Planet Fitness Appears Expensive, But Still Has Potential To Double
Summary
- COVID-19, while devastating, is an opportunity for Planet Fitness to emerge as a faster-growing, more established player, just as it did in 2008.
- Even in the face of growing e-fitness trends, Planet Fitness is poised to gain extensively, with the potential to double by the end of 2022.
- Today’s environment thus presents a rare opportunity to purchase Planet Fitness shares at an incredible discount.
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Elevator Pitch:
While Planet Fitness (NYSE:PLNT) is not the greatest gym, it is one great business - Planet Fitness is a value compounder that has built over 2,000 gyms since its inception in 1996. Planet Fitness's share price, despite optimistic vaccine news, has yet to recover to pre-COVID levels, reflecting the Street's fundamental misunderstanding of Planet Fitness's nuanced market positioning and business model. COVID-19, rather than destroying Planet Fitness's future, will aid in-market consolidation, produce a more attractive real-estate scene, and push members of luxury gyms towards discount gym alternatives.
Business Overview
Planet Fitness, as most may already know, is a discount gym with a franchise model. Out of its 2,000 gyms, ~1,900 are franchisee-owned while ~100 are corporate-owned. Additionally, each gym is an average of 20,000 square feet. Most of their gyms are in the US (about ~1,950 gyms), while the rest are in Puerto Rico, Canada, the Dominican Republic, Panama, Mexico, and Australia. Like most gyms, Planet Fitness offers a monthly, 6-month, and annual gym membership. Its widely known $10 monthly membership gives access to a single Planet Fitness gym, as well as group training. Planet Fitness also offers a premium membership - the PF Black Card - which is $22.99/month. The Black Card gives you access to all Planet Fitness gyms, allows you to bring a friend for free each visit, and gives you access to amenities (spa, juice bar, pool, among others).
Planet Fitness's revenue breaks down into 3 segments:
- Franchise (40% of revenues & 85% EBITDA margins): Recurring revenues via royalties (700 bps for new contracts) and other fees from franchisees who set up gyms in Planet Fitness's name. Planet Fitness's contracts with franchisees last an average of 5-10 years before they are renewed with new terms.
- Corporate Stores (23% of revenues & 41% EBITDA margins): Revenues from membership fees from its ~100 corporate-owned stores.
- Equipment (37% of revenue & 24% EBITDA margins): Franchisees are contractually obligated to purchase new equipment every 5-7 years from Planet Fitness.
Why has Planet Fitness 5x'd since its IPO?
Thesis Point 1: Planet Fitness is in a Rapidly Growing Industry with a large TAM
In the US, over 80% of Americans have never been to a gym - Planet Fitness specifically targets these casual and new gym-goers with their friendly gym environment (remember this, it will be important later). Already, Planet Fitness has about ~20% market share of existing gym members in the US, but it still has large revenue runways. For one, the US has one of the largest overweight populations. Combine that with growing societal pressure to be "fit" and the result is an expanding population of people who want to go to gyms. As a result, the fitness club market is projected to expand by ~8% CAGR until 2024. Besides that, there is immense room for expansion. An internal study suggests that in the US, Planet Fitness could build over 4000 gyms, more than two times what it has now. It also suggests another 600 potential gyms in Canada and Mexico. I back-checked this by looking at all highly dense metropolitan populations in the US and assuming a 100k population per gym. I calculated a nearly identical 4,000 gym total potential. Planet Fitness has consistently built 200-250 gyms a year for the last 5 years, giving me further confidence in their 4,000 total gym potential, especially as the fitness market expands further.
Thesis Point 2: Planet Fitness? - No, Planet Fortress
Planet Fitness has a nearly indestructible fortress in the gym industry, and in particular, the discount gym industry.
As a high-level overview - Planet Fitness has had its same-store sales grow for over 50 consecutive quarters (until COVID), consistently maintained 20%+ ROIC, and has increased total gyms by ~1000 since 2015, compared to discount competitors (Fitness 19, Retro Fitness, Youfit, and others) who have, on average, decreased total gym count by 2 since 2015.
Source: Created by the author using data from respective websites of gyms
Compared to mid-tier gyms (~$70 monthly memberships) like Gold Gym, LA Fitness, and Lifetime Fitness, Planet Fitness has outgrown them too - the average mid-sized gym grew total gym by ~200 since 2015. Planet Fitness has thus been able to grow over four times faster than its mid-tier gym counterparts.
I believe that Planet Fitness's surprisingly deep moat comes from three places. First, its counter-positioning: Planet Fitness entered the gym market with a revolutionary approach - charging a $10 membership fee compared to an industry average of $50 was unheard of at the time. Beyond that, Planet Fitness introduced the "Judgement Free Zone" and the "Lunk Alarm," all of which made the environment less intimidating for new gym-goers - the portion of the population they specifically targeted. In fact, over 40% of Planet Fitness's customers are first time gym-goers. While Planet Fitness's model may seem replicable, it is almost impossible for competitors to adopt it without completely remaking their own business model. Put simply, there is too much inertia behind gym competitor's existing business models, making drastic change unlikely. So far, that's held to be largely true.
Second, its network effect: the social aspect of going to the gym is highly understated. In fact, over 44% of people work out with a gym buddy, and you are 25% more likely to complete a workout program when you're with a friend. The 2nd biggest reason people upgrade to a PF Black Card is so that they can bring a friend with them. Why is this important? It means that a larger membership base will raise the social value of a Planet Fitness membership, as I am more likely to have friends/family who go to Planet Fitness. This is especially true if I am a casual gym-goer who won't go unless asked by a friend.
Third and finally, it is the industry standard: as mentioned before, Planet Fitness is the market leader, with ~20% market share. Planet Fitness is also the 2nd most recognized gym in the US, and 1st by a long shot in the discount gym space. This aspect of their moat is the most important - for first-time gym-goers, brand awareness is incredibly important. Casual gym-goers aren't spending much if any, time researching gym options, and they definitely don't want to spend lots of money on a membership. That's why they will opt for what they already know exists and is incredibly cheap: Planet Fitness.
Aside from attracting new members, Planet Fitness's brand name also attracts franchisees, which builds brand name, and attracts more franchisees. Additionally, management has mentioned how, because of their brand name, they are also one of the first ones to get called by landlords whenever something is available (this will be important later).
Thesis Point 3: An Excellent Business Strategy that Generates Excellent Margins
Planet Fitness has 40% EBITDA margins on its total revenue stream as well as its revenues from individual stores - corporate and franchise. For a discount gym, these numbers seem impossibly high; why is it that competitors like Lifetime Fitness, who charge six times more per month, have only EBITDA margins in the 20s?
Source: Credit Suisse Report on Planet Fitness in 2015
I believe it is mainly the combination of two factors.
First, superb marketing. Planet Fitness ranks #1 in unaided brand awareness in the gym category. I'm sure many of you have seen memes or YouTube videos blow up about the Lunk Alarm or other unique aspects of Planet Fitness's approach to an enjoyable gym experience. As a result, their CAC is far lower than their competitors.
Second, astonishingly high member to gym size ratios. In most stores, Planet Fitness has 10x as many total members as they can fit in the gym at any one time. In fact, 50% of Planet Fitness's members have NEVER stepped into Planet Fitness a single time after paying for a membership (this is mind-blowing to me). To these casual gym-goers, canceling the membership and admitting defeat is more painful than paying an additional $10 - these are customers who like the idea of exercise more than the actual thing. As a result, Planet Fitness can maintain extremely high total member to gym size ratios since they know most members will never show up.
Taken altogether, Planet Fitness has a defensible moat that will allow it to capitalize on secular tailwinds and maintain incredible margins, making them the textbook definition of a secular winner.
What is the Market Missing this time around?
While the market is largely correct in its recent selloff of indoor gym stocks, they have incorrectly extended their overarching generalizations to Planet Fitness, which is actually poised to gain extensively from COVID-19.
In particular, the market has extended two false overarching generalizations.
Overarching Generalization #1: COVID-19 is a major headwind, disrupting current and future Planet Fitness growth. Planet Fitness continues to trade at ~10% below pre-COVID levels.
I believe that investors are overly focused on the short-term impact of COVID-19 and missing the long-term opportunity it creates.
To start, I want to make clear that Planet Fitness is not in any financial danger: nearly all of the gyms have reopened, membership has essentially recovered YoY, not a single Planet Fitness gym has been permanently shut down, and while usage rates are lower, membership is constant, and that is what drives the top line. Further, a Deloitte study finds that there is an expectation that gym traffic will recover by end of 2021. This was published before vaccine news. COVID is not a crisis but an opportunity for Planet Fitness.
Specifically, COVID-19 will bring about two long-term structural changes, both of which will benefit Planet Fitness:
First, COVID will consolidate the market for Planet Fitness: Town's International, 24 Hour Fitness, Golds Gym have filed for bankruptcy. IHRSA forecasts that over ¼ gyms could permanently close by end of COVID. This will leave over fifty million members without gyms and create massive real estate opportunities at lower costs.
Second, COVID will push gym-goers to cheaper options: over 50% of current gym members are considering downsizing or downgrading from their higher-priced gym membership to a more affordable option. This also holds true for the ten million members who won't have a gym anymore.
These structural changes have played out historically: During the 08 crisis, Planet Fitness saw its same-store sales surge from high-teens to 30% and in 2010-2012, Planet Fitness built ~30% more gyms than they did before 08', taking advantage of massive real estate opportunities.
Source: Created by the author using data from Planet Fitness Website Gym Counts
Why do I think the Street is missing this?
First, sell-side misconceptions. I've read many sell-side reports (JPM, Goldman Sachs, Credit Suisse to name a few) on Planet Fitness. Not a single one mentions the surge in same-store growth that should accompany the future downscaling of gym memberships.
Second, consensus models. Consensus models (JPM, Goldman Sachs, Credit Suisse) new gym openings at a substantially lower number post-COVID compared to pre-COVID (260 new gyms in FY2019 vs 225 new gyms in FY2022). This reflects the street's belief that there will be fewer real estate opportunities post-COVID. I think this is, frankly, absurd. Especially FY2024 and beyond.
Ultimately, I think there is both the intent as well as capacity for Planet Fitness to gain in a post-COVID world.
Capacity: One might wonder: if other gyms are struggling, why isn't Planet Fitness? Besides it being an "inferior" service, making it very recession resilient, there are other reasons. For one, its franchisees are consolidated. Franchisees are not mom and pop shops, with the average franchisee owning ~15 stores - franchisee consolidation has led to more financially stable and healthy businesses that can weather short downturns. Additionally, many franchisees are large private equity firms. In fact, over 13 of Planet Fitness's largest franchisees are private equity firms that have experience taking advantage of low-interest rates and opportunistic environments by levering up - Planet Fitness allows for franchisees to borrow up to 80% of the initial investment.
Intent: Aside from empirical proof of their expansion (post 08/09) when there is a great real estate opportunity, management has given explicit guidance on their thoughts surrounding this. As per the Q2 2020 transcript:
Real estate availability is going to be more plentiful than it was. And I believe our franchisees will be just as aggressive at the building as they had been in the past...
Many franchisees see [COVID-19] as an aggressive opportunity to double down against the competition.
Overarching Generalization #2: COVID-19 has brought about an era of E-Fitness and Home Fitness, both of which will eat into Planet Fitness's TAM.
While a valid concern, I believe this reflects a misunderstanding of Planet Fitness's target market for 3 reasons:
First, e/home-fitness targets a separate customer demographic: casual-gym goers aren't willing to drop thousands to set up their own gym and work out multiple times a week. In fact, Peloton's average subscriber works out 21 times a month. Planet Fitness members? 5 times a month. Additionally, the average price for E- Fitness options is $30, with some going far higher, compared to Planet Fitness's $10 option. Clearly, Planet Fitness and e-fitness target different sub-demographics.
Second, e/home-fitness does not have a social aspect: studies have found that 50% of gym members show up not to work out, but to "check out the opposite sex or meet with friends." The gym experience is not replicable at home or virtually.
Third, Planet Fitness is providing its own digital option: Planet Fitness's digital app provides in-home workouts and has seen significant download growth in the past year. Planet Fitness has introduced a $5.99 premium plan to monetize the platform further.
Why do we think the street is misunderstanding Planet Fitness's business? For starters, earning calls. Analysts have expressed excessive fears of e-fitness headwinds. Management's response is always about their digital initiatives, which I think gives too much credit to the headwind. And once again, sell-side misconceptions. Sell-side reports consistently mention this as a long-term headwind, using it to justify multiple compression and project lower growth.
Now, for Valuation:
Both variant views support my belief that a post-COVID environment will propel Planet Fitness' membership growth and consolidation of the market.
So, how is this reflected in my core assumptions? I project higher gyms built and same-store sales growth. I assume ~250 new gyms in FY2022, and ~310 new gyms through FY2023 - FY2027. I also assume SSS growth of ~15% in FY2022, which then declines to regular levels over FY2023-2027.
I personally think 250 new stores in FY2022, especially with the emergence of a vaccine, is quite conservative. Even then, by FY2023, my calculated EBITDA and Revenue are 12% and 10% higher compared to the street, respectively.
Source: Created by the author using data from Bloomberg Terminal
Ultimately, my DCF, using the Gordon growth approach, which assumes a 2% LT growth rate from FY2027 and beyond (extremely conservative given how much more potential stores Planet Fitness can still open before hitting 4,000), I arrived at an intrinsic price of $152, implying ~95% upside.
Source: Created by the author using historical data found in 10-Ks as well as their own assumptions
I conducted three sanity checks on this initial valuation.
First, I conducted a sensitivity analysis since I'm aware of how much the LT growth assumption can impact a DCF. Assuming a 1% LT growth rate, the intrinsic price is still ~$98, commanding a 30% upside.
Source: Created by the author using a data-table
Second, I included bear, base, & bull case scenarios: The bear case assumes lower margins, liquidity restraints, and lack of membership recovery. The bull case assumes the opposite with higher margins, ample liquidity, and significant membership recovery. Given the analysis I have already done, I believe the latter to be more likely to play out. Thus, I weighted 15% to bear case, 60% to base case, and 25% to bull case, ending up with a weighted average price target of ~$156.
Source: Created by the author using scenario analysis
Finally, I valued Planet Fitness via a multiple-expansion approach: assuming an 22x EV/EBITDA multiple in FY2024 (this multiple implies a FCF yield of 3% which I think is reasonable given the low-interest rate environment and the steadiness of their FCF) I arrived at a target price of $140, which corroborates my previous conclusions.
Source: Created by the author
Catalysts
I believe the stock price will begin to appreciate as investors become more aware of the long-term growth story for a discount gym like Planet Fitness which historically thrives during downturns. COVID is a bit different in nature from previous recessions, which explains the delayed realization of investors for Planet Fitness's potential. Besides that, quarterly earning beats, especially during FY2022 - FY2025 (when it won't face liquidity restrictions and the aftermath of COVID will be clear), should lead to the stock appreciating more. Finally, future earning calls with more management guidance to help sell-side build in more accurate future projections of how much gym growth there will be and same-store sales should also help guide price targets higher.
Risks
What are the main risks to this thesis?
For starters, the Delta variant and the potential for future waves could pose a risk to the company. There are many mitigants, however. First, Planet Fitness has implemented a 'crowd meter' whereby members can track the level of activity in gyms so gym-goers can avoid going then. Management writes that people will simply go less during ex-peak hours, and more during off-days to avoid the crowd. Second, 50% of Planet Fitness members never step foot into an actual gym, so the gym is rarely packed at any single time. Third, delta will likely improve the long-term picture for Planet Fitness even more, which is poised exceptionally well to weather the storm compared to smaller gyms.
Another fear is that COVID has caused Planet Fitness to breach covenants & its franchisees face liquidity troubles. However, there is 56% and a 108% cushion to the first triggering event for Planet Fitness's debt service coverage ratio and system-wide sales covenant. And given the recovery happening already, it's unlikely Planet Fitness will actually breach it. Additionally, if the covenant is breached, it only forces rapid amortization if the controlling party enforces it. However, management has talked with lenders and they are willing to be lenient because of optimistic news and the reliability of Planet Fitness. In 2021, Planet Fitness proudly announced that zero gyms permanently closed during COVID.
The last and final major concern is that Planet Fitness gyms are too close in proximity and will steal each other's members (which will become a bigger and bigger problem as Planet Fitness continues expanding). While this is a fair concern, I believe it to be quite misguided: Planet Fitness gyms complement each other and help increase market penetration as casual gym-goers value convenience significantly - only 12% of gyms would overlap within a 5-minute radius. Beyond that, the opening of more gyms encourages people to upgrade to Black Card. In fact, the biggest reason why people upgrade to a Black Card is so that they can access multiple locations - 50% of Black Card members worked out clubs outside their home club.
Conclusion
On the surface, Planet Fitness seems to be a commoditized product with no pricing power, trading at absurdly high multiples, and on the wrong side of secular change in the form of e-fitness. A deeper inspection, however, suggests that this is a spectacularly run business with absolutely fantastic management, fantastic margins, & fantastic (and better than ever) runway.
Let's make this clear: Planet Fitness has and will continue to thrive during periods of adversity, for that is the true beauty of its business model. And although COVID is slightly different than what we've seen in the past, it has the same foundational effect on the broader market and consumer base. If there will ever be a time to own Planet Fitness, it's now. Over the next few years, Planet Fitness will showcase its ability to capitalize on crisis and emerge as an even stronger player - don't miss out on this rare price dislocation.
Ultimately, I would suggest buying, even at current prices, but it may be wise to wait for a dip (which I imagine is coming due to delta variant concerns and overall market volatility).
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of PLNT either through stock ownership, options, or other derivatives. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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