contribution and finally equipment segment has a low 23% EBITDA margin and 19% EBITDA contribution. The efficacy of the model of franchising stores and selling the brand and the strategy of growing franchised stores is clear.

The Unique Business Model Enables Solid Financials

The company has managed to capitalize on the aforementioned trends. It has managed to combine its rapid growth of 20% 3 year revenue CAGR with profitability and cash generation. Planet Fitness boasts a strong margin structure with 55% gross, 42% EBITDA, and 17% net income margins. The company has achieved ever growing profitability, as displayed in the EBITDA margin chart below, thanks to its franchising push.

Source: Seeking Alpha

Thanks to its franchising model, Planet Fitness has kept capex under control. It has very efficient investment metrics with capex at a mere 8% of sales in a very capital intensive business.

Planet Fitness is a solid cash generator as well, producing $78 bn in free cash flow in the TTM.

Valuation Is A Dealbreaker - We're Neutral

Trading multiples of Planet Fitness are out of touch with reality. The company is trading at TTM multiples of 57x non-GAAP P/E, 31x EV/EBITDA, and 32x P/CF. These numbers resemble those of high growth companies who are disrupting massive addressable markets.

We think that revenue growth settling to high single digits/low teens will cause the market to de-rate the stock back to earth. When and if that happens, we're buyers of the stock. But at these levels we have to walk away.

Source: Seeking Alpha

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.