Description

We are recommending shares of Planet Fitness (NYSE: PLNT or “Planet”) as a long. VIC members likely know the business well, and the stock was written up 3 years ago in August 2020 by StaminaVIC at ~$58 per share - that COVID-driven thesis worked out well with the stock nearly doubling to $95 in the 2021 market boom. Now, the stock is back down to ~$67 (down 15% YTD, and down ~30% from its peak), and we think it represents a compelling hold based on valuation and the intrinsic value of the business, with a potential catalyst on the horizon. 

Background

Planet Fitness is the #1 fitness/gym business in the US, with 8x as many members as its next-nearest competitor and 50% more locations than the next 17 competitors combined.  Because of this sheer scale, Planet can massively outspend its competition, dedicating over 10x as much in media spend as its next 15 largest peers.  Since its 2015 IPO, Planet has spent over $1 billion in media.  The company generates royalty revenue from its franchisees, as well as sales from its owned stores and the sale of equipment.

With its ubiquitous $10/month “get off the couch” pricing, Planet is the undisputed leader in the high-value, low-price segment of the fitness industry.  While most of the gym industry fights over the small population segment of already avid gym goers, Planet’s focus on creating a non-intimidating and unpressured environment attainable at a low price targets the majority of the population that aren’t already gym members and who may not necessarily already be in good physical shape.  

Planet operates a simple business model but one that competitors have been unsuccessful in copying at scale.  Because Planet does not provide many of the frills typically associated with gyms (such as personal training, sports, childcare, or towels and soap in locker rooms), it can operate with significantly-lower operational complexity and generate higher margins than peers.  This simplicity also makes it easier for Planet to successfully identify, open and operate new locations.

From 2011-2018, Planet accounted for 87% of all industry member growth from opening ~1,500 locations and growing existing ones robustly while needing to close or de-brand hardly any.  These striking figures have led to explosive performance over many years: the company achieved 12 consecutive years of positive comp store sales (which averaged 12% per quarter) before the pandemic lockdowns broke that streak (and now back on track).

Source: Investor Presentation

Planet’s unique low-cost business model and marketing firepower produce stellar economics, including low double-digit revenue growth that generates 80% gross margins and 40% EBITDA margins.  Over 90% of the company’s ~2,400 gyms are franchised, resulting in attractive free cash flow characteristics.  Economics for franchisees are also very attractive, with historically over 40% cash on cash returns vs. about half as much for the average quick-service restaurant franchisee.  Many franchisees in the Planet system are highly sophisticated and typically richly capitalized, as demonstrated by the fact that not a single franchisee went out of business during the pandemic shutdowns at a time when 25% of US fitness industry locations permanently closed (incidentally, Planet picked off many of these clubs by re-branding/converting them and acquiring their members during the downturn).  Its franchisee base continues to grow stronger as larger franchisees keep buying out smaller ones to extract synergies, as shown by the consolidation in franchisees from 160 in 2016 to 120 in 2022, while the unit count roughly doubled over that same period.

Why Now?

We believe a buying opportunity exists because COVID, inflation and supply chain issues have temporarily hurt Planet’s business by slowing franchisee unit growth. It’s now been 2-3 years of the hope of accelerated unit openings, however this has not materialized:

Particularly, since a November 2022 investor day where they guided to an average of “200 plus” new franchisee unit openings per year, PLNT has been forced to reduce 2023E estimates twice now, with a current guide of 160 being the “high end” of this year.

The stock held up after its investor day after one guide down, up until last quarter where investors ran for the hills and the stock dropped -16% on Q1 earnings which was its largest earnings day decline since IPO. While there have been some discrete items that slowed unit growth this year (such as HVAC availability, as well as one larger franchisee struggling due to its debt load), we also believe inflation and correspondingly higher interest rates have also made new location openings slightly less profitable than before for franchisees.  Our conversations with franchisees indicate that economics are still attractive vs. other unrelated opportunities, but they are just not as good as before. 

There’s an easy answer to this problem that companies in this industry, and every other industry out there, are doing: raise prices. Many superior and inferior business models have increased prices with little impact to demand elasticity (so far). However Planet has been in a unique situation. Planet’s unit and member growth has been so remarkable that it hasn’t needed to resort to major price increases. There is also the marketing aspect of its original $10/month pricing to get folks in the door. They have however synthetically raised prices through growth in annual/signup fees, as well as its premium membership (which is called a Black Card membership that now sells for $25/month and includes all-location access and other valuable amenities) - increased fees have not impacted demand, while uptake of the Black Card membership has been strong indicating the potential for price increases without much elasticity (Planet even increased the Black Card membership $2 last year and uptake has been up year over year).  

We think the base pricing strategy made sense in a low-inflation and low-rate environment, but we are not in that environment anymore. The market has punished Planet for anemic unit growth, and there is a clear “chicken and the egg” problem with franchisees who are hesitant to open units faster until their unit economics improve. Our conversations with franchisees confirms this. We believe this issue will be resolved one way or another: 

1. Planet will raise prices. If Planet does increase the pricing on its basic membership ($10/month going to $12-14, for example, is a 20-40% price increase but still the best gym membership deal in the country by far), such an increase could have a flywheel effect, where franchisee economics spike and cause them to start building ahead of schedule; Planet would, in turn, collect royalties on member dues that are 20-40% higher, and then potentially also increase its royalty rate.  This outcome would provide significant upside to the stock. 

2. If inflation subsides and rates also potentially come down, franchisee unit economics will improve and cause them to reaccelerate unit openings likely to their investor day target of 200+ openings.

3. If Planet does not increase pricing and inflation proves sticky, Franchisees might only open new stores in accordance with the minimum locations required by their development agreements. Planet will mute this impact by strictly enforcing minimum opening commitments (they have been lax due to COVID so far), as well as by finding new franchisees.

While there’s a clear hierarchy of the best outcome here, we think anyone with a long-term time horizon can be buyers of the stock in any of these scenarios, especially if knee jerk reaction to slow unit growth could drag the stock lower. The option for Planet to raise prices always remains on the table, and if the stock price drops low enough, management may be forced to act which we believe provides downside protection on this investment. 

Meanwhile, Planet is a dominant fitness brand and only became stronger post-COVID as mom and pop operators struggled. It has also shaken off many of the bear case thesis points through the years (see previous VIC write up for some of those points). At 16x ’24 EBITDA, the stock is trading near its lowest valuation since going public.  

Given the high likelihood of the company eventually growing to ~4,000 locations by opening 150-200 new locations per year on average (any individual year will vary), that implies at least 7-8 years of built-in growth from new stores as they ramp.  Meanwhile, mature stores continue to provide a foundation for baseline growth for the entire system.  As a result of this base growth, we believe EBITDA should grow by 50% in the next three years, which would result in a below-average 12x multiple for a much above-average business. And any movement on franchisee openings, or price increases, or both, would cause a substantial re-rating of the stock.

Catalyst

• Price Increases
• Reacceleration of franchisee unit growth