Thesis
Planet Fitness (NYSE:PLNT) owns and operates a chain of fitness clubs across the US. I have a positive view on the business given the large TAM and multiple levers of growing revenue. The issue with the stock so far since 2019, I believe, is valuation which has risen to a high of 70x earnings at one point. The derating of the stock valuation was inevitable in my view, and it did derate – from 70x to 29x earnings today. At 30x earnings, I am still worried that more derating will happen given the weak FY23 outlook (FY23 guided openings revised to a maximum of 160 rather than at least 160), which might spill over to FY24/FY25 (management’s mid-term outlook of opening >600 stores) if things do not turn for the better (especially since rates must come down for the cost of building to be cheaper, so franchisees can build more). My recommendation is a hold rating for now and will look to initiate a position when the short-term uncertainties are clear.
1Q23 results highlight
PLNT’s headline SSS increased by 9.9%, bringing total systemwide sales to $1.108 billion. There were 36 new units opened during the quarter (a growth of 1.5%), bringing the total number of units to 2,446. EBITDA coming in at $90.2 million was below expectations. In particular, the timing of April sales-related spending in addition to the higher local marketing expenditures in January likely contributed to the disappointing 31.7% margins at corporate stores.
TAM
PLNT is the largest player in the US HVLP fitness club segment, and I believe there is still a long runway ahead due to the large TAM. As of 1Q23, PLNT has 2,446 total number of units, which grew 7% from 1Q22. To put things into context, there are more than 30,000 health clubs in the US and PLNT is only a small amount of that at less than 10% of the total. While this method is not clean as there are many different segments in the industry, I believe this serves as a yardstick to think about PLNT’s long-term target of 4,000 units in the US. Specifically, the 4,000 number is likely the floor rather than the ceiling, which implies PLNT can continue to grow the number of units at 7% for the next 10 years. In addition, I think that over the next few years, PLNT will be able to capitalize on additional opportunities for unit and membership growth by increasing its market share among the Millennial and Gen Z populations. PLNT’s Gen Z penetration in the US stands at around 9% (based on 4Q22 earnings), and in total represents about 25% of the PLNT membership base. I think PLNT can continue to increase market share among these generations with initiatives like the High School Summer Pass, as well as with new perks/collaborations that can generate additional traffic and conversion opportunities. For instance, as part of their partnership with Amazon Halo, PLNT gives all new Black Card members a free Amazon Halo fitness tracker.
If one were to expand their focus internationally, PLNT’s growth still seems to be in its infancy. Although it’s still early, I anticipate that the company will put more resources toward its international expansion plans. According to its Investor Day in November, PLNT has invested in expanding its international team in order to increase the company’s rate of growth from roughly one to two new countries a year to three or four. The TAM increases significantly with the inclusion of international markets. Given that the majority of PLNT’s profits are still generated in the United States, I also believe that a significant portion of the company’s valuation does not account for the potential for International upside. Therefore, I believe the market will assign a premium to PLNT’s valuation if it can show success here (albeit gradually).
Revenue and margin levers
TAM aside, I also like the fact that PLNT has multiple levers it can pull to drive revenue growth, at a high incremental margin. I believe PLNT can continue to expand its royalty income via increases in blended royalty rates. While the average royalty rate has increased significantly since 2015, I believe not all of the franchisees are paying the same current rate as many contracts are signed in the past. As such, there is plenty of room for rates to be refreshed. To give context, PLNT raised the royalty rate to 7% in 2017, and the business already had 1,255 units in FY16, which is more than half of what it has today. These 1,255 units will eventually renew their contract, which will provide a gush of new cash flow to PLNT. As such, I see this as a significant opportunity for PLNT to further increase its average royalty rate, driving incremental revenue growth potential moving forward.
Conclusion
In conclusion, I recommend a cautious approach toward investing in PLNT due to short-term uncertainties and concerns about valuation. The stock’s high valuation of 70x earnings in 2019 has derated to 29x earnings, and there is a possibility of further derating given the weak FY23 outlook. With revised guidance for new store openings and the need for lower interest rates to reduce building costs. That said, while short-term uncertainties and valuation concerns persist, PLNT’s long-term prospects in a large TAM, potential international expansion, and revenue levers offer reasons for optimism.
Read the full article here