Planet Fitness: More Than Just Gym Memberships

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About: Planet Fitness, Inc. (PLNT)
by: BOOX Research
Summary

Q2 earnings beat top line and EPS estimates.

Stock initially sold off on the results but quickly bounced back.

Company has a very impressive growth history and solid franchising business model.

Significant upside to profitability with multiple drivers, but balanced by valuation headwinds.

Planet Fitness Inc. (NYSE:PLNT) has become something of a stock market juggernaut, up 370% since its 2016 IPO. The national chain of no-frills gyms and fitness centers continues to impress with steady growth and increasing profitability. The differentiation of the brand is an industry-leading low monthly membership fee from $10 which is made possible as the locations typically only feature workout equipment to maximize space with limited amenities. Planet Fitness now has 14 million members across 1,859 locations. The core business of selling gym members may seem simple, but a deep dive here uncovers a complex business model with a number of moving parts in an overall intriguing growth story. This article recaps the latest Q2 earnings and our view on where the stock is headed next.

PLNT stock price chart. Source: FinViz.com

Q2 Earnings Recap

Planet Fitness reported Q2 revenue of $181.66 million, up 29% y/y and exceeding consensus estimates by $13.75 million. EPS of $0.45 also beat estimates by $0.04. It was a solid quarter for the company with system-wide same-store sales increasing 8.8%. The company has now reported 50 consecutive quarters of positive same-store-sales. Higher margins are a theme with the operating margin increasing 120 basis points to 35.9% from last year.

PLNT Q2 earnings highlights. Source: Company IR

Management increased forward guidance including for more stores while boosting the full year revenue forecast to 18% from a previous 15%. From the conference call:

Now to our full year 2019 outlook. For the year ended December 31, 2019, we are adjusting our guidance as follows: total new store equipment sales will be in the range of 250 to 260 new stores, up from approximately 225, including approximately 25 international new equipment sales. Same store sales will be approximately 8% in line with our previous guidance of high-single-digits. Total revenue will increase by approximately 18%, up from approximately 15%. Total adjusted EBITDA will increase by approximately 22%, up from approximately 20%. Adjusted net income will increase approximately 20%, up from approximately 18%, and adjusted EPS will increase by approximately 26%, up from approximate 25%.

The stock initially sold off on the earnings release which may have been something of a "sell the news" type of event but quickly bounced back. The stock is trading within 8% of its all-time high which was near $82 back in June.

Analysis

Planet Fitness thinks it has a market potential to double its U.S. store location to reach 4,000 plus another 300 in Canada. From the map below it appears Planet Fitness has room for growth particularly in Western states where it currently only has 269 locations, representing 2.6% of the population and below the percentage of other regions. An international expansion is in early stages with a couple of locations between Mexico, Panama, and the Dominican Republic.

PLNT store locations. Source: Company IR

Typically in the consumer retail type businesses, you can simply model out future revenue growth as a function of new stores and same-store sales growth. The key here however is that Planet Fitness owns some of its own stores, and also has a faster-growing number of franchisees. Separately, the company makes significant revenue from selling fitness equipment to its franchise network as its customers. Currently, the franchise segment represents 39% of revenue followed by equipment sales at 37% and corporate-owned stores at 24%. The franchise segment has higher margins roughly double that of the company stores. The revenues from the franchises are royalty payments based on a percentage of monthly membership dues and annual fees generated by the franchise stores.

PLNT revenue and EBITDA. Source: Company IR

Bullish Case

Total revenue of $573 million in 2018 and adjusted EBITDA of $223 million in 2018 have each increased at a composite annual growth rate around 20% since 2014. The trend has continued with current estimates expecting full year 2019 revenue growth of 19%. What's interesting here is how revenue and earnings are expected to grow going forward.

From the franchise business, the average system-wide royalty rate is currently 5.61% which includes previously negotiated contracts with older lower rates. In April of 2017, the company raised the royalty rate on monthly dues and annual membership fees to 7% from 5%. The expectation here is that new stores will enter at the higher rate while franchisees will need to renew agreements and reset at the higher current rate. Essentially, Planet Fitness is set to capture an extra 139 basis points in royalty-take from the average existing store and open new stores with a higher rate. The combination here is one of the bullish dynamics for the stock.

Separately, from equipment sales segment, the company explains that the typical fitness equipment has a 5 to 7-year life cycle at which point they need to be replaced. Planet Fitness Inc sells "new" equipment to the franchises as the exclusive provider. All the equipment is branded with the Planet Fitness logo. The franchises are contractually obligated to replace everything which becomes a growing additional revenue stream. Considering the company has added about 1,000 franchise stores in the past 5 years, there is an effective pipeline of future equipment sales that will be realized in the coming years which will have a compounding effect to revenues. If you're not convinced on the growth story yet, consider that the company thinks there is room to increase the customer membership fees and charge a higher royalty from franchisees down the line.

Consensus estimates look for revenue growth of 19% this year followed up by a 12% rate through 2021. EPS growth is expected to accelerate from $1.22 in 2018 to $1.561 this year and continue higher at a near 22% rate over the next two years.

Chart Data by YCharts

It's no surprise to us the level of bullishness and optimism implied in the stock price. PLNT trades 48x its consensus forward earnings while the EV to EBITDA multiple at 30x is also richly priced. For all intents and purposes, the market is aware of the growth story and likes it enough to pay these premiums for it.

Chart Data by YCharts

Bearish Concerns

While we like the business model and recognized the impressive growth, there are some points to pour cold water on the party. One, we think the potential store count of 4,000 in the U.S. will be difficult to achieve in that most major markets are already serviced by competing gym and fitness options requiring new stores to search for more marginal locations. The company acknowledges the "high level of competition in the health and fitness industry" in its annual report and we envision other brands or new entrants attempting to replicate the low-cost model which doesn't seem to have much of a barrier to entry.

Also, the ability to increase the franchise royalty fee and customer membership fee may face challenges as any higher price begins dilute the value proposition and market positioning by Planet Fitness. A higher royalty also deteriorates the economics of a franchisee's own profit potential. It's will be a delicate balance going forward to keep franchisees and investors satisfied.

Takeaway

An impressive growth story and solid business profile is balanced by already lofty expectations. The question for investors really comes down to how much of the growth is already priced in. We take neutral view thinking it might be too late to join this planet, regretting we didn't "jump on this treadmill" sooner maybe $20-$50 lower. We officially rate PLNT as a "hold" based on the challenges to significantly exceed current expectations. We expect upside to be otherwise limited in the near term as the stock appears fully priced in.

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.