Debuting new campaign: “The World Judges, We Don’t. At Planet Fitness, Be Free”. Planet Fitness (NYSE: PLNT) is the first publicly traded company in Fitness Clubs and Equipment. The Company generates revenue through operations in three segments: Franchise, Corporate-owned stores and Equipment. A “Planet Fitness” is typically over 20,000 square feet, featuring a wide array of branded cardio, circuit, and weight training equipment. Black card members can go to any of the 1200+ locations in U.S, the District of Columbia, Puerto Rico, Canada and the Dominican Republic. As of September 30, 2016, Planet fitness owns a total of 1,242 stores.
Original Investment Rationale
The Roland George Investments Program invested in Planet Fitness in November of 2015 due to the company’s explosive growth opportunities and its best-in-class franchise model. Since then, it has returned 34% while the S&P 500 has returned 12%.
Understanding the Bigger Picture: When classifying the population into two categories, between regular gym goers and those who stay away from the fitness club environments, the results concluded a 20%-80% split. The 80% belongs to Americans who find the fitness club setting to be intimidating and costly. With this margin, Planet Fitness applies their business efforts towards the larger percentage of Americans that want to be healthier, but may only use the gym a few times a month. This allows for the industry to fight over the percentage of the population who considers themselves a “health nut”, while Planet Fitness looks to profit from the larger crowd that are more casual users. Their business model incorporates a non-intimidating, no frills, no-strings attached experience for an inexpensive membership fee starting at $10/month. Beyond being affordable, Planet Fitness has built its reputation on maintaining a non-competitive workout environment. This strategy has allowed for Planet Fitness to acquire roughly 10% of the people in the U.S. who belong to a health club.
Best-In-Class Franchise Model: To assure minimal, preferably zero, business failure Planet Fitness thoroughly screens potential new franchisees. To be considered it is stated that $3 million is needed in net worth, $1.5 million in liquid assets, and a freestanding income of $100k per year.
These requirements have produced zero loan defaults and zero store closures regarding financial underperformance since 2000. By month five, newly franchised clubs attain positive operating cash flow and reach maturity within 12-18 months. Cash on cash return is 35% and EBITDA margin is 36%, which are both industry franchise leading figures. Furthermore, 80% of their franchise segment revenue is produced by recurring revenue streams.
First Public Gym Franchisor: On August 11th, 2015 Planet Fitness officially completed their IPO to facilitate the disposition of equity interests and become the first fitness club to go public. With a total of 1,242 locations, including 58 corporate-owned and 1,184 franchisee-owned locations, Planet Fitness is the largest operator of fitness clubs in the U.S, the District of Columbia, Puerto Rico, Canada and the Dominican Republic with 8.7 million members. Additionally, Black Card members have the option to use any one of the 1,200+ locations at any time. The only public competitor is Town Sport International Inc. (NYSE: CLUB), which is a micro-cap health and fitness club company with shrinking revenues and negative income. Town Sport International’s target market will not conflict with Planet Fitness’ growth. Apart from fitness clubs, Planet Fitness’ non-direct competitors include Chili’s, Uno’s and movie theaters since they these companies must compete for their customers’ time, since that’s probably where they want to be.
Our investment in Planet Fitness has seen positive returns of 34.05% since its August 2015 buy decision. The following events affected the stock’s performance over this time period.
A. Stock Price Increases after First Quarter 2016 Earnings Released: After reporting stronger than expected first quarter earnings the stock price jumped 16.3% in May. With analysts computing the results it was reported that revenue, net income, and same-store sales all increased and outperformed analysts’ expectations. In addition to the stores strong financial performance, the company augmented 48 new franchise store openings in the period.
B. Stock Price Increases Following Secondary Offering: Company announced the pricing of its underwritten secondary public offering of 10,000,000 shares of the company’s Class A common stock by certain of its existing stockholders at a price of $16.50 per share on June 22, 2016. Due to the ownership structure of the company, the company did not sell any shares and did not receive any of the proceeds from the sale of shares of its Class A common stock by the selling stockholders, TSG Consumer Partners. After a price fall earlier in June, the secondary offering caused a price jump, due to more traders getting into the company’s stock.
C. New Record Intraday High After Second Quarter Earnings Released: After the company reported better-than-expected quarterly earnings on August 12th, stock price jumped to new high. Revenue for the gym operator’s second quarter clocked in at $91.5 million, 16% ahead of the prior year’s showing. Along with 36 new franchise openings and 7.6% spike in same-store sales, the stock price hit the all-time intraday high of $21.06.
D. Strong Same-Store Sales Growth: Planet Fitness opened 37 new franchise stores in the third quarter, bringing its total store count to 1,242 as of Sept. 30, 2016. The company also enjoyed a 10% jump in system wide same-store sales. Together, that helped drive a 26% year-over-year increase in total revenue to $87 million.
E. Position Boosted by Swiss National Bank: Swiss National Bank increased its position in shares of Planet Fitness by 43.4% during the third quarter. The Company attained an additional 18,700 shares during the period. Swiss National Bank owned approximately 0.12% of Planet Fitness worth $1,240,000 at the end of the most recent quarter.
Second Quarter 2016 Earnings: The Company reported total revenue increased from prior year period by 15.9% to $91.5 million. Franchise segment revenue increased 34.7% to $29.5 million. Corporate-owned stores segment increased 5.6% to $26.4 million. Equipment segment sales revenue increased 10.9% to $35.6 million. System-wide same store sales increased 7.6%. By segment, franchisee-owned same store sales increased 7.8% and corporate -owned same-store sales increased 4.7%. The company expects total revenue between $366 million and $372 million for the year ending December 31, 2016. The stock price achieved its new intraday high record as the company performed well than analysts’ expectation.
Third Quarter 2016 Earnings: The Company reported total revenue increased from prior year period by 26.4% to $87 million. Franchise segment revenue increased 37.5% to $27.2 million. Corporate-owned stores segment revenue increased 6.1% to $26.7 million. Equipment segment sales revenue increased 38.7% to $33.1 million. System-wide same store sales increased 10% compared to the prior year period. By segment, franchisee-owned same store sales increased 10.3% and corporate -owned same-store sales increased 5.4%. The Company for an adjusted net income of $65 million, or $0.66 to $0.67 per diluted share.
2016/17 Outlooks: Since the completion of the IPO in 2015, Planet Fitness has packed a punch full of financial highlights including recording 39 consecutive quarters of system-wide same store sales growth, year over year. As we enter this 2017 year, Planet Fitness has plans to move forward in expanding the business with the expectation to open 200 new stores during this year. With the release of the second and third quarter’s earnings of 2016, the Company expects total revenue to increase between $373 million and $378 million. With efforts by Planet Fitness to expand rapidly, the Company is estimating royalty rates to be around 3.5% during the year of 2017. When analyzing the Company’s equipment renewable revenue, they project a 7.5% increase in 2017.
Franchise Store Growth: With the current total opening of Planet Fitness’ 1,242 locations, the company is well underway to meet their long term target of 4,000 locations in the United States. Furthermore, franchise agreements for 1,000 more stores have already been signed in 2015, providing a clear runway for growth. The 1,000 new locations will be incrementally opened over the next five to seven years at a rate of ~200 locations/year. Membership in the most mature locations accounts for a mere 4% of surrounding population, while in less established markets, penetration is closer to 2%. Planet Fitness has already mapped out appropriate locations for all new franchise locations, averaging at least a 100-200k population per store. As of September 2016, the total number of members of Planet Fitness is already 8.7 million. Planet Fitness’ logistics team is confident that the areas they have targeted for expansion can sustain an additional 3,000 locations.
Store Commitments: Planet Fitness successfully attains a wide range of geographies and demographics when strategically placing their store locations. According to internal and third-party analysis, Planet Fitness believes they have the opportunity to grow their store count. Before going public in 2015, Planet Fitness entered the market with 488 stores as of December 31, 2011. Since 2015 annual report was released, they have grown their count to 1,124 stores, reflecting a compound annual growth rate of 23.2%. Currently, as of September 30,2016 Planet Fitness reported 1,242 stores, which is an increase of 10.5% showing steady but attainable progress towards their overall goal. From June 30, 2015 to June 2016 they established 192 stores putting them just less than 1% of their yearly goal.
Franchise Segment Growth: The franchise operating-segment currently contributes the largest amount of EBITDA. Right after the company’s IPO, the franchise segment revenue accounted for 28% of total revenue during the third quarter of 2015; and it was projected, by 2017, to contribute over 30% of total segmented revenue. As of September 2016, franchise segment revenue has already contributed 31.3% of the total revenue. Stable increases in royalty rates, increased store growth, and growing franchise comp growth will all support this revenue growth.
Same-store Sales Growth: Planet Fitness opened 37 new franchise stores in the third quarter, bringing its total store count to 1,242 as of Sept. 30, 2016. The company also enjoyed a 10.3% jump in system wide same-store sales. Together, that helped drive a 26% year-over-year increase in total revenue to $87 million. EBITDA adjusted to exclude acquisition and IPO-related costs and other special items rose 33.5% to $35.4 million. Broken down by segment, franchise EBITDA leapt 47.2% to $22.8 million, driven by royalties from new stores and higher sales from existing stores. EBITDA for Planet Fitness’ corporate-owned stores increased 14% to $10.6 million, due to greater same-store sales. And equipment segment EBITDA jumped 45.7% to $7.2 million, due to higher equipment sales to both new and existing stores. All told, adjusted net income surged 51.7% to $15.9 million, or $0.16 on a per-share basis.
|Source: Company 10-Q
Best In-Class Pricing: Planet Fitness’ business model revolves around providing a low-cost alternative to getting in shape. With gym membership starting at a mere $10/month, with a small or non-existent initiation fee, Planet Fitness is one of the most economical options within the health and fitness industry. Additionally, Planet Fitness offers a no frills experience, which is illustrated by the absence of over-priced services found at most fitness clubs, like juice bars, supplement stations, and personal training sessions
Economic and Industry Outlook
Industry Outlook: The health and fitness club industry has seen healthy growth over the last decade. Increased consumer awareness for promoting a healthy lifestyle has directly resulted in healthy growth in health clubs and memberships nation-wide. Over the last 10 years, membership has gone up by 12.8 million, from 41.3 to 54.1 million members. The industry has seen 7630 new clubs enter the market, bringing the total number of health clubs to 34460 in the United States. In 2015; total industry revenues grew 7.4% to $24.2 billion. Despite their large presence in the United States, Planet Fitness only accounts for 3% of the total market share, by number of stores. In fact, the largest 10 health club chains in the U.S only account for 22% of total clubs, leaving 78% of the market to be accounted for by small independent companies. This fragmentation within the industry can be used as a tool to support Planet Fitness’ 4,000 store target.
Supportive Industry Backdrop: Planet Fitness’ unique business model gives them the advantage of targeting a massive target market. As mentioned previously, the vast majority of the population (80%) is not being targeted by traditional gyms. There are 206 million people between the ages of 15 and 64 living in the United States today, which estimates a target population of 164 million people for Planet Fitness. With just over 8.7 million members, Planet Fitness is only capturing a mere 5.3% of their total target population, leaving plenty of room for growth.
Low Economic Sensitivity: Many health and fitness companies rely heavily on increasing discretionary income to support growth. Planet Fitness’ low cost model actually makes them a more attractive contender within the health club industry when discretionary income falls, stagnates, or grows at a slower rate than expected. Furthermore, they are capitalizing on the rising discretionary income by creating value added services in order to attract more members to their black card upgrade program. Living a healthy lifestyle and going to the gym are slowly taking “consumer staple” roles in our country, making Planet Fitness’ market positioning a prime recipient of new members if our economic growth begins to slow
Potential Franchise Cannibalization: Planet Fitness relies heavily on comp growth for their franchise segment. Out of their current 1,200 locations, approximately 68% of the locations overlap within ten miles, creating a very convenient national layout. As Planet Fitness moves closer toward their 4,000 store target, they might begin to see a cannibalization effect start to negatively affect membership rates. Planet Fitness has worked toward mitigating this risk requiring a minimum target population of 250k within a 10-mile radius of each location.
|Source: Company 10 Q
Potential Retention Issue: One of Planet Fitness’ most attractive features is their no-contract sign up structure and lax cancellation policy. Although these are great selling features, they could also potentially result in a lower retention rate for members, given the ease to cancel membership with no financial penalty. Planet Fitness is focusing on bringing in new members and increasing average monthly membership dues with value added services in order to combat this risk.
Increasing Competition: The health and fitness club industry is a highly fragmented market. With a growing number of large gym franchises and the adoption of alternative workout methods, such as spinning classes and cross-fit, gaining popularity, Planet Fitness could potentially lose market share to new competitors and/or alternative methods. The low price point and increased brand awareness through a national advertising campaign are a few ways that Planet Fitness is combatting this risk.
Failure to Re-Equip: The equipment sales segment is Planet Fitness’ largest revenue contributor. With a clause in every franchisee contract requiring them to re-purchase equipment every 4-7 years, Planet Fitness has created a sustainable method of an alternative revenue stream. The risk that franchisees may not abide by their agreement to replace equipment has the potential of negatively impacting the Planet Fitness’ largest revenue producing segment.
Heavily Concentrated Franchisee Base: Planet Fitness has a very concentrated base of franchisees running the majority of their franchised locations. There are currently approximately 190 franchisees operating 1,000 franchise locations. Repeat franchisees understand how the business model works, making them more effective managers; however, having such a small base of franchisees could restrict access to capital needed to expand as fast as Planet Fitness would like to. The recent IPO capital and adoption of $500 million of debt are a few ways that Planet Fitness is combatting these risks.
Interest Rate Risk: As of September 2016, Planet Fitness has $823.68 total liability on their balance sheet in order to support their aggressive growth projections. Planet Fitness bears this debt at a controlled variable rate, with a U.S dollar LIBOR floor of 1%. A dramatic 100 bps movement in interest rates would create an additional $5 million in interest expense on an annual basis. Planer Fitness manages these risks through the use of derivative instruments as well as maintaining healthy operating and financing metrics.
Pro Forma Income Statement
A pro-forma income statement was constructed to estimate Planet Fitness’s 2016 Q4/2017 revenues and earnings per share growth. Estimations were made based on the following:
Revenue: Estimated revenue growth was calculated using a weighted average of historical growth rates, management guidance, industry growth rates, market return rates, analyst estimates, and student estimates. Revenue growth over the past four quarters has averaged 18.14% year-over-year. Analysts estimates from Bloomberg average 10.14%. The consumer discretionary sector is expected to grow at 18.42%. S&P 500 has an average growth rate of 25.69%. I estimate revenue growth will be 15.04%. This pro forma estimates 2016 Q4 and 2017Y revenue growth for Planet Fitness of $378.42 million and $390.10 million.
Cost of Revenue: Cost of revenue was estimated based on management guidance and the company’s historical average over the past four quarters. The cost of revenue has historically averaged 39.02%.
Operating Expense: Operating expenses were estimated using a weighted average of historical growth rate. Based on my pro forma and the estimated predications I have calculated, I expect the company will continue its growth with its expanding stores, I weighted an increase of its operating expense of 13.68% per year, or 3.42% per quarter, along with its revenue growth.
Earnings per Share Growth: Earnings per share growth was calculated using the pro forma net income and basic weighted average shares outstanding estimates. This was done to keep estimates consistent with those of revenue growth and expected expenses.
Present Value of Growth Opportunity: I used Present Value of Growth Opportunity to value Planet Fitness based on predicted 1 yr. EPS, RRR, earnings growth, current price and a retention rate. I used a predicted 1 yr. EPS of $0.74, RRR of 7.94%, earnings growth of 3.4%, current price of $21.49, and a retention rate of 1.The valuation model estimated a fair price valuation of $25.25 for PLNT, representing an undervaluation of 17% (Appendix 4).
Franchise Value Model: The franchise model is appropriate when valuing companies that produce significant franchise value, i.e. repeating a successful business model at higher profit margins. Franchise value is created when the company uses its competitive advantage to reinvest its earnings at a rate higher than the rate of return normally required by investors given the investment’s risk characteristics. I used a growth rate of the book value of 15%, RRR of 20%, BPS of $0.39, and ROE and R of 920.59%. This model resulted in a fair value for Planet Fitness of $28.49, representing an undervaluation of 32.57% (Appendix 5).
Average Fair Value: Using the figures from the above valuation methods, of $25.25 and $28.49, I estimate that the average fair value price of Planet Fitness is $26.87. With recent price of $21.49, this means the company is undervalued by 25.03%.
Reasons to Hold:
Long Runway for Store Growth: PLNT has a long-term store target of 4,000 from ~1,000 today, implying mid-teens unit growth, or ~200 stores/year, contributing to comps in the mid- to high-single digits as new stores ramp, meaningful expense leverage, and brand awareness. Our analysis of metro market penetration and store overlap is supportive of a 4,000 store target. Additionally, Planet Fitness’s model aligns well with consumers’ preferences. A unique strategy Planet Fitness is doing is looking at Sports Authority stores that were to close as part of reorganization after filing for Chapter 11 bankruptcy protection in March 2016. CEO Rondeau is aiming for Planet Fitness to acquire more than 20 closed Walmart Neighborhood Market locations.
Franchise Growth Drivers: We expect Franchise revenue to grow to a third of the mix by 2017 from 31.3% in 2016, driven by steady increases in the average royalty rate, new franchise store growth, and strong franchise comps of 7.6% in 2015, and ~6% in the out years. Along with those predictions, Planet Fitness is putting in the initiatives required to enhance franchisee equity including a purchasing co-op, online purchasing catalog and P&L benchmarking tool. Through the co-op opportunity, Planet Fitness believes combining the purchasing power of the entire franchising system can lead to huge savings that can be achieved through economies of scale.
Re-Equipment Sales Opportunity: Planet Fitness expects this high margin segment to steadily grow in the high single digit range, supported by compounding re-equipment sales as older stores come due for new equipment every 4-7 years and new equipment sales from the roughly 200 stores expected to open each year. This increase will be driven by equipment sales to new franchisee-owned stores related to more new equipment sales compared to the prior year period and an increase in replacement equipment sales to existing franchisee-owned stores. Relative to expectations, Planet Fitness believe this could be a source of upside. As of September 2016, equipment sales have increased to 38.1% of revenue, a 9.8% increase as prior year reporting. Based on long term EPS model and valuation, I estimate equipment revenue for 2017/2018 to be $186 million and $196 million.
Membership on the Rise:3% increase in gym membership penetration among the working age population since 2000, which equates to 21.3 million more fitness club members. Planet Fitness has strategically targeted the market by leveraging members’ stories of health and fitness accomplishments on a mobile web site to encourage even more achievement while driving brand engagement. The name of this campaign is “Planet of Triumphs”. This campaign lets members who join via Facebook or Twitter post stories with a picture or video, becoming eligible to win weekly prizes and a role in a Planet Fitness commercial. This incentive allows Planet Fitness to gain coverage in the 80% of the market that does not have a gym membership through interactions on social media. Mobile now represents a majority of engagement received to all Planet Fitness web properties, giving the Company an advantage as they integrate seamlessly into the ways in which members are already using their mobile devices. With these strategies in play, forecasted membership growth is a key driver in Planet Fitness’s hold recommendation.
Recommendation: Planet Fitness has shown exceptional growth potential. The Company has been successfully expanding its franchised stores over the last four quarters since it went public. Its revenue growth and net income growth have been outperforming analysts’ expectations. With its total 1,242 openings and 8.7 million members, Planet Fitness has also increased its same-store sales consecutively, which will help the Company grow on its own and reduce its debt ratio. While the Company still targets to 80% of the consumers, who does not acquire gym membership, it still has a great potential to grow. In conclusion, I recommend that the Roland George Investments Program HOLD all 1500 shares of Planet Fitness.